Mr Th. R.Ludwig
This is the first article in a short series on some core obligations in the relationship between franchisor and franchisee and how to deal with them. The subjects of information provision, release from liability for forecasts issued (exoneration) and dispute resolution, including mediation, will be dealt with successively. The author also comes to a number of proposals that aim to further regulate the provision of information, limitation of liability in the case of forecasts and conflict management in the future.
As is known, the franchisor is obliged to inform his franchisee correctly and completely in the pre-contractual phase. Article 3 paragraph 3 of the European Code of Honor on Franchising stipulates in this: “To enable future individual franchisees to enter into any binding agreement in full knowledge of the facts, they shall be provided with a copy of this Code of Honor and complete and correct written information and documentation relating to the franchise relationship, within a reasonable time prior to entering into these binding agreements.”. Although the wording of this clause is somewhat faltering, its purport is clear: the franchisor must provide complete and correct information to the franchisee regarding the future franchise relationship during the introductory period. The addition to the European Code of Ethics on franchising, Article 3 paragraph 3 sub 5, then forces the franchisor to provide the franchisee with “financial estimates or forecasts, if available”, with reference to Article 3 paragraph 2 of the Code of Ethics. It states that: “figures or expected income for the individual franchisees … must be objective and not misleading”. In practice, one of the most salient obligations of the franchisor in connection with the foregoing is the provision of a sound financial forecast as to the franchisee’s expected income. On January 20, 1999 (Utrecht Court, January 20, 1999, Prg. 5112), the Stichtse Court ruled as follows in the relevant proceedings on the merits: “According to settled case law, a franchisor is liable towards the franchisee for incorrectly forecasted data, if – in short – the prognosis is based on incorrect assumptions and disregarded negative impacts that should have been included in the forecast, when the franchisor’s conduct and statements did not require the franchisee to take this into account or otherwise be aware that the forecast wasn’t realistic.” The ruling referred to can be seen as a follow-up to the standard developed in the so-called Renault Arrest (HR 19 February 1993, Prg. 1996,4459), in which the following was considered: “The controversial prognosis did not merely give a slightly too rosy “ favorable” scenario, but must be regarded as irresponsible because it was based on wrong assumptions and did not take into account clearly present negative effects. (….) . According to Renault’s own position, Van Mastrigt’s alleged insistence on an “optimistic prognosis” was not intended to provoke an irresponsible prognosis as intended.” The far-reaching responsibility and liability of a franchisor that can be derived from this has since led to a stream of judgments in which the above-mentioned standardization has been elaborated. For the record, the Utrecht court points out that the standardization concerns established case law; apparently the sitting magistracy wants to emphasize once again how the parties should behave towards each other in the pre-contractual phase, as well as how any resulting dispute should be viewed. A clear message for self-regulation can be derived from this. It is then up to franchisors, franchisees and other parties involved to further translate this insight.
This insight has meanwhile been translated both in and out of court into the generally accepted requirement that forecasts must be based on a thoroughly prepared and well-executed business location and market research, which in combination is sometimes referred to as a “feasibility study”. Such a feasibility study should at least include an investigation into the local competitive position, the demographic and income-related structure of the customer potential, as well as the foreseen and foreseeable market development in the entire sector. These requirements can be supplemented per situation. The judge on the merits in Breda considers this in its judgment dated April 14, 1998, Prg. 1998, 4967 as follows: “A special duty of care of Aviti (franchisor) for Het Kinderparadijs (franchisee) ensues from the franchise agreement. This duty of care entails that the turnover and profit forecasts presented by Aviti must be based on a thorough and carefully conducted market and location survey. If the forecasts presented cannot be traced back to an investigation as referred to here, then Aviti has failed imputably in the fulfillment of its contractual obligations and Aviti is in principle liable for the resulting damage. The foregoing clearly shows the importance of conducting a proper feasibility study. There may be special circumstances conceivable that could justify the omission of such an investigation. However, the fact that a concerned franchisor has been carrying out its own feasibility studies for many years or thinks it knows the industry well enough to make a proper forecast without doing so is not such a circumstance. In the same judgment, the court in Breda informed us that a special burden rests on the franchisor if the forecasted results are disappointing: “If the predicted results are disappointing, it is the responsibility of Aviti to enter into consultation with Het Kinderparadijs in order to mutually agree arrive at a situation that does justice to the franchise agreement, namely an agreement from which both Aviti and Het Kinderparadijs benefit.”. Apparently, a franchisor should actively provide advice and assistance if, along the way, the results turn out differently than he predicted. Article 2 paragraph 2 of the Code of Honor obliges the franchisor to provide “ongoing commercial and/or technical support” “during the entire term of the agreement.”. The obligation elaborated in case law therefore appears to also belong to the “general principles” (according to the Honor Code) of behavior between franchisor and franchisee, as laid down in that code, a regulation to which members of the Dutch Franchise Association are also obliged to behave. . The obligation of the franchisor to provide the franchisee with a financial estimate based on correct assumptions is therefore apparent from case law and regulations. However, this core obligation is generally not included in franchise agreements. This seems to be a lacuna, since parties without such a regulation do indeed have the obligation referred to above. Due to the absence of such a clause, unnecessary problems regularly arise in practice caused by incorrect or incomplete information provided, as well as by insufficient knowledge and willingness to resolve disputes arising from this. These problems can have very serious and far-reaching consequences. If a franchisee successfully argues, in or out of court, that he was misrepresented when entering into the franchise agreement, this may, depending on the circumstances of the case, result in the franchise relationship being terminated on various legal grounds. ends, possibly resulting in an indemnification or compensation obligation on the part of the franchisor. In order to partially address the above objections, I suggest that the franchisor and franchisee, when entering into their contractual relationship, include the following clause in their franchise agreement:
a. The franchisor provides (or has provided) the franchisee with all relevant information that is decisive for entering into the franchise relationship; more specifically, the franchisor provides (or has provided) a financial forecast based on sound assumptions with regard to the expected turnover, gross profit and net operating result over a period of five years. 1)
b. The Franchisee ascertains (/has ascertained) the correctness and truthfulness of the information made available to it and, if necessary, will at least independently convince itself of the soundness of the principles of the financial forecast made available to it, as well as the forecast itself.
Sub b is an impetus for limiting the franchisor’s liability. This will be discussed in more detail in the next article.
1. The following phrase may be added to clause (a) in connection with the requirement for feasibility studies, if desired: “which has been drawn up on the basis of a thorough and well-conducted feasibility study.”. However, this is not immediately necessary: the concept of “sound principles” covers the load sufficiently.