The Federal Republic of Germany has the strongest economy in Europe and is one of the leading economies in the world. With a population of 81 million, it also is the most populous country in Europe. Germany is a mature and successful franchise market with more than 950 franchised systems operating in the country. It has been ranked 24th out of 185 countries in the World Bank Group’s Ease of Doing Business Rankings.
German Law Governing the Offer and Sale of Franchises
There are no specific franchise laws or government agencies that regulate the offer and sale of franchises in Germany. The general provisions of contract law (the Civil Code), consumer law, commercial law (the Commercial Code), competition law, and unfair trade law are applicable to franchise contracts. In particular, the provisions of the Civil Code regarding standard terms and conditions can be applied where the franchisor presents its standard franchise agreements with the franchisee on a take-it-or-leave-it basis (Civil Code, Section 305). According to Civil Code Section 307, all standard provisions need to be reasonable and must not unreasonably disadvantage the other party contrary to the requirements of good faith. Otherwise, they are null and void. In addition, according to German consumer credit law, a franchisee that is an individual, and not a business entity, is entitled to withdraw from the franchise contract within 14 days of signing if he establishes an independent business enterprise, the contract contains an obligation to repeatedly take supplies of goods. and the total value of the franchisee’s investment does not exceed €75,000.
If the franchisee is a business entity, it is possible under German law to obtain a personal guarantee from the individual who is behind the franchisee, in order to ensure that the franchisee fulfills its obligations under the franchise agreement. However, given that German law differentiates between several forms of personal securities—with a guarantee being only one of them—and German case law has ruled that a guarantee can be unreasonable in terms of Civil Code Section 307, it is important to implement a personal guarantee which complies with the requirements of German case law. (This is not a problem if the guarantor is a business entity.) Further, it should be noted that a personal guarantee can also be subject to a 14-day withdrawal right of the individual, because the personal guarantee, more or less, has the same effect as if the individual himself would have become the franchisee. Therefore, the franchise agreement should provide that the non-withdrawal of the personal guarantee is a condition precedent to the franchise agreement remaining in force.
Under German law, presale disclosure in connection with franchise agreements is not regulated by a special statute or monitored by a specific agency. The general provisions regarding contractual negotiations apply, in particular the principle of culpa in contrahendo. This principle provides that, before the execution of a franchise agreement, the franchisor must ensure that all relevant facts have been clearly presented to the potential franchisee. The scope and content of the duty depend on each individual case, taking the experience and knowledge of the franchisee into account. German courts have stressed that, as a general rule, a franchisee should obtain information on its own initiative about the general market conditions and their impact on the prospective franchised business. However, if there are particular circumstances about which only the franchisor is aware, and which would be important to the potential franchisee’s decision as to whether to enter into the franchise contract, the franchisor must disclose that information. German case law has ruled that a franchisor must refrain from providing misleading information about the franchise system and must disclose all relevant information about it in order to avoid subsequent damage claims.
German case law has determined that at least the following items should be disclosed:
- Information about the franchise concept, including the date the franchise system began, the actual number of franchises; and the franchisees who have left the system;
- The identity of the personnel who have authority to act on behalf of the franchisor;
- Specifics of the franchise offer, including the location, performance, and experience of the existing business, the required investment, and the number of employees required for the franchisee’s business;
- Information that enables the franchisee to conduct its own location analysis and calculate the profitability of the franchised business;
- Information about situations where compulsory statutory pension insurance for the franchisee applies;
- The franchise agreement and the franchise manual (including all standard appendices);
- The franchisor’s memberships in franchise associations;
- Information on other distribution channels for the franchised product or service;
- Pending lawsuits with the potential to impact the franchisee’s business; and
- A description of the initial and ongoing support provided by the franchisor
In addition, the German Franchise Association (GFA) has issued non-binding guidelines regarding presale disclosure obligations. The presale information should be disclosed within a reasonable period prior to signing the franchise agreement. This applies also to any (preliminary) binding agreement between the parties; however, disclosure is not required in connection with a letter of intent between the franchisor and a potential franchisee since the term of those agreements is shorter, there are minor economic consequences from those agreements, and usually no requirement to enter into a franchise agreement.
Commencing Franchising in Germany
There are several advantages to franchising in Germany:
- No specific government consents or official authorizations with respect to the offer and sale of a franchise are required
- German statutory law does not provide for special requirements that a franchisor must meet prior to offering franchises. Nevertheless, the GFA lists numerous guiding principles in its code of ethics. These include:
- The franchisor must have successfully run a business concept for an appropriate period of time with at least one pilot project before starting franchising;
- The franchisor must be the owner or legitimate user of the company name, trademark, or any other special labeling of its network; and
- The franchisor must carry out the initial training of the individual franchisee and must ensure ongoing commercial and/or technical support to the franchisee during the entire term of the contract
- Observance of the GFA principles is obligatory in order to become and remain a member of the GFA and to demonstrate fair business practices. While the GFA is a non-government body and membership is not compulsory, membership in the GFA is regarded as an indication of quality for a franchise system.
- Under German law there is no difference between franchisors from EU and non-EU member states with regard to foreign citizens or non-national entities in the ownership/control of businesses or holding any interest in real estate
Termination of Franchise Agreements
Franchise agreements can be entered into for a definite or an indefinite term. In both cases, the parties can mutually agree to terminate the franchise agreement. A franchise agreement with a definite term can end as a result of the lapse of time or by termination for good cause. Under German law, a termination for good cause requires a major default of a party’s contractual duties under the franchise agreement. Franchise agreements with an indefinite term can be terminated either for good cause or without cause. If the franchise agreement is terminated without good cause, contractual or statutory periods of notice must be taken into consideration.
Under German law, the termination of franchise agreements is closely connected to the question whether the franchisee is entitled to indemnity. In Germany, a commercial agent is entitled to an indemnity at the end of the agreement, pursuant to section 89b of the Commercial Code, if it has generated new customers for the principal’s business, or has significantly increased the business with existing customers and the principal continues to derive substantial benefits from business with said customers. This right to claim indemnity cannot be waived in advance. German law provides some exemptions—for example, if the contract is terminated for cause owing to culpable conduct of the commercial agent. Since the franchisor or a replacement franchisee can continue to sell to the former franchisee’s customers, a franchisee also may be entitled to indemnity. Section 89b of the Commercial Code applies analogously in the case of termination of a franchise agreement if two conditions are met:
- The franchisee needs to be included in the franchisor’s sales organization to the extent that it has duties that are financially comparable to those of a commercial agent; and
- The franchisee needs to be contractually obliged to (directly or indirectly) transfer its customers to the franchisor no later than at the termination of the agreement
In order to mitigate the risk of an indemnity payment, franchisors should make sure that the franchise agreement does not stipulate an obligation to transfer the franchisee’s customer base to the franchisor—either directly or indirectly.
Dr. Tom Billing is a partner in the Berlin Office of Noerr LLP. As a lawyer, he has advised on the structure of a number of well-known national and international distribution systems and the expansion of those systems nationally and internationally. He is the author of several published texts in relation to franchising and contract law. Robert Smith is a partner in the Washington, DC office of Quarles & Brady LLP. He has represented franchisors for almost 40 years in a variety of transactions, including franchise deals in more than 80 countries.
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