The franchisor’s pre-contractual duties to inform: Judgement of Munich Higher Regional Court dated 23 June 2021 – 7 U 6141 /19

Introduction

Under German law, each party to a contract is generally responsible for informing itself about the general market conditions and the resulting risks prior to entering into a contract. As an economically independent entrepreneur, the franchisee itself has to bear the economic risks associated with entering into contracts, as does any other businessperson. In order to enable the potential franchisee to realistically assess these risks, however, the franchisor is obligated to inform the potential franchisee prior to entering into the contract about such circumstances that are known only to the franchisor and about which the franchisor knows or must know that they may influence the potential franchisee’s decision to enter into the contract. In franchise law, the franchisor’s pre-contractual duty to inform is discussed in particular in connection with the conclusion of franchise agreements. However, the pre-contractual duty to inform applies not only prior to the conclusion of a franchise agreement, but to the conclusion of any contract that the franchisor enters into with the franchisee. This is because the commencement of contractual negotiations creates a pre-contractual relationship of trust which gives rise to mutual duties of protection (sections 311(2) and 241(2) of the German Civil Code).

In its judgement (dated 23 June 2021 available at juris – 7 U 6141/19), Munich Higher Regional Court recently had to decide whether the franchisor had breached its pre-contractual duty to inform the franchisee in connection with the conclusion of a company purchase agreement.

Facts of the case

The judgement was based on the following facts: The franchisor (defendant) operated a franchise system in the fast-food sector and owned 100% of the shares in a company (in the following: the “Company”) which was fully sold to the plaintiff by way of a notarised purchase agreement. The Company was to operate a restaurant – not yet in business at the time the purchase agreement was concluded – as a franchisee in the defendant’s franchise system. The parties agreed to pay the purchase price in instalments.

The Company had already entered into a franchise agreement with the franchisor prior to the conclusion of the purchase agreement, i.e. at the time when it was still wholly owned by the franchisor as parent company and the plaintiff was not yet a managing director. Later, the franchisor terminated the franchise agreement for cause due to non-payment of the franchise fees and due to discontinuation of business operations.

With the lawsuit, the plaintiff and the purchaser of the company’s shares contested the enforcement of the purchase agreement, with which the defendant asserted the outstanding purchase price debt. In addition, the plaintiff asserted claims for damages on his part.

He primarily based his claim on the fact that the purchase agreement for the shares in the Company was to be rescinded due to incorrect pre-contractual information, thus preventing the defendant from demanding payment of the outstanding purchase price. Instead, the plaintiff claimed to have a claim for damages against the defendant on his part. He was of the opinion that the franchisor had verbally promised minimum sales figures. Moreover, he stated that the franchisor had also predicted annual sales that would increase every year in an earnings forecast that had been sent to him. However, the projected figures were completely incorrect. The sales had turned out to be significantly lower.

The plaintiff’s action was dismissed by Munich Regional Court (judgement dated 19 September 2019 – 29 O 12976/17). In the appeal proceedings, Munich Higher Regional Court now had to assess whether the franchisor had breached its pre-contractual duty to inform.

Court’s reasoning

Munich Higher Regional Court dismissed the appeal. There was no breach of the pre-contractual duty to inform.

1. The court first clarified that a clear distinction must be drawn between the individual contractual relationships. The plaintiff contested the claim arising from the notarised purchase agreement to which he – and not the Company – is a party. He demanded the cancellation of this purchase agreement. In addition, he asserted (at least primarily) his own claims for damages, not those of the Company. All of this is exclusively based on the purchase agreement for the shares in the Company, not the franchise agreement. The fact that the purchase agreement was preceded by the conclusion of a franchise agreement between the Company and the defendant does not change the fact that the contractual relationships are separate and must therefore be assessed separately.
   
   This becomes particularly clear from the fact that the defendant did not have any duty to inform the Company prior to entering into the franchise agreement. This is because at that time, the defendant was still the shareholder (parent) of the Company. Also, the franchisor (defendant) and the Company still had identical managing directors, with the result that they had the same knowledge.
   
   
2. With regard to the purchase agreement, the court first determined that only an intentional breach of the pre-contractual duty to inform could lead to a cancellation of the purchase agreement. This was because in the case at hand it was disputed whether a quality (earnings potential) of the object of purchase had been agreed upon. The court reasoned, however, that German warranty law, which takes precedence in this respect, required intentional conduct. Consequently, this must also apply to the pre-contractual duty to inform. Otherwise the warranty law would be undermined.
   
   
3. After the conclusion of the taking of evidence, the court could not find an intentional breach of the pre-contractual duty to inform by the defendant. In the course of the taking of evidence it turned out that the defendant had not presented the actual achievement of a particular level of turnover by the plaintiff as certain. The plaintiff’s witness statements were able to be refuted by the defendant’s witness statements. The defendant’s witness credibly stated that he did not promise or guarantee any sales figures. He also only released the internal data at the plaintiff’s insistence and with the explicit remark that the plaintiff could “play around” with the data.
   
   In the course of the taking of evidence it also emerged that the figures provided by the defendant were not given arbitrarily. The defendant’s witness credibly stated that he believed in the figures provided. The figures therefore reflected the defendant’s expectations, even if they were only estimates.
   
   There was also no breach of the duty to inform derived from the fact that the franchisor had to file for insolvency in 2003 and 2007. Insolvency is not a circumstance requiring disclosure in this respect. It was therefore unlikely to jeopardise the performance of the contract. In fact, insolvency had already occurred five years earlier and had been overcome by the franchisor. Consequently, it was within the plaintiff’s sphere of responsibility to inform himself about the franchisor’s background. It would also have been possible for him to do so via the internet.
   
   In addition, the purchase agreement contains an unambiguous exclusion of liability in favour of the defendant, which also includes any claims for breach of any pre-contractual duty to inform. The exclusion of liability also related – as is customary in company purchase agreements – to information regarding profitability. The profitability also includes information on sales, which was used to determine the profitability. Also, when the defendant sent figures to the plaintiff, it was always pointed out that they were only an estimate and that no liability was assumed.

Conclusion

The ruling by Munich Higher Regional Court illustrates that the franchisor’s pre-contractual duty to inform plays a role not only in the conclusion of the franchise agreement but also in the context of company purchase agreements. It also becomes clear that it is generally the franchisee’s responsibility to obtain comprehensive information before entering into the contract. In fact, legal disputes regarding the breach of the pre-contractual duty to inform often result in the taking of evidence. The franchisor will therefore be well advised to clearly state that any figures presented by it are only an estimate. For the purpose of verifiability, this statement should be made in writing. Otherwise, the franchisor risks being exposed to the assertion of claims for damages or the rescission of company purchase agreements. It is also advisable to include exemptions from liability with regard to the earning power in company purchase agreements.