There is no specific franchise law in Germany. However, franchisees do enjoy a relatively high degree of protection.
Some German courts now expect franchisors to bring debt collection proceedings rather than terminate a franchisee for non payment of franchise fees.

This disturbing recent trend in German franchise law is the result of the application of the former Article 9 of the German Unfair Contract Terms Act (now Paragraph 307 of the German Civil Code) to termination clauses. Article 9 allows the courts to strike out unfair provisions in a standard form agreement. Previously it was thought that the parties to a franchise agreement were free to agree what constitutes “a material breach” which would entitle the franchisor to terminate. A presumption applied that any matter listed in the termination clause would be a serious matter because the parties had specifically agreed to insert it into the termination clause.

Where franchise agreements contained a technical right to terminate for minor offences, the courts used the general principle of good faith which applies to all contractual relationships in Germany to help the franchisee. This meant that each individual termination notice was considered from the point of view of good faith. Even when the contract, on the face of it, entitled the franchisor to terminate, he had to consider whether it was “bad faith” on his part to terminate for relatively minor breaches. In practice this meant that prior to terminating a franchise agreement for technical breach, the franchisor had to consider whether (having regard to all the circumstances of the breach and his general relationship with the franchisee) it was fair and reasonable to terminate.

More recently a new trend has started whereby the courts will strike out unreasonable termination clauses in their entirety without considering the detailed facts of the termination notice in question. If the clause has been struck out, it no longer applies, so that termination for non payment becomes impossible.

In the so-called “Burger King” case, the Court of Berlin struck out a termination clause which entitled Burger King to terminate its franchise agreements in the event that the franchisee did not pay royalties due within 10 days of having received a written reminder notice. This is of course a very common clause which can be found in many franchise agreements. The court came to the conclusion that the termination clause was creating a significant imbalance between the rights and obligations of the parties and was therefore “unfair”. In these cases the German Unfair Contract Terms Act (now part of the Civil Code) provides that a court can strike out the clause in its entirety. The reasoning was that franchise agreements involve long term commitments (of usually between 5 and 10, sometimes even 20 years). The court felt that it was unfair to stipulate that such an agreement which involves substantial investment and commitment on the part of both parties should be terminated because one party is 10 days late with a payment. In the opinion of the court, termination for non payment can only be justified where the delay exceeds 6 weeks. The court suggested that in some cases a delay of more than 6 weeks (for example 12 weeks) may be necessary before termination can be justified. The Court suggested that Burger King bring debt collection proceedings to recover the amount outstanding.

What “period of grace” should franchisors allow before they terminate for non payment?

The correct period depends on the nature of the contractual relationship between the parties, particularly its duration and the amount of investment which the franchisee has to make. The franchisor has to consider particularly that termination of the franchise agreement before its contractual expiry date could drive the franchisee to insolvency. In the circumstances, the clause was struck out.

Practical Steps

Franchisors will have to review their termination clauses to allow for a much longer “period of grace” in the event of payment delay. We recommend a solution which allows termination for non-payment in the following two cases.

Payment default of more than six weeks in respect of an amount equal to at least one month’s franchise fees, or
Payment delay of twelve weeks with respect to an amount of more than 5000 Euro.
It has to be noted that the amount has to be set at an appropriate level. The franchisor has to ask itself what amount of arrears has to build up before a relationship with a franchisee is no longer tenable. Depending on the size of the business and the investment required, 5000 Euros/one month’s fees may or may not be the correct figure.