Franchise Agreements: Choice of court vis-à-vis start-ups invalid

Franchise agreements provide by default for a choice of court agreement (“forum selection clause”), usually combined with a choice of law, e.g.:

“If the Parties have not otherwise resolved any claim through the face-to-face meeting as de-scribed in Clause [...], the courts of [...] shall have exclusive jurisdiction over any unresolved claim and any question regarding the existence, validity, termination or expiration of this Fran-chise Agreement and any any contract concluded within its framework.”

Without such clause, each party to an international franchise agreement generally is to be sued in the courts of the EU Member State where such party is domiciled (i.e. with legal persons: where it has its statutory seat, central administration or principal place of business, cf. Articles 4 and 63 of Brussels-Ia-Regulation). Through such clause, however, the parties (i.e. usually in the interest of the franchisor) can agree on a specific court, thereby concentrating all franchise related legal issues in the same court (usually at the franchisor’s principal place of business).

While such forum selection clause is usually valid within international franchise agreements, such clause requires within domestic, German agreements that the parties are merchants, legal persons or special assets under public law (Section 38 of the German Code of Civil Procedure).

The Regional Court of Stuttgart has now confirmed in its decision of 18 October 2021 (Case No. 15 O 298/21) that this personal prerequisite is missing where the franchisee is a start-up: The court de-clared a choice of court provision void because the franchisee was, when signing the agreement, not yet active as independent businessperson, but just a start-up:

“The decisive point in time for being qualified as a merchant is at the the conclusion of the choice of court agreement … This means that the commercial business, i.e. the commercial activity, must already have commenced when the agreement is concluded; a mere preparation in the context of the "establishment of a business" does not suffice”.

The court thereby recurs to and confirms the existing case law, e.g. the earlier decisions of the Higher Regional Court of Cologne (21 November 1991, Case No. 18 U 113/91) and of the Higher Regional Court of Karlsruhe (22 March 2002, Case No. 14 U 148/01, para. 17).

Practical advice:

• When considering going to trial, check the franchise agreement – and, despite any compe-tent court stipulated in the franchise agreement, check the situation at the time of its conclu-sion in order to assess the right venue: within domestic agreements in Germany, each party needs to be a merchant to make such agreement valid.
• Consider that the mere planning or the mere establishment of a trading company is not suffi-cient, nor is the conclusion of legal transactions that aim at preparing the business, e.g. in the present case obtaining of business appraisals or draft contracts.
• A court of a EU Member State shall have jurisdiction if a defendant enters an appearance before such court (except where it aws entered to contest the jurisdiction, or where the par-ties have agreed on another court having exclusive jurisdiction, Article 26 Brussels-Ia-Regulation). However, this is usually only the last resort.

Franchise Agreements: Fees to be considered, especially entry fees

Franchise agreements often require the franchisee to pay an entry fee (also: entrance fee) – in other, simple words: the franchisee shall pay an initial fee in return for joining the franchise system. Currently, Entry fees are common in franchise agreements internationally (if not a “must”, as per the definition of the Federal Trade Commission in the USA, cf. the Code of Federal Regulations, Title 16 Chapter I Subchapter D Part 436 Subpart A).

In Germany, they regularly vary between EUR 0.00 and EUR 60,000, with franchisees paying an aver-age of EUR 13,400.00 as some franchise systems waive or simply do not charge entry fees. In the case of McDonalds, which is currently celebrating its 50th anniversary in Germany, the entry fees currently amount close to EUR 50,000, while other systems reach up to even EUR 250,000 (for the fleet rental system Fleetlink, cf. the latest figures of the German Franchising Association).

As franchisor, one should however be aware that such entry fees may have to be paid back if the franchise agreements is terminated earlier. The Higher Regional Court of Frankfurt am Main has now reconfirmed in its decision of 8 December 2021 (Case No. 4 U 251/20) that a franchisor had to return the entry fee due to faulty pre-contractual information. While the Regional Court of Frankfurt had ini-tially upheld the franchisor's claim for payment of the entry fees (in particular, the franchise agree-ment was not void under French law, nor did the fees constitute an unreasonable disadvantage to the franchisee under Section 307 (1) sentence 2 BGB). However, the Higher Regional Court has now dis-missed the action because the franchisor would have to return the entry fee due to faulty pre-contractual information (so-called dolo-agit rule, cf. para. 41 et seq.).

Practical advice:

• Fees to be considered when designing a franchise system are especially entry fees, ongoing fees (often: “royalties” or “running royalty”), marketing fees, and renewal fees. In the context of payments, also deposits can be useful (which the franchisor is entitled to draw from in case of certain events, especially in case of the franchisee’s breach of contract, e.g. late payment).
• Fees should be reasonable, especially: they should be commensurate and balanced with the franchisor's expertise and system integration services. As far as the ongoing fees are con-cerned, they should correspond to the franchisor's ongoing services specified in the fran-chise agreement.
• Fees must not be clearly disproportionate to the services provided by the franchisor; espe-cially, the franchisee must be able to earn money (Regional Court of Karlsruhe, 16.9.1988. Case No. 4 O 214/88).