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31 July 2018
Franchise agreements may be cancelled on various legal grounds (eg, due to a franchisee's error or wilful misrepresentation by the franchisor). Pre-contractual disclosure in franchise agreements is the subject of extensive and recurring case law in France where the franchisee's business becomes unsuccessful and the franchisee alleges that it was misled by the franchisor on the financial prospects of the business. Where a court considers that a lack of information (or inaccuracy in this regard) has deceived the franchisee, it may hold the franchise agreement null and void and, in some cases, find the franchisor liable for damages if the latter has committed misrepresentation.
Once the agreement has been cancelled by the court in such circumstances, an issue arises as to the practical consequences of such cancellation for the parties. Contrary to termination, which normally operates only in the future, cancellation means that the agreement should never have existed as per Article 1178 of the Civil Code. This means that the parties must be placed into such a situation as if the agreement had never been entered into (retroactive effect), giving rise to restitutions on both sides.
The challenge for franchise agreements is that restitutions made to franchisees often include entry fees and royalties paid by the franchisee during the agreement, while the services provided by the franchisor (eg, know-how, assistance, training and licencing of IP rights) may not be restituted as such.
As illustrated below, this is often a critical issue on which the courts' position is not always consistent.
In a recent Paris Court of Appeal decision concerning a franchised hairdressing business,(1) the court held that the agreement was null and void on the ground that the precontractual information provided to the franchisee was materially incomplete in light of the applicable legal provisions.
Turning to the subject of restitutions, the court referred to the principle that 'cancellation' is defined as retroactive deletion of a contract, even if its performance takes place over time. It thus awarded the bankrupt franchisee's liquidator amounts equal to the entry fees and royalties paid by the franchisee. The franchisor argued that these amounts should be reduced due to the benefits that the franchisee had derived from the services provided by the franchisor. In response, the court stated that:
There is no reason to deduct any benefit derived by the franchisee from the services provided by the franchisor during the agreement since only the party to the cancelled contract who is of good faith may request the sentencing of the liable party to repair the loss incurred as a result of the execution of the cancelled contract.
In other words, depending on which party is deemed liable for cancellation of the agreement, the extent of the restitutions may vary.
The Paris Court of Appeal's decision is open to criticism, as it arguably mixes two different issues:
Further, the decision contravenes the principles of the Civil Code. The abovementioned Article 1178 provides that performed services must give rise to restitution, while Article 1352-8 adds that the restitution of a service must be made in value, which is determined when the service is rendered.
In a 2016 Supreme Court judgment,(2) the court reaffirmed that where a cancelled agreement has been performed, the parties must be placed in the same situation as existed before such performance. Where this is impossible, the party that benefitted from such service which cannot be restituted in kind must pay a restitution in value.
A contrary solution would obviously create an unfair unbalance to the detriment of the franchisor, as it would mean that the franchisee could freely keep the know-how and methods it had benefitted from, while the franchisor would have to repay the monetary amounts paid by the franchisee.
It is often difficult in practice to assess a posteriori (when the agreement is held null and void by the court) the value of the know-how and services that the franchisee had benefitted from while the agreement was in force (assuming, of course, that such know-how and services have been effectively provided).
Overall, a franchisor's situation will not be completely secure in light of this case law; instead, it very much depends on the circumstances of the case, including the severity of the reasons for cancellation. Some courts have completely ignored the restitution to be made to the franchisor, considering only the restitution to be made to the franchisee. Other decisions have concluded that since the services rendered by the franchisor may not be restituted in kind, the franchisor need not repay the financial consideration paid for such services (ie, entry fees, royalties and marketing fees). Finally, some decisions have attempted to fix the amount of the restitution in value that the franchisor is entitled to for the services and benefits provided to the franchisee (but often as a rule of thumb).
As the cancelled agreement is deemed never to have existed, the contractual provisions are not binding on the judge when taking a decision. However, it may be worthwhile incorporating in the franchise agreement or in the disclosure document some information on the value of the services provided by the franchisor (eg, training and marketing investments) so that in the event that a franchise agreement is cancelled by a court, such information is brought to the attention of the judge and the risk of the franchisor having to repay all of the entry fees and royalties without receiving anything in return is more limited.
For further information on this topic please contact Raphael Mellerio or Bertrand Baheu-Derras at Aramis Law Firm by telephone (+33 1 53 30 7700) or email (firstname.lastname@example.org or email@example.com). The Aramis Law Firm website can be accessed at www.aramis-law.com.
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