Breakdown of franchise negotiations: what recourse is available after a zone reservation?

The creation of a franchised point of sale generally requires several months of preparation: searching for premises, negotiating the commercial lease, setting up a company, developing the financing plan, carrying out studies and initial development work.

To secure this period, the franchisor and the candidate can sign a territory reservation agreement. The candidate then benefits, for a specified period, from priority or exclusivity in a territory, pending the signing of the franchise agreement.

But what happens if the franchisor ultimately breaks off negotiations? Can the candidate obtain a refund of expenses incurred? Can they claim the profit they hoped to make from operating the future outlet?

The freedom to break off negotiations remains the principle. However, a late, unfair, or contradictory termination, contrary to the commitments made, may render the party responsible liable. The existence of a zone reservation agreement then plays a decisive role.

What is a zone reservation contract?

The area reservation agreement is a pre-contractual agreement frequently used in franchise networks.

It allows the franchisor to temporarily reserve a geographical territory for the candidate so that the latter can pursue his project without fearing, in principle, the simultaneous installation of another franchisee of the same network in the area concerned.

Depending on its wording, the contract may stipulate:

• the precise definition of the reserved territory;
• the duration of the reservation;
• the exclusive or simply priority nature of the reservation;
• the amount possibly paid by the candidate;
• the diligence expected of each party;
• the search and validation of a location;
• the financing procedures;
• the conditions for the return or retention of the sum paid;
• the circumstances allowing the franchisor to definitively reject the application;
• the conditions under which the perimeter of the zone can be modified;
• the provisional timetable for signing the franchise agreement.

The reservation agreement does not necessarily constitute a firm promise to conclude the future franchise agreement. It all depends on its content.

A clause may expressly state that the reservation does not constitute final approval of the candidate or an irrevocable commitment by the franchisor to conclude the agreement. However, it does not necessarily authorize the franchisor to act in bad faith or to disregard the specific commitments made during the reservation period.

Is the signing of the franchise agreement still a matter of free choice?

According toArticle 1112 of the Civil Code, the initiation, conduct, and termination of pre-contractual negotiations are free. However, they must imperatively comply with the requirements of good faith.

Even when negotiations are advanced, neither party can be forced to conclude the final contract unless they have previously given their firm consent.

The franchisor retains the right to refuse an application when a key element of the project does not meet the network's criteria: insufficient funding, unsuitable premises, lack of competence of the candidate or disagreement on the essential terms of the contract.

For his part, the candidate remains free to abandon the project if he considers that the economic, legal or operational conditions of the franchise are no longer suitable for him.

This freedom, however, does not preclude all responsibility. It is generally not the decision not to enter into a contract that is penalized, but rather the circumstances under which negotiations were conducted or interrupted.

When does breaking off negotiations become abusive?

Breaking off negotiations can be wrongful when it occurs in circumstances contrary to good faith.

No single criterion is sufficient to characterize a termination as abusive. Judges make an overall assessment, taking into account, in particular:

• the duration of the negotiations;
• of their degree of advancement;
• assurances given by one party;
• of the possible transmission of a finalized draft contract;
• the existence of a reservation contract or an exclusivity agreement;
• expenses incurred with the knowledge or encouragement of the other party;
• of the proximity of the scheduled opening date;
• of the absence of an objective reason for termination;
• the sudden nature of the decision;
• concealing parallel negotiations;
• of a possible misuse of the information provided by the candidate;
• the time allowed for him to reorganize his project.

The termination can therefore be considered unfair when one party maintains for several months the legitimate belief that the contract will be signed, encourages significant investments, sends a finalized version of the contract, and then abruptly interrupts negotiations without serious cause.

Conversely, even a late termination will not necessarily be considered wrongful if it is justified by the discovery of a determining element, by the refusal of an essential condition, or by the lack of progress of the project attributable to the other party.

Does refusing to modify the reserved area justify termination?

This question was examined by the Court of Appeal of Nîmes in a judgment of December 1, 2021, No. 19/04575.

In this case, a franchisor had entered into two successive territory reservation agreements with a prospective franchisee, each for a period of six months. Negotiations had reached a particularly advanced stage, and the franchise agreement and its appendix had been submitted for signature.

The franchisor, however, decided against finalizing the agreement, citing a loss of confidence in the candidate. She had refused to change the location of the area initially reserved.

The judges considered that the termination was not really motivated by a loss of confidence, but by the candidate's refusal to accept the change of territory desired by the franchisor.

The court notably noted:

• the existence of successive reservation contracts;
• the very advanced state of negotiations;
• the transmission of the franchise agreement for signature;
• the proximity of the store's planned opening;
• the absence of an established legitimate reason;
• the link between the break and the refusal to modify the reserved area.

The termination, which occurred two months before the opening of the point of sale, was deemed abrupt and marked by a particular bad faith.

This decision serves as a reminder that a franchisor cannot necessarily unilaterally challenge the territory it has contractually reserved, and then blame the candidate for the failure of negotiations because the latter refuses this modification.

Breakdown of negotiations or non-performance of the reservation contract?

The analysis should not be limited to pre-contractual liability.

The area reservation agreement is itself a contract. Its poor execution can therefore give rise to contractual liability on the part of the defaulting party, independently of the breakdown of negotiations relating to the future franchise agreement.

Two foundations can therefore be considered.

Pre-contractual liability

It penalizes unfair circumstances in which franchise contract negotiations were conducted or interrupted.

It is based primarily on Article 1112 of the Civil Code.

Contractual liability

It can be invoked when a party fails to comply with an obligation contained in the reservation contract, for example:

• the commitment to reserve an area exclusively;
• the prohibition against presenting the same territory to another candidate;
• the obligation to seriously study the project;
• adherence to a schedule;
• the conditions for modifying the zone;
• the return of the sum paid;
• an obligation of confidentiality.

The distinction is important because the nature of the fault, the applicable clauses, and the damages that may be compensated can differ.

The clause stating that the franchisor remains free not to conclude the final contract does not automatically neutralize the other contractual obligations stipulated during the reservation.

What damages can be compensated?

Compensation for an abusive termination of negotiations should not place the victim in the situation they would have been in if the contract had been concluded.

Article 1112 of the Civil Code specifies that in the event of fault committed during negotiations, compensation cannot be intended to offset:

• the expected benefits of the uncontested contract;
• the lost opportunity to obtain these benefits.

The candidate therefore cannot claim the margin, turnover or profits that he hoped to achieve through the operation of the future franchised point of sale.

However, he can claim compensation for the harm directly caused by the wrongful conditions of the termination.

The negotiation fees have become unnecessary

The following may be affected:

• the consulting fees incurred for the negotiation;
• certain travel expenses;
• the cost of studies specifically carried out for the project;
• the costs directly related to the preparation of the contract;
• certain expenses related to research or validation of the premises.

The candidate must demonstrate that these expenses were incurred due to the progress of the negotiations and that they became unnecessary due to the wrongful termination.

Investments specifically made for the network

Certain expenses for development, equipment, signage or communication may be compensated when they were specific to the franchisor's concept and cannot be reused.

On the other hand, general investments useful to any commercial operation are more difficult to attribute to the disruption.

In the case judged by the Nîmes Court of Appeal, the expenses for architect, purchase of equipment and fitting out of the premises were not compensated since these were general works, useful for the operation of a store and not specific to the franchise envisaged.

This distinction is essential:

• A sign, furniture or layout designed exclusively according to the network concept may become unusable after the break;
• An electrical installation, air conditioning, or standard commercial equipment generally retains value for another business.

The loss of another opportunity to contract

The candidate may sometimes argue that the exclusivity granted to the franchisor or the trust maintained during negotiations led him to abandon another project.

Such harm must be demonstrated with particular rigor. It is necessary to establish the existence of a sufficiently serious, and not merely hypothetical, possibility, as well as a direct link between the loss and the wrongful conduct of the other party.

This potential loss of an alternative operation should not be confused with the loss of opportunity to obtain the expected benefits of the unconcluded franchise agreement, which Article 1112 expressly excludes.

Damage to image or disorganization

In certain situations, a particularly late termination can disrupt the candidate's activity, affect their relationships with a landlord, financiers, suppliers or employees already recruited.

These damages can be invoked if they are certain, documented and directly caused by the wrongful circumstances of the termination.

Can a company created by the candidate claim damages?

The franchise candidate frequently forms a company intended to operate the future point of sale.

This company may sometimes seek compensation for its own damages, even if it was not personally a signatory to the initial exchanges or the reservation contract.

However, it must establish:

• the existence of harm that is personal to him;
• his effective involvement in the project;
• the franchisor's awareness of this involvement;
• the link between the wrongful behavior and the expenses or losses she cites.

The losses suffered by the individual candidate and those suffered by the operating company must be distinguished. The same expense cannot be compensated twice.

It is therefore important to precisely identify the person who signed the contract, paid the funds, concluded the lease, ordered the work or bore the costs.

Is the reservation contract subject to pre-contractual information?

When a person makes available to another a trade name, a brand or a business name requiring a commitment of exclusivity or near-exclusivity, ArticleL. 330-3 of the Commercial Code requires the delivery of a pre-contractual information document.

This document must notably present the network, its experience, the state and development prospects of the market, as well as the main stipulations of the future contract.

It must be submitted at least twenty days in advance:

• the signing of the contract;
• or the payment of any sum required prior to its conclusion.

When a zone reservation contract provides for the payment of a sum by the candidate, the question of the prior delivery of the pre-contractual information document must therefore be carefully examined.

Failure to provide the document or the provision of incomplete information does not automatically invalidate the contract. However, it may give rise to liability on the part of the franchisor and, if it has vitiated the candidate's consent, contribute to justifying a claim for annulment.

To prepare a project more broadly, our article Franchise Restaurant: 9 Mistakes to Avoid Before Starting Out presents the main points to check before signing.

Do not confuse a breakdown in negotiations with the abrupt termination of an established business relationship

The abusive termination of negotiations should not be confused with the abrupt termination of an established business relationship as provided for in Article L. 442-1, II of the Commercial Code.

The first occurs before the formation of the envisaged contract. It penalizes wrongful conduct in the conduct or termination of negotiations.

The second condition presupposes the prior existence of a business relationship that is ongoing, stable, and regular. It primarily penalizes insufficient notice given upon termination of this relationship.

Even advanced negotiations do not generally constitute an established business relationship on their own.

The term "abrupt termination" can be used in both situations, but the grounds, conditions and methods of compensation are different.

How to secure a zone reservation contract?

The contract must precisely define the rights and obligations of the parties during the reservation period.

For the franchisor

It is particularly recommended to specify:

• that the reservation does not constitute final approval;
• the conditions that the candidate still needs to fulfill;
• the criteria for validating the premises;
• the expected financing conditions;
• the reasons for rejecting the application;
• the consequences of not signing the final contract;
• the fate of the sum paid;
• the assumptions allowing a modification of the zone;
• the expenses that the candidate may incur before their final approval.

The franchisor must also ensure consistency in its behavior. It is risky to encourage the opening of the outlet, approve the work, and submit a finalized contract while later claiming that the application remained entirely uncertain.

For the franchise candidate

The candidate must, in particular, verify:

• the exact delimitation of the zone;
• the nature of the exclusivity granted;
• the duration of the reservation;
• the renewal conditions;
• the possibility for the franchisor to modify the territory;
• the conditions for the return of the sum paid;
• the criteria for final approval;
• clauses relating to premises and financing;
• expenses that may be incurred before signing;
• the absence of contradiction between the reservation contract, the pre-contractual information document and the draft franchise contract.

It is prudent to make the most important commitments — commercial lease, specific works, recruitment or equipment orders — conditional upon the signing of the final contract or written validation from the franchisor.

What should be done if negotiations break down?

As soon as the break-up is announced, it is necessary to gather the elements needed to reconstruct the negotiations:

• reservation contract and amendments;
• pre-contractual information document;
• successive drafts of the franchise agreement;
• emails and messages exchanged;
• meeting minutes;
• documents relating to the validation of the premises;
• agreements given on the work;
• invoices and proofs of payment;
• exchanges with the landlord and banking institutions;
• provisional opening schedule;
• justification of the reason for termination given.

A formal notice can then be sent to obtain explanations, the return of sums paid and, where applicable, compensation for damages directly caused by the termination.

The strategy must distinguish between claims based on poor performance of the reservation contract and those based on the wrongful nature of the breakdown of negotiations.

What are the key takeaways?

Signing a zone reservation agreement does not automatically guarantee the conclusion of the franchise agreement. However, it does create obligations that must be fulfilled in good faith.

The breakdown of negotiations can be considered wrongful when it occurs late, without legitimate reason, after the franchisor has encouraged the candidate to incur significant expenses or expenses in contradiction with the reserved territory.

The candidate cannot claim the profit he hoped to derive from the future operation. He can, however, obtain compensation for expenses and damages directly caused by the abusive circumstances of the termination, provided he can substantiate them precisely.

The prevention of disputes relies primarily on the drafting of the reservation contract, the consistency of pre-contractual documents and the traceability of exchanges that took place before the final decision.

ARST Avocats assists franchisors, candidates and franchisees in drafting and negotiating reservation contracts, pre-contractual information documents and franchise agreements, as well as in contractual and commercial disputes related to the breakdown of negotiations.

Morgan Jamet,
Partner Attorney – ARST Attorney