12 May 2022
CA Paris, 24 November 2021, n° 18/14501; CA Paris, 1st December 2021, n° 20/01009; CA Paris, 1st December 2021, n° 20/01027
The transmission of know-how constitutes, together with the provision of distinctive signs and operational assistance, one of the defining criteria for the classification of an agreement as a franchise agreement.
Know-how is defined as “a package of non-patented practical information, resulting from experience and testing by the supplier, which is secret, substantial and identified” (article 1 g) of Regulation (EU) n°330/2010 of 20 April 2010).
The Paris Court of Appeal has clarified the franchisor's obligations with respect to the transmission of know-how in three recent decisions.
Firstly, while the franchisor is obliged to update its know-how and to allow franchisees to benefit from these updates (for example: CA Paris, 21 June 2006, No. 04/16234), it is not obliged to allow franchisees to benefit free of charge from technological developments that are independent of the know-how.
This was recalled by the Court in the first case (CA Paris, 24 November 2021, No 18/14501). In this case, the franchisor had developed a smartphone application allowing customers to order products directly on their phones. The franchisees argued that this technological development was part of the franchisor's obligation to update its know-how and that it should therefore be made available to them free of charge. The Court rejected the argument, considering that the franchisor's know-how was based on the quality of the service provided, the freshness and quality of the products offered for sale, creative dishes, original names but not on the ordering system. The franchisor was therefore not obliged to give franchisees free access to this application. The franchisees also argued that the application was used to promote the brand and was therefore already funded by their advertising fees. This argument was also rejected as the purpose of the application was to allow for ordering the products not communicating on the brand.
Secondly, the know-how must be “significant and useful to the buyer for the use, sale or resale of the contract goods or services” (article 1 g). of Regulation (EU) n°330/2010 of 20 April 2010) and provide a competitive advantage to the franchisees (Cass. Com., 10 December 10, 2013, n° 12-23115) but once its existence is demonstrated, any subjective characterisation (and in particular any comparison with the competitors) must be rejected.
This was recalled by the Paris Court of Appeal in the two other decisions (CA Paris, 1 December 2021, No. 20/01009 and CA Paris, 1 December 2021, No. 20/01027). In these cases, the franchisees complained that the franchisor did not offer "the same competitive advantage as its competitors" and that, consequently, the franchise agreement was deprived of cause (former Article 1131 of the Civil Code) and consideration (new Article 1169 of the Civil Code) and had to be annulled.
The Court rejected this request, since the franchisor justified having made available to the franchisee a know-how which met the characteristics required by statutory and case law.
These two decisions must be approved as they prevent an overly subjective approach of the know-how.
Cass. Com., 1st December 2021, n° 18-26572
Pursuant to the provisions of Articles L.330-3 and R.330-1 of the Commercial code, the franchisor is obliged, before signing a franchise agreement with a franchisee, to provide the latter with sincere information enabling him to make an informed decision.
While the annual accounts for the two previous fiscal years are part of the information that must be provided to prospective franchisees, the franchisor is under no obligation to provide the franchisees with forecasted accounts.
However, franchisors often do so, in particular to reassure the franchisees about the profitability of the system, to help them prepare their business plan and to facilitate obtaining bank loans. This practice nevertheless comes with a risk that should not be ignored.
In the case under review, a franchisor, active in the kitchen design and manufacturing sector, had provided its franchisee with forecasted accounts which turned out to be incorrect, since a difference of 78.15% between the forecasted turnover and the actual turnover was noted in the first year of operation and an average difference of 49% in subsequent years.
The franchise agreement was signed in December 2009. In December 2015, the franchisor terminated the contract and the franchisee took legal action in the course of 2016, i.e. almost 7 years after having signed the contract, requesting both the forced continuation of the contractual relationship and compensation for the damage suffered on the basis of fraud (i.e. deception).
The franchisor quite logically replied that the franchisee’s action was time banned. In this respect, it should be remembered that in matters of fraudulent representation, the limitation period is 5 years and runs from the day the franchisee discovered the fraud (Article 1144 of the Civil Code).
The franchisor thus argued that the franchisee had been aware of the issue from the end of the first financial year (i.e. from the end of 2010). According to the franchisor, the action was therefore time-barred since the end of 2015.
The reasoning seemed relatively straightforward.
However, the Paris Court of Appeal ruled that the franchisee could only really have become aware of the existence of a fraudulent representation at the end of its second year of operation. According to the Court, the franchisee could not have had legitimate doubts about whether or not there was fraud at the end of its first year because the poor results of the first year "may have had various causes" and the first year's accounts were "not sufficiently significant".
This solution is clearly debatable.
However, the Court of Cassation rejected the franchisor's appeal, emphasising the sovereign power of the Court of Appeal to assess the starting point of the limitation period.
This decision is a useful reminder to franchisors of the need to be very careful at the pre-contractual stage, to be wary of forecasts, and to resist the temptation to make the bride look much more beautiful than she really is.
If the franchisor chooses to provide the franchisee with information on achievable turnover or profitability, this information must be sincere and verifiable (based on the situation of existing units).
In fact, in the event of a significant difference between what was achieved and what was announced (beyond the margin of error inherent to any forecast), the franchisor runs the risk of being held accountable, even many years later…
CA Paris, 26 January 2022, n°20/04761
In this case, a distributor had been offered to enter into a new distribution agreement by its supplier. Notwithstanding several exchanges and negotiations proposed by the latter, the distributor repeatedly refused to sign the contract offer, considering that its conditions were unacceptable.
Underlining the “refusal [of the distributor] to make progress on finalising the draft contract", the supplier decided to continue trading with the distributor under the commercial terms of the original contract for a few more months and finally decided not to grant the distributor the prices granted to its designated distributors, as it was no longer bound to it by a distribution contract.
The distributor then sued the supplier, alleging unfair competition, abrupt termination of an established business relationship and attempted submission to a significant imbalance.
In fist instance, the Paris Commercial Court dismissed the distributor's claims, except for the significant imbalance, considering that the proposed new contract was based on a significant imbalance in the parties' rights and obligations and that this imbalance had justified the distributor's refusal to sign (T. Com. Paris, 23 January 2020, No. 27025791).
Dissatisfied with this decision, the distributor lodged an appeal before the Paris Court of Appeal.
This is the decision at stake.
The Court of Appeal confirmed the absence of unfair competition and abrupt termination of an established commercial relation but overruled the decision of the Commercial Court regarding the submission to a significant imbalance.
After recalling that one of the criteria for applying the text (Article L.442-6, I, 2°, now L.442-1, I, 2°, of the Commercial Code) is the existence of a bid or attempted bid, the Court of Appeal specified that this condition was met if it could be demonstrated that there was an "absence of effective negotiation" of the offending clauses.
The Court of Appeal emphasised that the distributor, which achieved more than 70% of its turnover with the supplier, was indeed in a situation of economic dependence with the supplier, that the negotiation of the distribution contract "had a particular importance" for it and that the conditions of the contract were "less favourable" than those it benefited from under the previous contract. However, the Court of Appeal noted that the distributor had had the opportunity to negotiate the proposed contract. For the Court, the supplier was "free to suggest the modification of the conditions of distribution of its products" and in this case, these conditions were entirely negotiable, the supplier having expressed "on several occasions that it was open to discussion".
Even if "the distributor was not in a favourable position considering its situation of economic dependence and the initial content of the proposals" of the supplier, the Court noted that it had not demonstrated that concrete counter-proposals or amendments to the draft contract had been refused by the supplier.
Thus, for the Paris Court of Appeal, the criterion of submission or attempted submission is not established when the distributor, even in a situation of dependence with the supplier, is not able to provide evidence of the supplier's refusal to effectively negotiate.
This ruling is in line with the Court of Cassation’s case law which periodically recalls that the criterion of submission is not met when the parties could have negotiated the terms of the contract or when certain pre-drafted terms could have been discussed between the parties (Cass. Com., 20 November 2019, nº 18-12823; CA Paris, Pole 5, Chamber 5, 9 July 2020, nº 17/18660).
In a decision of 5 January 2022, in a procedure initiated by the Minister of the Economy on the basis of significant imbalance, the Paris Court of Appeal had however adopted a much more questionable position, considering that the "absence of real room for negotiation of the franchise agreement" characterising the existence of a submission or attempted submission was sufficiently demonstrated by the franchisor's position of strength in relation to its franchisees, the “apparent attractiveness” of the network, the numerous identical standard contracts signed and the lack of information on the way the network was really operating (CA Paris, 5 January 2022, No. 20/00737).
Ignoring the franchisor's argument that the contract could be negotiated and that in this case there was no evidence "that the franchisees had expressed their desire to negotiate the contract and had been refused", the Court held that the contracts in question "were not effectively negotiated, [...] [and] were not negotiable either because of [...] misinformation of the franchisees on the real functioning of the network".
The Paris Court of Appeal thus appears to be practicing a “double standard” jurisprudential policy, depending on whether the procedure is initiated by the Minister of the Economy or by the party claiming to be the victim of the significant imbalance. This is absolutely not satisfactory.
Read and download the full content
by multiple authors
by multiple authors
Our latest Franchise and Distribution insights across Europe