Some light reading on the new Dutch Franchise Act
On January 1st 2021 the Dutch Franchise Act became effective. This blog contains an overview of the main aspects to bear in mind now that (for the first time) statutory rules apply in the Netherlands with the aim to (better) protect the interests of franchisees.
Some light reading on the new Dutch Franchise Act
2021 did not only start with great expectations for those desperately awaiting better days after the global pandemic. A better future also seems to lie ahead of Dutch franchisees: as of January 1st, 2021 the Dutch Franchise Act is applicable.
The relationship between a franchisor and franchisee can be rather challenging. Their cooperation usually starts of promising, with a joint focus and a joint aim for (commercial) success. Much like certain other long-term relationships however, it may become a bumpy ride somewhere along the way. For one reason or the other. In the retail business for instance, a franchisor often directly competes with its franchisees by (also) operating a web shop which is a well-known and widespread cause for disputes between franchisors and franchisees. Another cause for trouble is that after years of working with the franchisor’s franchise formula, a franchisee usually develops into an entrepreneur that has the knowledge and capabilities to ‘do it better himself’ (or at least thinks so).
Whatever the reason that causes difficulties between franchisor and franchisee, the franchisor usually has more power over the franchisee than the other way around and may be able to financially drain the franchisee out of the formula and into bankruptcy. Then again, if a franchisee is able to unite with other dissatisfied franchisees, it will be very difficult for the franchisor to keep control over its formula. Self-regulation has been tried for many years (in the Netherlands) via a code of honor. However, this has not led to a better balance of power between franchisors and franchisees (as for instance proven by the many disputes that were covered by the media over the years). And that led to a call for legislation.
Before the Dutch Franchise Act became applicable, there was (thus) no specific legislation under Dutch law for franchise agreements. Now, we have an Act that is statutory law and from which (future) parties to a franchise agreement are not allowed to deviate in a manner that is adversary to a franchisee that has its place of business in the Netherlands. Come again? If a franchisee has its place of business in the Netherlands (regardless of the country from which the franchisor operates its business), the new Franchise Act will apply to its current and/or future franchise agreement. A bit of a relief with respect to existing franchise agreements: certain new statutory rules on for instance goodwill and post contractual non-compete arrangements between franchisor and franchisee will only have to be processed in the existing franchise agreement within two years. The Dutch legislator realized that these subjects were nuts too tough to crack prior to the Act becoming applicable and wanted to avoid that existing franchise agreements that do not comply with the new Act yet, became (partially) void on New Year’s eve.
What is particularly important to realize for entrepreneurs, is that the Franchise Act will also apply to agreements that are not actually titled ‘Franchise Agreement’ but do – according to the definition in the Franchise Act – qualify as such. This is something to bear in mind. It may be an unpleasant surprise to learn you are actually a franchisor only by the time that your contracting party starts claiming goodwill as franchisee. On the other hand, it may be smart thinking if you intend to argue that you are a franchisee yourself…
You may expect (and recognize) franchise formulas immediately in the retail or restaurant business, but franchise formulas also exist in other sectors like healthcare and IT. In essence, the question is whether an agreement entails that one party (the franchisee) pays the other party (the franchisor) for the right and obligation to sell products and/or perform services in accordance with a certain formula that is prescribed by the other party (the franchisor). According to the definition in the Franchise Act, a franchise formula is:
‘[An] operational, commercial and organizational formula for the production or sale of goods or the performance of services, that is determinative for the uniform identity and appearance of the franchise companies within the chain in which this formula is applied and that in any event entails: 1. a trademark, model or tradename, corporate identity or design, and 2. knowhow (….)’ A shared identity and shared knowhow, used for products or services: that is basically it. And realize that payment of a franchise fee to the franchisor does not literally have to be identified in the agreement as ‘franchise fee’ but may be ‘hidden’ in other payment obligations. Depending on the nature of your business, with this new statutory Act, it may be wise to ask yourself whether the way you are operating your business may be a franchise formula. Evidently, if you already know you are in one: take notice of the new Act and make sure your agreements comply with it (in time).
You should mainly be concerned about the new Franchise Act if you have (or fear you may have) the role of franchisor. The Act is supposed to be ‘franchisee friendly’ i.e.: protecting the interests of the franchisee and franchisee-to-be. With that aim as a basis, the Act prescribes for instance that the franchisor has an obligation to provide a future franchisee with certain information. The idea is to make sure that the future franchisee is able to make a considered decision on whether or not it is wise to enter into the agreement. This may concern (i) information on the financial contributions expected from the franchisee (including investments and franchise fees obviously), but also (ii) information on the financial state of the franchisor itself, (iii) financial information with respect to the franchise location (or, if not available, a similar location), (iv) the degree in which the franchisor will compete with franchisee and (v) any other information of which the franchisor knows or reasonably should know that it is important to the franchisee prior to concluding the franchise agreement. Know that a franchisee will also have to provide financial information itself and that the franchisee should take reasonable precautions to prevent it concludes a franchise agreement based on misrepresentation. Also know that, between the moment that a new franchisee receives the prescribed information from the franchisor and the final draft of the franchise agreement, there is a standstill period of (in principle) four weeks. Within this standstill period the franchisor is not entitled to enter into the franchise agreement, nor to change the contents of the draft agreement (in a manner detrimental to the franchisee), or ask for financial contributions of the franchisee et cetera. If the information provided to the franchisee is rather complex, a longer standstill period may be reasonable. Thus, the new franchisee is given some time to take its decision and for instance discuss its contemplated business with its own advisors. It remains to be seen however, what the consequences in a specific case may be if the standstill period is neglected by franchisor and franchisee, because the Act does not sanction this explicitly (although the standstill period is statutory).
This blog does not contain an extensive overview of all obligations in the new Franchise Act (this is supposed to be a light read, I’m stretching it already) but it would be inappropriate not to mention the three hottest topics in the new Franchise Act. Being that:
- the Act prescribes that a franchise agreement must contain how it is determined whether (a) there is goodwill in the company of the franchisee, if so, (b) of what it consists and (c) to which degree the goodwill is attributable to the franchisor. The kicker: the agreement must also contain how goodwill that is reasonably attributable to the franchisee is compensated to the franchisee when the franchise agreement ends. The idea behind this is not so much that franchisees will in general become eligible to higher (or even: any) goodwill compensations upon termination of their franchise agreements. The idea is that clearer arrangements on goodwill compensation are made so that a franchisee is better able to consider the consequences of a termination of its franchise agreement.
- the Act limits to possibilities to keep a franchisee tied to a non-compete clause after the franchise agreement has ended. A non-compete clause may for instance not apply for a period longer than one year and may geographically not apply to a larger area than the area in which the franchisee had exclusivity.
- the Act prescribes that if the franchisor wants to unilaterally change the franchise formula (assuming that the agreement allows the franchisor to do so – which it usually does) and such change has a certain financial impact on the franchisee(s), the franchisor should obtain consent from either the majority of all its franchisees based in the Netherlands or consent from all franchisees based in the Netherlands that are actually affected by the change in formula. Given that the Act is statutory law from which franchise partners may not deviate in a manner detrimental to the franchisee, you may expect that unilateral changes to the franchise agreement without consent of the franchisee(s) will not become applicable. The Act allows for agreeing on certain thresholds in the franchise agreement regarding the financial impact of unilateral changes. Thus: it is allowed to agree that if a (unilateral) change to the formula and/or franchise agreement has a financial impact below amount X, that the franchisor does not have to acquire the consent of its franchisee(s).
Stipulations deviating from the first and second of the ‘topics’ mentioned above in a way that is detrimental to the franchisee are void; the Act is quite strict in this respect. As mentioned before: franchisors and franchisees in existing franchise relationships are allowed some time to get used to the new Franchise Act. They will have two years (as of 1 January 2021) to align their agreements with the new statutory requirements. For some franchisors, this means that some tough negotiations lie ahead. But to all of them: December 2022 will probably be a bit late to start negotiating if you are a franchisor or if this blog scared you into believing you may be a franchisor. Our advice: start taking action now and give us a call if you need any legal input in the process.