The Lifecycle of Franchise and Distribution Agreements in Europe – Part 3

So far, the article series has explored key issues which arise during the pre-contractual stage and the drafting and interpretation of these types of agreements. 

This final article will focus on termination and post-termination. Clear termination provisions and appropriate post-termination restrictions can make the end of a relationship straightforward to manage, but it can quickly become difficult terrain to navigate if you fail to appreciate differences between jurisdictions.

I. Limitations on the Right to Terminate

A. Justification and Notice of Termination 

The standard English common law approach is to follow the agreed words of the contract, even if the party being terminated thinks that termination is premature or disproportionate. However, as mentioned in the first article of this series, there can be complicating factors around estoppel, collateral contracts and reliance. Good faith and the Braganza duty also now frequently feature as a part of the legal arguments brought forward by aggrieved parties in pre-action correspondence when disputes arise. This suggests that although the usual approach under English law remains "contract is king", this does not go unchallenged.

Moreover, there are overriding principles of English law which will impact on termination – for example, there is a common law right to terminate a contract immediately for repudiatory breach (which is not the same as a material breach as described in the contract) even where the contract does not provide for an express termination right. A repudiatory breach is one which "deprives the other party of substantially the whole benefit of the contract" and that "goes to the root of the contract". A party that terminates the agreement should exercise great caution if relying on a breach being a repudiatory breach as if a dispute arises and a court deems that the breach was not repudiatory in nature, it will be a wrongful termination and the terminating party would be liable for damages.

The position is different in other European countries, with many jurisdictions including Germany, the Netherlands and Belgium imposing an overriding obligation that termination must be for "good cause". In Italy, for example, any right which grants a party the ability to terminate with immediate effect must be listed among the most important clauses in the contract ("clasuola risolutiva espressa"). In Spain, early termination does not have automatic effect if one part terminates a contract due to a breach and the other party contests it. In this situation, termination is not immediate, instead court consent must be sought for termination and if approved, effect will be given to it from the first request for termination.

The rules around what level of notice must be given to end contracts also varies across jurisdictions. Under English law, a right to terminate by "reasonable notice" may be implied where it is obvious and necessary to give the contract business efficacy. For example, this likely would be implied for contracts with indefinite terms, or where the "term" of an agreement has expired but the parties continue to perform their respective rights and obligations under the agreement. Similarly, in Italy, for such contracts providing reasonable notice is usually acceptable, but where there may be divergence from the English law approach is what each legal system deems "reasonable". Under English law, this will be a factual determination, but there is no "hard and fast" rule. In Italy, what is deemed reasonable will depend on the duration of the agreement. For distributor agreements it is helpful to consider the provisions in relation to agency agreements as a guideline. For agency agreements one month's notice every year of relationship up to five months is generally acceptable. In Germany, in the absence of a notice period in the contract, the statutory notice period implied into commercial agency agreements which is staggered according to the contract duration, and can be applied analogously to franchise agreements (at least if the franchisee is embedded in the distribution system of the franchisor). This being said, the German courts have made it clear that what is deemed reasonable is to be determined on a case-by-case basis and that the statutory notice period implied into commercial agency agreements may be deemed as too short in certain contexts. In Belgium, a "reasonable notice period" is typically three to six months, but recent case law in relation to exclusive distribution agreements has established that reasonable notice for the termination of such contracts will be a significant number of months.

B. Goodwill Compensation – Not Just Limited to Commercial Agency?

Under English law, goodwill compensation (i.e. a payment made at the end of the contract, unrelated to a right to damages, in recognition of the goodwill in the brand which has accrued during the term of the agreement) is not payable on termination in respect of franchisees or distributors. However, the risk of this type of payment obligation can arise in the context of franchising and distribution in some European jurisdictions. In Spain, for example, goodwill compensation is due in circumstances where the franchise is considered to be a quasi-agency. Under German law, goodwill compensation for loss of clientele following termination can apply to franchisees and distributors where there has been a high level of investment and integration into the franchisor's or principal's system. It is worth noting that the requirement to provide goodwill compensation in the context of franchise and distribution agreements in Germany will only apply if the agreement is subject to German law. Choosing English law as the governing law will circumvent this requirement, provided there is a legitimate link to between the contract and the UK.

II. The Approach to Post-Termination Restrictions

The English law of restraint of trade is applicable to non-compete clauses.  It sits alongside UK competition law and needs to be considered separately.  A post-termination non-compete clause may be struck down either on competition law or on restraint of trade grounds. Restraint of trade is wider than competition law in its application to non-compete clauses.  It covers relationships, such as that of employer/employee or principal/agent, which are not caught by competition law at all. It is also wider because the English Courts will recognise a wider range of legitimate interests that can be protected than the two factors which derive from the Pronuptia case (namely that a post-termination restriction falls outside of the scope of UK competition law so long as the restriction is essential for (i) protecting the know-how transferred by the franchisor to the franchisee and/or (ii) maintaining the identity and reputation of the franchised network) for example, goodwill, loyalty to the brand, loyalty of the franchisee's employees.

The English Courts recognise that it would be extremely difficult for a franchisor to find a new franchisee if a former franchisee, with all their previous experience, knowledge and contacts in the area, was free to compete in the same area as soon as the franchise agreement expired or was terminated.

The consensus has been that a one-year post termination restriction on operating a competing business is generally enforceable (and this is mirrored in UK competition law block exemption known as "VABEO"). However, the recent Dwyer Group case[1] suggests that even shorter periods might be needed in certain franchise contexts and franchisors should not assume a one size fits all and adopt a one-year post-termination restriction without considering if that length of restriction is appropriate and necessary, taking into consideration the nature of the franchise and the position of the parties. The same is true of the scope of the restriction. VABEO limits restrictions to the franchisee's place of business (which is not always straightforward to determine) but Pronuptia and the restraint of trade rules may allow for wider restrictions, but it will always be fact dependent.

The principles of the EU Vertical Block Exemption Regulation ("VBER") rules are very similar to VABEO, as is the interplay with the principles arising under Pronuptia. Whilst the position is generally uniform across the EU, it does at times vary. For example, under German law there is a requirement to pay an equitable compensation for the duration of the restriction of competition. However, as with goodwill payments mentioned above, the requirement to provide this equitable compensation in the context of franchise and distribution agreements in Germany will only apply if the agreement is subject to German law and choosing English law as the governing law will circumvent this requirement.

Concluding Thoughts and Practical Advice

• The express terms of the contract are the key reference point under English law when considering a party's right to terminate. However, competition law, case law and common law principles can impact on the enforceability of an express term and in the case of repudiatory breach, give rise to rights outside of the contract.
• In other countries within Europe, a party's right to terminate may be fettered by overriding principles, which can impact on notice periods and whether a right to terminate with immediate effect is justified.
• Parties should remain attentive to the risk of a franchise or distribution relationship being subject to agency laws by analogy and the impact this may have.
• Post termination restrictions require careful consideration and should be looked at in relation to the jurisdiction and the nature of the relationship between the parties.

If you would like more information on this topic, please contact Gordon Drakes or Rachel Bowley.

This article was co-authored by trainee Melissa Couvet.