Germany’s Federal Court of Justice dismisses franchisee’s Claim for indemnity after termination of contract
For many years, legal scholars have been debating whether franchisees are entitled to indemnification for the goodwill and the client base they developed during the term of their contract. A recent decision by the German Federal Court of Justice provides guidance on this matter. The franchisee might be entitled to an indemnity if certain conditions are in place. These terms, however, are very unlikely to be met in many franchise systems as these systems operate predominantly in anonymous high-volume business sectors. Therefore, the risk that franchisors might be obliged to pay an indemnity to the franchisee at the end of a contract has significantly decreased.
Starting from the 1980s at the very least, the majority of lawyers in Germany were of the opinion that a franchisee is entitled to a goodwill indemnity at the end of a franchise contract. This might seem a bit surprising as there is no statute regulating franchising in Germany. In Germany “franchise law” was developed by practitioners, academics and the courts of law by applying various kinds of provisions directly or by analogy. These provisions are extremely diverse, ranging from general civil law to consumer protection law, among others, and even to competition law. Articles 84 to 92 c of the German Commercial Code, for example, contain such provisions, where there is some debate, whether they should apply to franchise contracts by analogy. These provisions regulate the relationship between commercial agents and their principal. With respect to many of these articles there is universal agreement that they should apply by analogy to franchise relationships, whereas for others the general opinion is that they do not. One of the provisions of the German Commercial Code on Agency is article 89 b. This article provides for an indemnity of the agent at the end of a contract. The article contains quite detailed terms as to whether or not an indemnity must be paid and regulates the modalities for calculating the amount of indemnity.
Relatively soon after the enactment of the provision contained in article 89 b of the German Commercial Code, a discussion began whether this provision should be applied by analogy to other distribution intermediaries, in particular to authorised dealers. In 1983, the German Federal Court of Justice (Bundesgerichtshof) ruled that the provision of article 89 b of the German Commercial Code must be applied by analogy to authorised dealers. Specifically, the case brought before the court was about an authorised car dealer, who at the end of the dealership contract demanded an indemnity from the car manufacturer. The business relationship between a car dealer and his customers is mainly determined by the addresses and contact details of his customer base. Thus, the car dealer is able to inform his clients of upcoming car service appointments, a well as new models, new accessories, promotion programs and the like. Since the car manufacturer was aware of the importance of data bases containing customers’ contact details, he had obliged the car dealer to disclose to him all contact details of his customers by the end of the contract at the latest. Based on this contractual obligation, the German Federal Court of Justice ruled that article 89 b of the German Commercial Code was applicable by analogy to the car dealer’s contract. The Supreme Court held that article 89 b of the German Commercial Code applies by analogy to other distribution intermediaries subject to two conditions. The first condition being that the distribution intermediary must be integrated into the distribution network to a degree that is similar to that of a commercial agent. The second condition of analogy is the presence of a contractual obligation stipulating the transfer of the clients base to the head of the distribution network by the end of the contract at the latest.
After this decision by the German Supreme Court of 1983, the great majority of German lawyers was of the opinion that article 89 b of the German Commercial Code applies by analogy also to franchisees, as franchisees are usually more integrated into a distribution network than authorised dealers and as many franchise contracts contained an obligation to disclose the contact details of franchisees’ clients to the franchisor. Later, in order to avoid the application of article 89 b of the German Commercial Code many franchisors even expressly stated in their franchise contracts that they did not wish the franchisee’s customer data to be disclosed to them.
Starting from the 1990s, there were several decisions of first and second instance courts on the analogous application of article 89 b of the German Commercial Code to franchise contracts. In their majority, they granted an indemnity to franchisees after the end of the franchise contract. However, not a great number of indemnity cases was brought before German courts. Some German authors presume that attorneys of German franchisees focused on other claims. Perhaps many franchisors even tried to settle court cases before they were published. In any case, before 5 February 2015 there was no decision of the German Federal Court of Justice regulating the analogous application of article 89 b of the German Commercial Code to franchise contracts. The German Federal Court of Justice had only ruled on cases, where it admitted the analogous application of other provisions of articles 84 to 92 c of the German Commercial Code.
On 5 February 2015, the German Federal Court of Justice found its first opportunity to decide on this issue with case No. VII ZR 109/1. The Court had to deal with a franchise network which runs more than 900 bakery stores in Germany, mostly by franchisees. The franchise contract between the franchisor and the franchisee was mutually terminated due to the insolvency of the franchisee. Following the termination of the contract, the insolvency administrator sued the franchisor for payment of an indemnity. He argued that the franchisor would benefit from the good will and the client base that the franchisee had developed during the term of the contract. The claim was based on the analogous application of article 89 b of the German Commercial Code.
The German Supreme Court left open whether article 89 b of the German Commercial Code can generally be applied by analogy to franchise contracts. However, it also stated that the conditions of analogy, which once were developed for dealership contracts, also apply for contracts with all other kinds of distribution intermediaries. Therefore, we can conclude that the two conditions of analogous application (integration in the distribution network and obligation to transfer the customer date base) will in future also be referred to by German courts, when they have to decide on the analogous application of article 89 b German of the Commercial Code to franchise contracts. The German Federal Court of Justice left the general question open, as it stated that one of the conditions of analogy was not fulfilled, i.e. the obligation to disclose the client data base.
Bakery shops usually do not keep lists of clients, since the business is mostly anonymous, i.e. clients come to the shop, buy directly from the shelves and pay in cash. Therefore, there is no need and probably also no use for the bakery shop to register the contact details of its customers. Satisfied clients will return to the same bakery shop at the same location acting under the same trade mark. As a consequence, the franchisor did not see any reason to obtain the contact details of his franchisee’s customers. Thus, the franchise contract had not contained any obligation for the franchisee to transfer the contact details of his customers. However, the franchisee was obliged to hand over his shop to the franchisor at the end of the contract.
Before court the franchisee or its insolvency administrator had argued that due to the obligation to hand over his shop to the franchisor the customers would factually also be handed over, as the customers would continue to buy at the same shop at the same location under the same trade mark. Since the 1990s, the jurisprudence in Germany had developed towards admitting a factual continuity of the client base as equivalent to an actual transfer of customers data. The term of factual continuity is used to describe the fact that the customers continue to shop at the same shop at the same location and under the same trademark, irrespective of a change of ownership. There were even some rulings of the German Supreme Court, which admitted such a factual continuity of the customers as sufficient for article 89 b of the German Commercial Code to be applied by analogy to authorised dealers. In recent years, the rulings of the German Federal Court of Justice have once again been characterised by more severity by calling for an explicit obligation to transfer the contact details of the customers.
The Federal Court of Justice took quite a formal stance, when it stated that a factual continuity of the client base was not fulfilling the condition of a contractual obligation to transfer customer details. Even the argument that such a transfer was pointless in cases involving an anonymous mass business could not change the outcome. Likewise, the obligation to hand over the shop to the franchisor had no influence over the ruling, because the court referred to the law of leases, where an increase in value of the rented object shall not be indemnified by the landlord to the tenant at the end of the contract.
This court decision has been commented in legal articles ever since. Some experts expressed their support, others their disagreement. Almost every comment considered the decision to be a bit too short and simple. In their majority, scholars and practitioners in Germany are of the opinion that the Federal Court of Justice should have examined the factual situation in a more profound way. Most of the commentators considered it too simplistic to state that in an anonymous mass business a franchisor cannot make easy use of the client base created by the franchisee. Moreover, the Federal Court of Justice’s reference to lease law was often criticised.
Despite all this criticism, it seems very likely that the decision of the German Federal Court of Justice of 5 February 2015 will be adhered to by German civil courts in future cases, at least for some years. As the decision explicitly excludes franchises of anonymous mass businesses from the analogous application of article 89 b of the German Commercial Code, we can safely predict that franchise systems operating in anonymous mass business sectors such as restaurants and most of the shops selling everyday consumer items will not have to fear the analogous application of article 89 b of the German Commercial Code to their contracts, as all these businesses are anonymous mass businesses according to the definition of the German Federal Court of Justice. As the vast majority of franchise systems in Germany seem to operate in businesses, which the German Federal Court of Justice defined as anonymous mass businesses, most franchisors operating in Germany will not risk having to pay an indemnity to their German franchisees.
Please feel free to contact Horst Becker if you have any questions about this matter.