The Code of Ethics

The European Franchise Federation publishes a Code of Ethics which each Member State Franchise Association has adopted and requires its members to follow. All franchisors entering the EU should be familiar with this Code which is detailed below.

1. Definition of Franchising

Franchising is a system of marketing goods and/or services and/or technology, which is based upon a close and ongoing collaboration between legally and financially separate and independent undertakings, the Franchisor and its Individual Franchisees, whereby the Franchisor grants its Individual Franchisees the right, and imposes the obligation, to conduct a business in accordance with the Franchisor’s concept. The right entitles and compels the individual Franchisee, in exchange for a direct or indirect financial consideration, to use the Franchisor’s trade name, and/or trade mark and/or service mark, know-how (*), business and technical methods, procedural system, and other industrial and/or intellectual property rights, supported by continuing provision of commercial and technical assistance, within the framework and for the term of a written franchise agreement, concluded between parties for this purpose.

“Know-how” means a body of non patented practical information, resulting from experience and testing by the Franchisor, which is secret, substantial and identified.

“Secret” means that the know-how, as a body or in the precise configuration and assembly of its components, is not generally known or easily accessible; it is not limited in the narrow sense that each individual component of the know-how should be totally unknown or unobtainable outside the Franchisor’s business.

“Substantial” means that the know-how includes information which is of importance for the sale of goods or the provision of services to end users, and in particular for the presentation of goods for sale, the processing of goods in connection with the provision of services, methods of dealing with customers, and administration and financial management; the know-how must be useful for the Franchise by being capable, at the date of conclusion of the agreement, of improving the competitive position of the Franchisee, in particular by improving the Franchisee’s performance or helping it to enter a new market.

“Identified” means that the know-how must be described in a sufficiently comprehensive manner so as to make it possible to verify that it fulfils the criteria of secrecy and substantiality; the description of the know-how can either be set out in the franchise agreement or in a separate document or recorded in any other appropriate form.

2. Guiding Principles

2.1 The Franchisor is the initiator of a franchise network, composed of itself and its Individual Franchisees, of which the Franchisor is the long-term guardian.

2.2 The obligations of the Franchisor

The Franchisor shall:

have operated a business concept with success, for a reasonable time and in at least one pilot unit before starting its franchise network
be the owner, or have legal rights to the use, of its network’s trade name, trademark or other distinguishing identification
provide the Individual Franchisee with initial training and continuing commercial and/or technical assistance during the entire life of the agreement.
2.3 The obligations of the Individual Franchisee

The Individual Franchisee shall:

devote its best endeavours to the growth of the franchise business and to the maintenance of the common identity and reputation of the franchise network
supply the Franchisor with verifiable operating data to facilitate the determination of performance and the financial statements necessary for effective management guidance, and allow the Franchisor, and/or its agents, to have access to the individual Franchisee’s premises and records at the Franchisor’s request and at reasonable times
not disclose to third parties the know-how provided by the Franchisor, neither during nor after termination of the agreement.
2.4 The ongoing obligations of both parties

Parties shall exercise fairness in their dealings with each other. The Franchisor shall give written notice to its Individual Franchisees of any contractual breach and, where appropriate, grant reasonable time to remedy default.

Parties should resolve complaints, grievances and disputes with good faith and goodwill through fair and reasonable direct communication and negotiation.

3. Recruitment, advertising and disclosure

3.1 Advertising for the recruitment of Individual Franchisees shall be free of ambiguity and misleading statements.

3.2 Any publicly available recruitment, advertising and publicity material, containing direct or indirect references to future possible results, figures or earnings to be expected by Individual Franchisees, shall be objective and shall not be misleading.

3.3 In order to allow prospective Individual Franchisees to enter into any binding document with full knowledge, they shall be given a copy of the present Code of Ethics as well as full and accurate written disclosure of all information material to the franchise relationship, within a reasonable time prior to the execution of these binding documents.

3.4 If a Franchisor imposes a Pre-contract on a candidate Individual Franchisee, the following principles should be respected:

prior to the signing of any pre-contract, the candidate Individual Franchisee should be given written information on its purpose and on any consideration he may be required to pay to the Franchisor to cover the latter’s actual expenses, incurred during and with respect to the pre-contract phase; if the Franchise agreement is executed, the said consideration should be reimbursed by the Franchisor or set off against a possible entry fee to be paid by the Individual Franchisee
the Pre-contract shall define its term and include a termination clause
the Franchisor can impose non-competition and/or secrecy clauses to protect its know-how and identity.
4. Selection of individual franchisees

A Franchisor should select and accept as Individual Franchisees only those who, upon reasonable investigation, appear to possess the basic skills, education, personal qualities and financial resources sufficient to carry on the franchised business.

5. The Franchise Agreement

5.1 The Franchise Agreement should comply with the National law, European community law and this Code of Ethics.

5.2 The agreement shall reflect the interests of the members of the franchised network in protecting the Franchisor’s industrial and intellectual property rights and in maintaining the common identity and reputation of the franchised network. All agreements and all contractual arrangements in connection with the franchise relationship should be written in or translated by a sworn translator into the official language of the country the Individual Franchisee is established in, and signed agreements shall be given immediately to the Individual Franchisee.

5.3 The Franchise agreement shall set forth without ambiguity, the respective obligations and responsibilities of the parties and all other materials terms of the relationship.

5.4 The essential minimum terms of the agreement shall be the following:

the rights granted to the Franchisor
the rights granted to the Individual Franchisee
the goods and/or services to be provided to the Individual
Franchisee

the obligations of the Franchisor
the obligations of the Individual Franchisee
the terms of payment by the Individual Franchisee
the duration of the agreement which should be long enough to allow Individual Franchisees to amortize their initial investments specific to the franchise the basis for any renewal of the agreement
the terms upon which the Individual Franchisee may sell or transfer the franchised business and the Franchisor’s possible pre-emption rights in this respect
provisions relevant to the use by the Individual Franchisee of the Franchisor’s distinctive signs, trade name, trade mark, service mark, store sign, logo or other distinguishing identification
the Franchisor’s right to adapt the franchise system to new or changed methods
provisions for termination of the agreement
provisions for surrendering promptly upon termination of the franchise agreement any tangible and intangible property belonging to the Franchisor or other owner thereof.
6. The Code of Ethics and the Master Franchise System

This Code of Ethics shall apply to the relationship between the Franchisor and its Individual Franchisees and equally between the Master Franchisee and its Individual Franchisees. It shall not apply to the relationship between the Franchisor and its Master Franchisee.

The Treatment of Franchising by the Law of the European Community

The most important aspect of EU law as regards franchising is Article 81 of the Treaty of Rome. This is the EU's anti-trust law. It prohibits a number of practices commonly found in franchising. There are, however, a number of exemptions available to franchisors.

The new EU antitrust regime

The so-called “modernisation regulation” came into force on 1 May 2004. It re-defines the role of National Competition Authorities vis-a-vis the European Commission.

National Competition Authorities will now take the lead in applying European competition law (Articles 81 and 82 of the Treaty of Rome), whilst the European Commission will concentrate on European-wide problems and on ensuring uniformity of application.

The new regulation has four main effects:

It requires National Competition Authorities and courts within Member States to directly apply articles 81 and 82; this applies even in a domestic context and is intended to ensure uniformity of application.
It removes the requirement for businesses to notify restrictive agreements to the European Commission to gain exemption under Article 81(3).
The Regulation is intended to create a level playing field for the treatment of agreements across Member States by ensuring that National Competition laws do not prohibit agreements, which are permitted under Article 81.
The Regulation provides for Member States to co-operate more closely with each other in enforcing EC Competition Law in particular by exchanging information and conducting investigations on each other’s behalf. To facilitate this, a European competition network is established.
It is important to appreciate that the underlying law has not changed. What’s illegal today will remain illegal after 1 May 2004 1. It is the way in which the law is applied and not the substance of the law that has been changed. However, the procedural change is so wide ranging that it will have a number of practical implications for franchisors:

Firstly, and most importantly, there will be no more notification of restrictive agreements. Businesses will now have to evaluate their proposed agreements on the basis of existing case law and European Commission guidelines. Experienced European Counsel will play an important role in advising franchisors on their position. In practice, franchisors will not know for certain if their agreement infringes competition law until there has been litigation. This is seen as a weakness of the new regime by some. Others point out that the old notification system was cumbersome and expensive. They say that already under the old regime many companies preferred to perform a self-assessment 2.

It may still be possible to obtain informal guidance from the European Competition or the National Competition Authority where there is genuine doubt as to how to apply the competition rules to a particular agreement or set of circumstances.

The effect of the new regime will be that all agreements which satisfy the exemption conditions will automatically be exempt without the need for a prior decision by either the Competition Commission or a National Competition Authority.
The second important effect of the new regulation is that an agreement can no longer be prohibited under domestic law if it would not be prohibited under Article 81. Prior to 1 May 2004, there were a number of EU Member States with stricter regimes in place. For example, in Germany franchisors were not allowed to set either maximum or minimum prices, whilst under the applicable block exemption regulation maximum prices were permitted. These inconsistencies will now disappear.

However, National Competition Authorities will continue to apply stricter national regimes to unilateral conduct such as abuse of dominant position.
The De Minimis Exemption

Many franchisors have a market share of less than 10%. Thus, they do not need to take advantage of the block exemption as they are automatically exempted from Article 81(1).

Exemption available to franchisors

On 22 December 1999, the Franchise Block Exemption (Regulation EC4087/88) was replaced by a new Block Exemption Regulation (Regulation EC2790/1999) (the “Regulation”) creating a new broad safe harbour exemption from the impact of Article 81 of the EC Treaty (which was formerly Article 85).

As stated above, Article 81(1) prohibits agreements (or practices) which prevent, restrict or distort competition. In the past it has been interpreted to catch a broad range of the vertical restraints commonly found in franchising. The block exemption replaced not only the franchising block exemption, but also the exclusive distribution block exemption (Regulation EC 1983/83) and the exclusive purchasing block exemption (Regulation 1984/83).

Key points

Key points to note about the Regulation are:

it is only available to franchisors with a market share of less than 30%
it applies to both exclusive and non-exclusive arrangements
services and goods are included
multi-party agreements are now covered (i.e. more than two parties)
some vertical arrangements between competitors will be exempt
franchisors may impose maximum price restrictions on their franchisees (but not price maintenance).
Transitional provisions meant that current franchise agreements or franchise agreements which were in force at the end of May 2000 and complied with Regulation EC 4087/88 retainedtheir exemption from Article 81(1) until the end of December 2001.

The Commission has issued guidelines outlining its policy on interpretation of the Regulation. They are detailed and are crucial to a full interpretation of the block exemption. The Commission has indicated that it will regard itself as bound by the terms of the guidelines – although authorities and courts in Member States will not be bound by them.
What the Block Exemption means in practice

Franchising is not mentioned expressly in the Regulation, but is considered in the guidelines. The exemption will apply if the franchisor has less than 30% market share. As long as no hardcore restraints are included, the parties are left to negotiate their own terms. For franchisors, there remain a number of issues of concern under the Regulation including:

Exclusivity

Exclusive territories are not permitted, although a location clause will be allowed. Franchisees must be free to actively promote their sales to end users wherever located. According to the guidelines the area outside which mobile outlets may operate can also be restricted. A franchisee may be restrained from selling to unauthorised dealers outside the network.

Non-compete clauses

During the term, non-compete clauses of more than five years are not permitted unless the franchisor is the landlord of the franchisee (Article 5(a)). This will often not be the case. At the same time, the current draft guidelines provide that a non-compete clause relating to the goods or services supplied under the franchise arrangements, whilst not exempted under the block exemption, will not be caught by Article 81(1) as long as the franchisor is not dominant in the market and the restraint is necessary ‘to maintain the common identity and reputation of the franchised network’.

Post-term

A post-term non compete may be imposed if it:

relates to goods or services which compete with the goods or services dealt with by the franchisee under the terminated agreement; and
is limited to the premises from which the franchisee operated during the contract period; and
is indispensable to protect the franchisor’s know-how; and
is for a period of one year after termination.
If the franchisor cannot rely on De Minimis or SME Exemption (see page 3) then the post-term restriction will be unenforceable. The franchisor will need to amend the agreement or apply for individual exemption.

Tying

Franchisees may not be restrained from selling the brands of particular competing suppliers. Quality specifications may, however, be laid down (paragraphs 188-9 and 131 of the draft guidelines).

How does the market share test work?

The 30% market share test applies to the franchisor’s market share. The franchisor’s market share includes connected undertakings and relates to the sales value of the contract goods or services, together with competing goods or services. The benefit of the exemption will not be lost (for a two year period) if the 30% market share rises to 35%. If a party’s market share rises above 35%, then the exemption will continue to apply for one year. However, these two dispensations cannot be combined.

When can competitors use the block exemption?

The New Regulation contains a number of provisions concerning competitors. As regards franchises that deal in goods (but not services) vertical agreements between the association of franchisees and its members, or between the association and its suppliers, are permitted provided no individual member has an annual turnover of more than Euro 50 million ($US50 million). However, Article 81(1) may still apply to horizontal agreements between members, and to decisions of the association.

What if a franchise agreement falls outside the scope of the new block exemption?

A franchise agreement may not benefit from the new block exemption for a number of reasons. If it contains one of the hardcore restrictions contained in Article 4 of the New Regulation (such as exclusivity, price maintenance and restriction on cross supply) then the entire agreement will fall outside of the exemption and it will probably be caught by Article 81(1). It will then need to be individually assessed for a possible notification for specific clearance. If the agreement contains one of the black-listed restrictions set out in Article 5 (such as certain non-compete clauses), then only that provision will fall outside the scope of the exemption and it will also need to be assessed individually. If the market share test is failed then the agreement will not automatically lose the protection of the safe harbour straight away. The market and the parties’ position in the market, will need to be assessed to determine whether there is a serious risk of a reduction in competition. Retrospective clearance of such agreement under Article 81.3 can also be applied for.

How does this affect national competition rules?

It is a general principle of Community law that no provision of national law should conflict with the uniform application of the European competition rule (Recital 17 of the New Regulation paragraph 11 of the draft guidelines). To the extent that a franchise agreement falls outside the scope of the exemption, then national competition rules may apply. In the UK a new Competition Act will came into force on 1 March 2000. This new Act introduced a prohibition, the Chapter I prohibition, modelled closely on Article 81(1). Under the Act, an agreement which complies with the terms of a Community block exemption is treated as having a ‘parallel exemption’ under UK national law. The Act grants to the national regulator, the Office of Fair Trading (OFT), the power to limit, or withdraw the benefit of, a block exemption. This may be controversial where an agreement spanning more than one Member State benefits from the new block exemption and the OFT seeks to withdraw the benefit of the safe harbour. It is to be expected that the exercise of this power may be subject to challenge.

The new block exemption also contains an express power for the national competition authorities to withdraw the benefit of the block exemption where the effects of the agreement are felt in particular in that Member State and it constitutes a discreet geographic market (Article 7 of the Regulation). Where the geographic market is wider than a single Member State the Commission reserves the exclusive power of withdrawal of the benefit of the exemption.

Can the Commission withdraw the benefit of the exemption?

Yes. Under Article 6 of the New Regulation the Commission may withdraw the benefit of the exemption. This has rarely occurred, but the draft guidelines indicate that where the net effect of a series of similar agreements significantly restricts competition, or access to a market is foreclosed, it may intervene (Article 6 of the Regulationsnes).

The Commission may also disapply the exemption as regards agreements containing particular restraints in markets characterised by 50% coverage of networks of similar agreements.

Timing

The new block exemption will apply to new agreements made from 1 June 2000 and will last for ten years until 31 May 2010. Existing agreements which comply with one or other of the outgoing block exemptions are ‘grandfathered’ in until 31 December 2001. After that they must either comply with the new block exemption or be notified for specific clearance.

Small and medium-sized enterprises

Agreements between small and medium-sized undertakings (SME’s) (as defined in the Annex to Commission recommendation 96/280/EC) are considered by the Commission as being rarely capable of significantly affecting trade between Member States. Consequently as a general rule they are not caught by the prohibition in Article 81(1). Medium-sized enterprises typically have less than 250 employees with a turnover of less than ECU 40 million (US$40 million). Small-sized enterprises have a turnover of less than ECU 7 million (US$7 million).