This article was published on www.maverick-law.com
Franchise agreements play a special role in competition law. In an earlier blog we paid attention to the main competition law principles of franchise agreements. There recently have been various Dutch and European developments in this area. The current state of affairs in the field of franchise and competition is addressed in this blog.
Legal framework
Franchisors are keen to protect the uniform appearance of their formulas and the knowledge they have accrued. For that purpose they often include provisions in franchise agreements that restrict the commercial freedom of franchisees (such as non-compete clauses and purchase obligations). Those provisions may be at odds with competition law, since the cartel prohibition bars agreements or contacts between companies that may significantly restrict competition.
Franchise agreements have a special place in competition law: the Court of Justice of the European Union has ruled that if provisions of franchise agreements are necessary to protect the franchisor’s know-how and the identity and reputation of the franchise network, they are not in breach of the cartel prohibition. Furthermore, there is a safe haven for certain vertical franchise agreements in the Vertical Block Exemption Regulation. If the market share on the relevant market(s) of both the franchisor and the franchisee does not exceed 30% and the agreement does not contain any hard-core restrictions, the agreement does not fall within the scope of the cartel prohibition.
Dutch case law
Recent cases have further defined the relationship between franchise agreements and competition law.
Obligation to furnish facts and burden of proof
In 2018, the Court of Midden-Nederland assessed a non-compete clause in the funeral sector. The franchise agreement provided that a former franchisee was prohibited after termination of the agreement from performing any competing activities in the territory for a period of one year. The preliminary relief judge found that this non-compete clause was consistent with the cartel prohibition because the claimant had furnished insufficient specific and relevant facts on the basis of which the judge could assess whether competition was appreciably restricted. Unfortunately, parties in civil proceedings are regularly faced with this stumbling block: the party relying on competition law must substantiate its position by presenting relevant economic and other facts and circumstances, so that the market in question can be sufficiently understood to determine whether and, if so, to what extent free competition on that market is being or might be distorted.
However, the Vertical Block Exemption Regulation provides that one-year post-contractual non-compete clauses are exempt, provided that the clause is limited to the location (premises and grounds) where the franchisee worked. In the case in question the non-compete clause may have been broader, because the term werkgebied (territory) was used. If the claimant had complied with the obligation to furnish facts and with the burden of proof it was under, it could have argued that the clause was geographically broader than strictly necessary to protect the franchisor (and was therefore in breach of the cartel prohibition).
Resale price maintenance
In 2018, the Court of Appeal of Den Bosch assessed the admissibility of resale price maintenance. Franchisees in the field of training and courses argued that the franchise agreements in question were void because the applicable regulations obligated the franchisees to apply a fixed resale price. The Court of Appeal found that this was indeed a prohibited form of resale price maintenance, because it was aimed at restricting competition. It is remarkable that it is not apparent from the judgment that the franchisees had presented economic facts and circumstances to further substantiate their argument that a restriction of competition was involved. The Court of Appeal therefore appears somewhat more lenient than courts have been in competition cases in the past. In light of the seriousness of the violation (resale price maintenance is a no-go), this approach of the Court of Appeal is easy to explain in our opinion. But the Court of Appeal found with regard to the nullity that not the entire agreement was void, in the absence of an inextricable connection between the regulations and the franchise agreement.
Avoid horizontal cooperation
Parties must beware, however, that their cooperation in a franchise formula does not have or acquire a horizontal nature. In 2011, ACM fined four industrial laundries, on the grounds that they had breached the cartel prohibition by working together, according to ACM: the franchisees were able to influence the admission of new members and the allocation of districts. Both the court and the Trade and Industry Appeals Tribunal found, as did ACM, that their cooperation essentially constituted unlawful cooperation between competitors. The reason for this was that the franchisees were the sole shareholders in the franchise formula and were closely involved in the franchise policy. They therefore called each other to account regarding compliance with their competition restricting obligations. In sum, parties must ensure that a franchise formula does not constitute (disguised) horizontal cooperation between competitors, because the assessment of horizontal agreements against the cartel prohibition is much stricter than the assessment of vertical agreements.
Possibilities of restricting online sales
The European Court of Justice (the “ECJ”) confirmed in the famous Coty judgement that a supplier of luxury products may prohibit selective distributors from selling via an Internet platform such as Amazon or Bol.com. Coty Germany, a company selling luxury cosmetics in Germany, imposed such restrictions on its distributors in order to maintain the luxury image of its brand.
In its judgment, the Court of Appeal first found, in keeping with established case law, that a selective distribution system is not in breach of the cartel prohibition if the distributors are selected on the basis of objective, qualitative, proportional and non-discriminatory criteria. The ECJ then found that selective distribution may be necessary in the case of luxury products in order to protect the prestigious image, since it helps to safeguard the quality of the product. It ruled that selling the product only via approved resellers, which are guaranteed to meet the agreed quality requirements, is an appropriate means of protecting the luxury image: the Internet platforms do not form part of the selective distribution system, which prevents the supplier from enforcing quality requirements. The fact that platforms are a sales channel for all kinds of products also does not contribute to the luxury image of the product, in the ECJ’s opinion.
All in all, the ECJ found in this judgment that a marketplace ban is not a hard-core restriction. In our opinion the scope of the Coty judgment (1) is not restricted to luxury products alone and (2) is not restricted to selective distribution. Also in the case of selective distribution of non-luxury products, it is permitted to stipulate quality requirements regarding the environment in which the products are sold. Those quality requirements cannot be enforced in the case of a third-party platform, in the absence of a contractual relationship between the supplier and the platform. Regardless of whether a luxury product or selective distribution is involved , a ban on sales via third-party Internet platforms is still permitted if the supplier and distributor have a market share of less than 30%. When parties have a higher market share, it has to be assessed in each individual case whether a luxury product or selective distribution is involved, or whether an individual exemption is possible.
The Amsterdam Court applied the ECJ’s approach in the Coty case to a case involving the franchise formula of the Size Zero Easy Shape weight-loss product. The franchisor prohibited franchisees from independently offering their products on an Internet platform. The franchisor itself did use the Internet platform in question to offer collective nationwide campaigns. Two franchisees argued that the ban on selling via Internet platforms was in breach of the cartel prohibition. The franchisees did not dispute the franchisor’s argument that Size Zero Easy Shape constituted a luxury product. The Amsterdam Court therefore found that, in keeping with the Coty judgment, a ban on selling via an Internet platform may be permitted in the case of luxury products to protect the luxury image, provided that the ban is proportionate to the proposed objective. That latter point is where things went wrong for the franchisee, because the franchisee itself did use the Internet platform in question. In the Amsterdam Court’s opinion, Size Zero’s reliance on reputational damage was inconsistent with that use. The ban imposed on the franchisees was therefore in breach of the cartel prohibition.
Other developments
Vertical restraints and geo-blocking
Online platforms and Internet sales have a major impact on franchising. We have noticed that franchisors are increasingly trying to influence the online sales behaviour of their franchisees (for instance by banning sales via platforms, as in the Coty case). The interest in these types of restraints, which are not always permissible, is therefore increasing. In May 2017, the Commission published a report on its e-commerce sector inquiry. The report showed that online sales and advertising restrictions, restrictions on online platforms and geo-blocking are the main causes of competition law problems. Geo-blocking is involved if traders block or restrict access to their websites and apps for customers from other member states, thereby undermining the free movement of goods. A case in point is the Commission v. Guess, on which the Commission imposed a fine in 2018. Guess prohibited its distributors from selling products outside an area allocated to them (geo-blocking). The resellers were furthermore allowed to advertise only in that specific area. These actions constituted a violation of the cartel prohibition in the Commission’s opinion. A fine of more than EUR 39 million was consequently imposed on Guess.
Vertical Block Exemption Regulation ends in 2022
As explained above in the legal framework, franchise agreements may in some circumstances profit from the safe haven offered by the Vertical Block Exemption Regulation. This Regulation, however, ends on 31 May 2022.
The European Commission is currently evaluating whether the exemption should remain in place, or whether it should be amended or abolished. For that reason the Commission has conducted a public consultation to form an impression of the opinion of stakeholders on the Block Exemption Regulation. According to the Commission, that evaluation has shown that the franchise sector is one of the sectors that is not convinced of the positive effects of the Block Exemption Regulation (compared with other stakeholders). In the Commission’s opinion, one of the reasons for this is the increased importance of online sales and online agents: the Block Exemption Regulation offers the parties little to go by in these areas. That is not entirely illogical, since the Block Exemption Regulation is almost ten years old and the current developments were not taken into account to a great extent when it was drawn up.
Conclusion
The developments regarding digitalisation and online sales also have a major impact on franchise relationships and will definitely give rise to new civil cases in the future. We furthermore believe that competition authorities will focus more on vertical restraints in the coming years. It is therefore important for every franchise formula to thoroughly study the dos and don’ts of competition law.
This blog was also published as an article in Franchise & Recht (franchise.nl).