Automatic renewal of franchise agreements

Franchise contracts at times provide for automatic renewal clauses, eg:

“This franchise agreement will be renewed automatically for a renewal period of one (1) year when its initial term or then current renewal period expires unless…“

German law does not need a specific term for franchise agreements. The parties may agree either franchise contracts with fixed or indefinite terms. However, franchise contracts usually provide for a specific term. Terms vary by the branch of industry concerned; often, franchise contracts provide for initial terms of 5 to 10 and 20 years, with options for renewals.

The Higher Regional Court of Munich has now – in an obiter dictum – confirmed the case law existing in Germany. In the decision of 17 March 2021 (Case No. 20 U 5294/20), the court deals with the automatic renewal clause concerning a marketing contract. According to such clause, the contract extended beyond the original contract term of 24 months by further 24 months unless terminated with prior notice. The court declared such clause, stipulated within a standard form contract, void for being – outside especially of franchise contracts – unreasonable, while within franchise contracts such automatic renewal clause would in principle be valid because they did not unreasonably disadvantage the franchisee: The franchisee generally had an interest in a long-term contractual relationship to have the opportunity to amortize the entry fee and any further money invested into the business.

The decision confirms the existing case law, especially the earlier Higher Regional Court of Frankfurt’s decision of 8 October 2014 (Case No. 4 U 41/14). In that case, the court considered that reasonable notice periods and a fixed contract term are in principle in the interest of both parties: They were in (i) the interest of the franchisor who, in the event of termination of the contract by the franchisee, faces the difficulty of finding a successor and would like to reserve the know-how acquired by the franchisee within its own franchise system for as long as possible and (ii) in the interest of the franchisee because from his perspective the contract term must be in reasonable relation to the entry fee and the other initial investments. However, even after the initial investment had been amortized, the franchisee might still need time to make a profit from the franchise system. Accordingly, the term of the contract should, according to the court, cover at least a period within which amortization of the investment can regularly be expected, taking into account that, like a commercial agent who is bound to act for a sole principal, the franchisee usually becomes closely economically dependent on the franchisor's business concept, and that such dependency increases with the length of the contract.

Practical advice

Best practice for renewing franchise contracts is to establish criteria only upon whose fulfilment by the franchisee is entitled to extend the term, eg starting as follows: "Term and Renewal. The initial term of this Contract shall be for a period of [X] years, to commence on the Effective Date and terminate on ___________ (the “Initial Term”). Franchisee shall have the right to extend the term of this Contract for one (1) renewal term of [X] years (the “Renewal Term”), subject to all of the following conditions: ...“.

Consider which criteria to establish for the franchise contracts‘ renewal, eg:

• timely notice before the end of the term (for the sake of good planning)
• franchisee complies with the relevant rules of the franchise contract
• franchisee pays a renewal fee
• franchisee signs the form of franchise agreement franchisor is then using at the time of the extension.