New decision on franchise law by the Higher Regional Court Frankfurt a.M.
Recent decisions on the franchisor's pre-contractual duty to inform and on jurisdiction agreements in franchise agreements
The Higher Regional Court of Frankfurt on the Main (“Higher Regional Court” or “the court”) has dealt with the franchisor's pre-contractual duty to inform in two decisions. In the first decision of 01 December 2021 (Case No. 12 U 7/21), the Higher Regional Court provides findings on whether a franchisor is liable for statements made by a consulting firm recommended by him or for a business concept prepared by this consultancy firm. The second decision of 08 December 2021 (Case No. 4 U 251/20) deals with the pre-contractual duty to inform in cross-border master franchise agreements. As an aside, the Higher Regional Court takes a position on the question of whether jurisdiction agreements in franchise agreements with business founders can be effectively agreed.
I. Judgment of 01 December 2021 – 12 U 7/21
Facts
The defendant franchisor runs a franchise system, the object of which is to operate cosmetic studios for permanent hair removal.
The plaintiff franchisee approached the franchisor in May 2015, expressing interest in the franchise system. As part of the initial provision of information, the franchisor gave the franchisee a company brochure on its franchise system. After a reservation agreement had been signed, the franchisor sent the franchisee an information brochure for prospective franchisees and a location check. Upon the franchisor’s recommendation, the franchisee then engaged a consultancy firm to draw up a business plan which also included information from the franchisor’s area of business. The franchisee presented this plan to its bank in order to obtain financing for the franchise business. The wife of the consultancy firm’s CEO was also a franchisee of the franchisor. In February 2016, the franchisor and the franchisee entered into the franchise agreement.
The business plan included the recommendation for the franchisee to conduct cold calling, e.g. by approaching potential customers in shopping malls. After the franchisee was unsuccessful in her cold-calling campaign to win customers, she closed her business. She challenged the franchise agreement on the grounds of fraudulent misrepresentation due to faulty pre-contractual information given by the franchisor and demanded the cancellation of the franchise agreement. The franchisor refused to cancel the agreement, demanded further payment of the franchise fees and imposed various contractual penalties after issuing a warning.
In essence, the parties were in dispute over the question of whether the business plan provided by the consultancy firm had given the franchisee false expectations due to misleading information and whether this could be attributed to the franchisor. The trial court (Darmstadt Regional Court, judgment of 25 November 2020 – 9 O 198/18) ruled that the franchisor had not breached its pre-contractual duty to inform the franchisee. The information package provided contained all essential information and the business plan prepared by the consultancy firm could not be attributed to the franchisor. It was only prepared at the franchisee’s instigation and was not produced for clarification purposes, but to be presented to the bank for obtaining financing.
Decision
The Higher Regional Court confirmed the ruling of the Darmstadt Regional Court. It came to the conclusion that any misrepresentations in a business concept prepared by a consultancy firm recommended by the franchisor but commissioned by the franchisee cannot be attributed to the franchisor and therefore cannot be the basis of a pre-contractual breach of duty to provide information.
The court first repeats the requirements that are generally placed on the franchisor's pre-contractual duty to inform (within the meaning of section 311 (2) of the German Civil Code): In principle, each party bears its own contractual risk. They must inform themselves about the risks and opportunities of the envisaged business relationship and form their own opinion of the market opportunities. It is not up to the franchisor to provide start-up advice to a potential franchisee. In particular, the franchisor does not have to inform the franchisee about the general risks of self-employment or draw up calculations for a franchisee which it is able to prepare itself with basic business knowledge. However, the franchisor must not deceive or mislead the franchisee about circumstances essential to the contract. Also, the franchisor must inform the franchisee about circumstances which are known only to the franchisor and regarding which the franchisor knows, or ought to know, that they influence the franchisee’s decision. This applies in particular to circumstances which are key to the franchisee’s business success and which the franchisor is more familiar with due to its knowledge of the system and its position in the market. The scope of this duty to provide information cannot be defined in general terms, but depends on the circumstances of the individual case, taking into account the principle of good faith (see also Hamburg Higher Regional Court, judgement of 25 February 2022 - 1 U 104/19).
Based on these principles, the court held that the franchisor had not breached any duty to inform. The court did not have to comment on whether parts of the business plan prepared by the consultancy firm were misleading or insufficient. It is already lacking that the actions of the consultancy firm could be attributed to the franchisor according to section 278 of the German Civil Code. According to section 278 of the German Civil Code, the franchisor would only have had to accept the fault of the consultancy firm if the consultancy firm had been a vicarious agent (“Erfüllungsgehilfe”) of the franchisor, which the court denied in the present case.
Since the creation of the business concept was not a separate obligation of the franchisor that it had to fulfil towards the franchisee. The purpose of the business plan was to obtain financing from a bank. It did not serve to inform the franchisee. Additionally, the consultancy firm was not commissioned by the franchisor, but by the franchisee. No attribution can be made solely based on the recommendation of the consultancy firm by the franchisor or on the basis of personal connections (via the wife of the firm’s CEO).
Even an overall view of the circumstances did not justify a different result in the opinion of the court: irrespective of whether the franchisor had provided the consultancy firm with incorrect or insufficient, i.e. outdated, information regarding the business plan, it was the responsibility of the consulting firm to update information on the franchisor or on the development of the system.
II. Judgment of 08 December 2021 - 4 U 251/20
Facts
In the second case, the plaintiff master franchisor based in Germany concluded a master franchise agreement with a defendant master franchisee based in France. The master franchisee was a business founder when the master franchise agreement was concluded. The parties had made a choice of law in favor of German law in the franchise agreement as well as an agreement on the place of jurisdiction on the courts in Frankfurt on the Main, Germany. The master franchisor brought an action seeking payment of the contractually agreed entry fee. The master franchisee defended itself against this claim. For a start, it was of the opinion that the choice of law clause was inadmissible and that French law should be applied. Furthermore, it took the view that the jurisdiction agreement was invalid and that it had no obligation to pay the entry fee because the master franchisor had breached its pre-contractual duty to inform. The master franchisee alleged that the assertion of the claim for payment of the entry fees was therefore in any event an abuse of law (section 242 of the German Civil Code).
Decision
Regarding the agreement on the place of jurisdiction, the court confirmed the legal opinion of the lower court that this agreement was admissible. The master franchisee was a business founder who did not take up a commercial activity until the master franchise agreement was concluded. In such cases, it is controversial whether a jurisdiction agreement can be validly concluded under German law (cf. section 38 of the Code of Civil Procedure). While the Stuttgart Regional Court, for example, recently held such a so-called prorogation to be inadmissible (Stuttgart Regional Court, decision of 18 October2021 - 15 O 298/21), the lower court took the position that it is sufficient for the status of a merchant that a commercial enterprise is first established by the master franchise agreement. A jurisdiction agreement could therefore be effectively agreed with business founders. The Higher Regional Court confirmed this legal opinion. In addition, the court stated in the context of the argumentation on the consumer contract (Art. 6(1) and (2) of the Rome I Regulation) that the purpose for which the contract is concluded is decisive for the classification as a consumer. The fact that the master franchisee only started the commercial activity for the future does not change the fact that the activity is of a commercial nature and the master franchise agreement was therefore concluded for a commercial purpose.
In the matter of the pre-contractual duty to inform, the court initially reiterated the principles provided in the first decision: The master franchisor must inform the master franchisee completely, unambiguously and correctly about all circumstances that are obviously of substantial importance for its investment decision. The reason for the pre-contractual duty to inform is the information gap that typically exists between the parties. The (master) franchisor often has information on the investment needs, sales, costs and earnings of the existing system operations, which it can use to draw conclusions about the development of new operations and for making forecasts as to future developments. This is usually not possible for the (master) franchisee. The information gap exists especially when the franchisee - – as in the present case – is not an experienced business person, but rather a business founder.
In the present case, it was undisputed between the parties that the master franchisor had made inaccurate statements prior to the conclusion of the contract; in particular, the defendant master franchisee was inaccurately informed about the sales opportunities and the prospects of success of the franchise system. Moreover, the master franchisee only found out after the conclusion of the contract that the marketing opportunities – contrary to the statements in the recitals of the master franchise agreement – were scientifically disputed. As a result, the master franchisor was thus not entitled to payment of the entry fee This was because the entry fee had been validly agreed, but due to the breach of the duty to inform, the master franchisor would have had to pay the entry fee as damages pursuant to sections 280 (1), 311 (2) no. 1 German Civil Code in conjunction with section 249 German Civil Code, so the master franchisee would have had to return the entry fee to the master franchisee almost immediately, which would have made it contrary to the principles of good faith to claim the entry fee.
III. Conclusion
The Higher Regional Court of Frankfurt on the Main confirms and clarify the existing standards regarding the scope of the franchisor's pre-contractual duty to inform in national and cross-border situations. If (as is usually the case) the franchisor has no contractual obligation to provide a business plan to the franchisee, the franchisor is also not liable for a business plan that an external consultancy firm prepares on behalf of the franchisee. This also applies if the franchisor has recommended a certain consultancy firm firm which then prepares the business plan.
Nevertheless, the ruling shows that the outcome always depends on the circumstances of the particular case. In fact, the franchisor may become liable if it promises support in preparing a business plan or instructs an external consultant to prepare the plan. In these cases, or where the franchisor deliberately collaborates with the consultant to the detriment of the franchisee, other bases for liability are conceivable as well. Both the franchisor and the franchisee are therefore well advised to clearly define who is responsible for the assignment and the purpose of the assignment before commissioning an external consultant, if necessary by seeking legal advice.
The Higher Regional Court affirmed the still controversial question of whether effective jurisdiction agreements can also be concluded with franchisees as founders of a business - in pleasing contrast to the Stuttgart Regional Court (decision of 18 October 2021 - 15 O 298/21). Nonetheless, parties should be aware that there is a risk that German courts will regard jurisdiction agreements with business founders as invalid until such time as the issue has been resolved by the Federal Court of Justice.
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