Franchise agreement: which clauses can create a significant imbalance?

Can the clauses of a franchise agreement be invalidated when they impose excessive obligations on the franchisee or grant disproportionate powers to the franchisor? Exclusivity, supply, termination, contract modification, price fixing: several stipulations can be challenged on the grounds of significant imbalance.

The franchise agreement necessarily establishes a structured relationship based on the franchisor's concept, brand, and know-how. To preserve the identity and consistency of its network, the franchisor generally imposes numerous obligations on franchisees: adherence to the concept, sourcing from approved suppliers, use of the network's IT tools, participation in advertising campaigns, and compliance with commercial and technical standards.

This organization is not, in itself, unbalanced. It is even one of the characteristics of the franchise model.

However, some clauses may go beyond what is necessary to protect the network and create a significant imbalance between the rights and obligations of the franchisor and the franchisee.

The assessment then depends on the content of the contract, the context of its negotiation and the overall economics of the relationship.

What constitutes a significant imbalance in a franchise agreement?

ArticleL. 442-1, I, 2° of the Commercial Code establishes the liability of the person who, in the context of the negotiation, conclusion or execution of a contract, subjects or attempts to subject his business partner to obligations creating a significant imbalance in the rights and obligations of the parties.

Two elements must therefore be characterized:

1. the submission or attempted submission of the partner;
2. the existence of obligations creating a significant imbalance.

The judge does not penalize every difference between the rights of the franchisor and those of the franchisee. A commercial contract necessarily includes distinct obligations depending on the role of each party.

The imbalance becomes legally questionable when a clause imposes an excessive constraint on one of the contracting parties, without reciprocity or sufficient justification with regard to the purpose of the contract.

How can we characterize the franchisee's submission?

The mere presence of a pre-established contract by the franchisor is not necessarily sufficient to demonstrate the franchisee's submission.

The judge may investigate whether the franchisee was actually able to negotiate the terms of the contract. Several factors may be taken into consideration:

• the systematic use of a standard contract;
• the absence of effective negotiation;
• the general refusal to modify the proposed clauses;
• the existence of a balance of power that is very unfavorable to the candidate;
• the obligation to accept the contract in its entirety;
• the economic dependence of the franchisee during the execution of the contract;
• the circumstances in which the contractual modifications were imposed.

Conversely, the existence of genuine exchanges, modifications to the draft contract, or reciprocal concessions can allow the franchisor to demonstrate that the contract was negotiated.

Therefore, preserving the different versions of the contract, the observations made, and the responses provided is an important precaution.

Should the contract be assessed clause by clause?

The significant imbalance may result from a specific clause, but the judge must also take into account the overall economy of the contract.

A clause that appears unfavorable to the franchisee may be offset by another contractual advantage. Conversely, several clauses that would not necessarily be unlawful when examined separately may, when combined, create an overall imbalance.

The assessment focuses in particular on:

• the purpose and duration of the contract;
• the investments required from the franchisee;
• the franchisor's control powers;
• financial obligations;
• supply conditions;
• the distribution of responsibilities;
• the options for termination;
• the consequences of the end of the contract.

The unbalanced nature of a clause cannot therefore be deduced solely from its severity.

Which clauses in a franchise agreement should be monitored?

Unilateral modification clauses

The franchisor must be able to evolve its concept and know-how. A franchise network cannot remain static for the entire duration of the contract.

However, a clause allowing the franchisor to unilaterally and without limit modify the franchisee's obligations can be challenged, particularly when it allows the franchisor to:

• to impose significant investments;
• to substantially modify the concept;
• to add new royalties;
• to replace approved suppliers;
• to transform the economic model of the point of sale;
• to impose new tools without regulating their cost.

The clause should define the nature of the changes that may be decided, the methods of informing the franchisee and, if necessary, a reasonable period for compliance.

Exclusive supply clauses

Exclusive or near-exclusive sourcing may be justified by the need to preserve the identity, quality and homogeneity of the network.

This justification does not preclude examining:

• the duration of the exclusivity;
• the scope of the products concerned;
• the possibility of using equivalent products;
• transparency of pricing conditions;
• margins or commissions possibly received by the franchisor;
• the consequences of a failure of the referenced supplier.

ArticleL. 330-1 of the Commercial Code limits the duration of certain exclusivity or quasi-exclusivity clauses to ten years.

This rule does not mean that all franchise agreements are necessarily limited to ten years. It targets commitments that restrict the business owner's freedom to conduct their business under the conditions defined in the agreement.

Price fixing or control clauses

The franchisor can communicate recommended prices, organize marketing campaigns or guarantee a consistent positioning within the network.

However, it cannot deprive the franchisee of their freedom to set their resale prices, subject to the specific rules applicable to certain sectors.

A clause that directly or indirectly imposes a resale price must therefore be examined in light of:

• of the law on anti-competitive practices;
• of the law of commercial relations;
• of the legal and economic autonomy of the franchisee.

The qualification depends on the terms of the contract, but also on the concrete practices of the network.

Termination clauses

A termination clause can create an imbalance when it allows the franchisor to immediately terminate the contract for minor breaches, while the franchisee has no equivalent rights in the event of fault on the part of the franchisor.

The following must be checked:

• the seriousness of the breaches allowing for termination;
• the existence of a prior formal notice;
• the time allowed to remedy the deficiency;
• the reciprocity of the grounds for termination;
• the financial consequences of the breakup;
• the cumulative effect of termination, compensation and penalties.

The absence of strict reciprocity is not sufficient to render the clause unlawful if it is justified by different obligations. However, immediate and disproportionate termination may be subject to penalties.

Penalty clauses

The contract may provide for compensation in the event of non-performance or early termination.

When this compensation constitutes a penalty clause, the judge may moderate or increase it if it is manifestly excessive or derisory, in accordance with Article 1231-5 of the Civil Code.

The contract must also avoid the unjustified accumulation of several sanctions having the same purpose:

• termination compensation;
• advance payment of the remaining royalties;
• fixed penalty;
• additional damages;
• loss of sums already paid.

Non-competition and non-affiliation clauses

During the contract, a non-competition obligation may be necessary to protect the know-how and identity of the network.

After termination, restrictions are more strictly regulated. A post-contractual clause must, in particular, be limited in terms of its activity, territory and duration, and be necessary to protect the legitimate interests of the network.

Article L. 341-2 of the Commercial Code also sets out specific conditions for clauses which have the effect of restricting the freedom to carry out commercial activity after the expiry or termination of certain distribution contracts.

A ban that is too general, covering all competing activities and an excessive territory, may be declared unenforceable.

Clauses relating to the transfer of the point of sale

The franchisor may legitimately want to verify the identity and skills of the buyer in order to preserve the quality of the network.

The approval clause must, however, be sufficiently regulated. The contract should specify:

• the selection criteria for the buyer;
• the time frame within which the franchisor must respond;
• the reasons that may justify a refusal;
• the possible existence of a right of preference;
• the methods of valuing the fund or securities;
• the fees charged in connection with the transfer.

The discretionary power allowing the franchisor to refuse any transfer without justification can be a source of dispute.

Clauses relating to applicable law and dispute resolution

In international networks, contracts may provide for the application of foreign law or recourse to arbitration organized abroad.

Such clauses are not automatically unlawful. However, their validity and enforceability must be examined in light of the context of the contract, the applicable mandatory rules, and the specific difficulties they impose on the franchisee.

The cost and remoteness of the procedure, combined with other unfavorable stipulations, can contribute to characterizing an imbalance.

The Subway case: several clauses sanctioned

The Paris Commercial Court ruled on October 13, 2020, on several clauses of the contracts offered by the Subway network to its French franchisees.

This decision came following a national investigation by the DGCCRF into the network's business practices.

The court examined, in particular, clauses relating to:

• to applicable law and dispute resolution;
• to the termination of the contract in case of late payments;
• to the duration of the commitments;
• to the operating conditions of the network;
• to the obligations imposed on franchisees.

Seven clauses were declared contrary to the provisions relating to significant imbalance. The court also imposed a civil fine of 500,000 euros due to the harm caused to economic public order.

This decision is important, but it does not allow us to conclude that all similar clauses are automatically unlawful. The analysis depends on their wording, their relationship with other stipulations, and the specific circumstances under which they were imposed.

Commercial Court of Paris, October 13, 2020, RG No. 2017005123.

Can the franchisee also invoke the Civil Code?

Article 1171 of the Civil Code provides that, in a contract of adhesion, any non-negotiable clause determined in advance by one of the parties and creating a significant imbalance between the rights and obligations of the parties is deemed unwritten.

However, this text does not allow the judge to control the main purpose of the contract or the adequacy of the price to the service.

Its application also assumes that the contract can be classified as a contract of adhesion and that the disputed clause was not negotiable.

The relationship between Article 1171 of the Civil Code and the special provisions of the Commercial Code must be examined on a case-by-case basis.

What sanctions are in place in the event of a significant imbalance?

Depending on the legal basis used and the author of the action, several consequences can be envisaged:

• cessation of the practice;
• removal or unenforceability of the clause;
• restitution of unduly obtained benefits;
• compensation for the damage suffered;
• pronouncement of a civil fine;
• publication or dissemination of the decision.

The action may in particular be brought by the victim of the practice, the public prosecutor or the minister in charge of the economy under the conditions provided for by the Commercial Code.

The invalidation of a clause does not necessarily lead to the cancellation of the entire contract. The judge may invalidate the disputed stipulation if the rest of the contract can continue to exist without it.

How to secure a franchise agreement?

The control must focus on the legal balance of the contract, but also on its practical operation.

For the franchisor

The franchisor should, in particular:

• identify the objective justification for each obligation;
• avoid insufficiently regulated unilateral powers;
• proportion the sanctions to the seriousness of the breaches;
• organize a formal notice procedure;
• explain the main economic constraints of the network;
• preserve evidence of negotiations;
• harmonize the contract, the DIP and the operating manual;
• Check historical contracts regularly.

A clause protecting the network will be more easily defensible if it is necessary for the transmission of know-how, brand identity, or the quality of products and services.

For the franchisee

Before signing, the prospective franchisee must, in particular, verify the following:

• supply conditions;
• the possibilities for the evolution of the concept;
• future investments that may be subject to taxation;
• the franchisor's control powers;
• the reasons for termination;
• the applicable penalties;
• post-contractual restrictions;
• the possibilities of transferring and exiting the network;
• the competent jurisdiction and the applicable law.

The franchisee must also retain proof of modification requests made and responses provided by the franchisor.

A balance compatible with network protection

The significant imbalance does not call into question the fundamental principle of franchising. The franchisor must be able to protect its brand, its know-how, and the unity of its network.

The drafting of the contract must, however, seek a balance between this necessary protection and the independence of the franchisee.

A precise, proportionate and objectively justified clause presents less risk than a general prohibition or discretionary power left to a single party.

ARST Avocats' support

ARST Avocats assists franchisors and franchisees in drafting, auditing and negotiating franchise contracts, as well as in disputes relating to their execution or termination.

Our team intervenes in particular on the pre-contractual information document (DIP), exclusivity clauses, supply, pricing, support obligations, termination conditions and post-contractual restrictions.

Discover our Contract Law, Distribution and Franchise Law.

Morgan Jamet,
Partner Attorney – ARST Avocats