On June 16, the Dutch Parliament, voted in favor of the proposed new franchise law. This all but guarantees that the law will pass. The Dutch equivalent of the Senate must approve the law, but it expected to do so later this year. Barring some unforeseen circumstances, the law will take effect on 1 January 2021 in its current form.
Up till now, there was no specific law regulating franchise agreements in the Netherlands. Instead, franchising has been governed by general Dutch contract law.
Over the years, the Dutch government has become more interested in adopting specific regulations for franchising. The background of this legislative proposal is that government believes that franchise is an increasingly important sector, and that franchisors have – as they are the owners of a business method (which the Dutch legislation calls “formula”) – dominance over franchisees. The new law aims ‘to restore balance’ by strengthening the legal position of franchisees.
This article aims to provide the reader with an overview of the most relevant aspects of the new law.
Definition franchise agreement
The law introduces a legal definition of franchise. The Dutch franchise law will apply to all forms of franchise, regardless of the characterization that parties grant their form of cooperation as long as the definition of franchise agreement is fulfilled: “an agreement whereby, in exchange for a fee, the franchisor provides the franchisee the right and obligation to exploit a franchise formula in a designated manner for the production or sales of goods or the performance of services”. The law also provides that franchisor and franchisee have to act towards each other as a ‘good franchisor and a good franchisee’. According to the explanatory memorandum of the legislator, parties have to act reasonably towards the other party. What is reasonable conduct depends on the circumstances, for example the type of franchise formula, the branch, the size of the franchise chain, the duration of the franchise relationship and the experience of the parties.
According to the law, the franchisor must provide its franchisee with a disclosure document at least four weeks prior to the date the franchise agreement will be concluded.
The information that must be provided by the franchisor must include : i) the (negotiated/final) draft franchise agreement, including annexes; ii) full details of fees, mark-up charged on the supply of products or services and other financial commitments such as the expected investments for the franchisee (including recurring investments); and iii) information regarding: 1 the way and frequency of the consultation between franchisor and franchisee (e.g. franchisee council, if applicable), 2 the extent and manner the franchisor may compete with the franchisee (whether or not via a derivative formula, such as a webshop), and 3 the manner and frequency of how the franchisee may take note of the turnover figures that are relevant for its business operations. Furthermore the franchisor must provide relevant information about its financial position. Providing a prognosis is not compulsory.
During the four-week period, there is a standstill, meaning that the franchise agreement shall not be amended to the disadvantage of the franchisee and the franchisor may not induce the franchisee to make payments or investments related to or in connection with the franchise agreement.
The franchisee has the obligation to carefully assess the information provided by the franchisor, engage advisors (if necessary) and make inquiries about the experiences of other franchisees with the operation of the franchised business. It is stressed that franchisees are responsible for making their own business decision.
The law introduces some obligations for the franchisor for the duration of the franchise agreement, such as the obligation to a) inform the franchisee regarding intended amendments to the franchise agreement, b) information regarding required investments by the franchisee, c) the notification of any decision of the franchisor to use, directly or via third parties, a “derivative formula”, which notification must include the “essence of the derivative formula”, and d) other information if the franchisor knows or should reasonably have known that the information is important in carrying out the franchise agreement. Additionally, the franchisor must provide an annual report to the franchisee on how it has spent franchisee contributions to central marketing and other share services. The consultation between franchisor and franchisee will take place at least once per year.
The franchisor is required to provide the franchisee with all commercial and technical assistance that is reasonably expected in view of the nature of the franchise formula. If the franchisee deems a form of assistance necessary, it will inform franchisor and parties will enter into consultation with one another.
Termination and Goodwill Compensation
The Dutch law further introduces the notion of goodwill compensation upon termination of the franchise agreement. The franchise agreement must stipulate 1) the method how to assess a) whether there is any goodwill in the undertaking of the franchisee, and b) if yes, how to calculate this goodwill, and c) to what extent the goodwill is attributable to the franchisor; and 2) the method how the franchisee is compensated for the goodwill attributable to the franchisee, if the franchisor takes over the undertaking of the franchisee to operate the location itself or to transfer the company to a new franchisee. If there is a transfer between franchisees, the goodwill provision is not applicable.
A post term non-compete clauseis only valid if it is in writing, and the restrictions of the franchisee must be limited to activities that compete with the franchise. Furthermore, the restrictions must be essential to protect the knowhow that was transferred from the franchisor to the franchisee and the restriction may not apply longer than one year after the end of the franchise agreement. Lastly, the geographical restriction may not be wider than the area in which the franchisee operated the franchise formula based on the franchise agreement. This reflects the position under EU competition law.
Changes to the formula and consent
Certain major system changes may be subject to consent. The law states, if the franchisor wishes to “change the formula” or intends to operate a “derivative formula”, franchisees may have the right to consent. The franchisor requires the consent of its franchisees, if the franchisor intends to make use of a unilateral change clause in the franchise agreement or if the franchisor wants to operate a competing business using a new version of the franchise concept (so-called “derivative formula”) without formally amending the franchise agreement. This will typically be the case if the change is implemented through a manual change and is operational rather than legal in nature. A manual or system change will require consent if the franchisor seeks a) an investment of the franchisee, or b) a higher fee, margin or other financial commitment from the franchisee, or c) franchisee to pay other expenses, or d) implement any measure and it is reasonably foreseeable that there will be a negative impact on the turnover of the undertaking of the franchisee, and the financial contribution/impact exceeds the threshold value in the franchise agreement.
Relevant for the mandatory consent is the agreed threshold, as consent is only required if the financial impact for the franchisee exceeds a predetermined threshold level.
The past year there has been a debate whether the franchise law would be (or: should be) mandatory in case parties to the agreement are not Dutch. The text of the proposed law was not entirely clear on this issue. Last week, an amendment was proposed to clarify and this amendment passed. The law will be mandatory, and if the franchisee is based in the Netherlands the law will be applicable regardless whether parties selected another governing law. Parties can still select another governing law, and this will be valid choice of law but when it comes to the mandatory elements as set out in the Dutch law, the Dutch Franchise law will prevail. If a clause of the franchise agreement is in conflict with the Dutch law, that clause will be null and void. If the franchisee is not based in the Netherlands, parties are free to select another governing law.
The Franchise law will be applicable immediately for all new franchise agreements, so the agreements that are not concluded on the day this law takes effect. For all existing franchise agreements, parties will get two years to amend their agreement and incorporate the new mandatory law.
This means that all existing franchise agreements, except the ones which will end within two years, will have to be reviewed and renegotiated.
The law introduces a number of new concepts such as the notion of franchise formula, derivative formula and the notion of goodwill compensation. It uses some well-known solutions such as Disclosure but it also explores new concepts such as goodwill compensation and mandatory consent to certain types of manual change. Germany, in domestic law, has a similar approach to franchising, but the Dutch law will be internationally mandatory (when the franchisee is based in the Netherlands) so the traditional fix of using English law will not work. Franchisors will need to find a way to define the “formula” and what constitutes a “formula change” to avoid invalidity of important elements of the franchise agreement.
Definition of Franchise: The concept of the “franchise formula” is new. There is no uniform European definition of “franchise” and the Dutch government is adding to the confusion by creating its own definition based on the “franchise formula”. The law does not define this further.
Disclosure: The Franchise community is of course familiar with disclosure. Generally, it is best practice to disclose. However, it may be commercially impractical that the fully negotiated final franchise agreement must be included in the disclosure pack. As a result the parties are forced to conduct all negotiations before disclosure and cannot do so on parallel, thus creating a 4 weeks waiting period, during which the franchisee can review the business case, seek advice and potentially reconsider.
Relationship Law The law imposes certain ongoing obligations on the franchisor including control over the development of “derivative” concepts. Time will tell how this restriction will apply. Many franchisors have more than one brand or concept in the same market. Furthermore the ability of the franchisor to introduce system changes may be restricted. Careful drafting will be needed to ensure the system can evolve to the benefit of all.
Termination. The goodwill compensation clause has been intensely debated during the legislative process. Goodwill compensation may be payable if there is separate goodwill in the business of the franchisee and the franchisor takes over the location, or transfers the business to a new franchisee. Some may argue that this will only apply if the franchisor exercises a step-in or buy out right. In such cases it must pay the agree value.
Overall the Netherlands will move from a country where franchising was not regulated to one of the most highly regulated countries in the world. The new relationship laws will present a particular challenge as franchising depends on the evolution of the franchise system which cannot be set in stone. Seeking franchisee consent to manual change will be a great challenge. Careful drafting will be needed to ensure that franchisors can continue to evolve the system for the benefit of all concerned.