U.S. franchisors looking to expand into Europe may think of the European Union (“EU”) as having a single legal system, or at least a relatively homogenous set of legal systems. They would be mistaken. Although the EU aspires to be seen as a single economic unit, its 28 member states take a wide range of different approaches to legal issues that affect franchising. This is certainly true regarding the member states’ different approaches to the enforcement of post-termination covenants against competition.
At a basic level, these differences can be divided into the civil law approach, found in countries such as Germany and France, and the common law approach, found in the UK and Ireland. Even within the civil law jurisdictions, however, significant differences exist on how post-termination covenants are addressed. U.S. franchisors entering the EU must be aware of these differences and accommodate them in their franchise agreements.
The Civil Law Approach
In Germany, the law of commercial agency is applied by analogy to franchise agreements. This means that a franchisor seeking to enforce a covenant against competition after a franchise agreement terminates may have to pay the franchisee post-termination compensation, known as contract indemnities. The franchisee may agree to be bound by post-termination non-compete obligations for a maximum of two years after termination. In return, the franchisee may claim compensation under the commercial agency laws. See Handelsgesetzbuch [HGB] [Commercial Code], § 90a (3).
Notably, a former franchisee’s right to claim compensation pursuant to Section 90a does not exclude the right to claim compensation upon termination under Section 89b of the Commercial Code. See Hopt, in: Baumbach/Hopt, HGB Kommentar, 33rd ed., 2008, § 90a Rn. 18. This section allows compensation for loss of business opportunities.
A franchisor can avoid the obligation to pay compensation if it waives the non-compete restriction in writing at least six months before the end of the contract term. If the franchisor gives less than six months’ notice of the waiver, it must pay compensation for each month’s difference between the mandatory six-month period and the actual notice period given. If the franchise agreement is terminated for material breach, however, the non-breaching party may waive the non-compete restriction on one month’s written notice. Any contract terms that exclude these rights of the franchisee are null and void. See Cass. Soc., 10 July 2002, Dr. Soc., November 2002, n° 11, p. 949; Cass. Com., 1 July 2003, JCPE, n° 22,27 May 2004, p. 869.
In Austria, there are limits to the enforcement of post-term termination covenants based on the country’s antitrust laws. Austrian courts sometimes view franchisees as agents of the franchisor and analyze the franchise relationship in the context of agency legislation. Under this analysis, post-termination covenants against competition are null and void. See Handelsvertretergesetz [HVertG] [Commercial Agent Act] § 25.
Although French courts enforce non-compete covenants binding employees strictly, in accordance with the wording of the employment agreement, they take a less stringent view of non-compete covenants outside the employment context, including non-compete undertakings by franchisees. To be enforceable, covenants against competition by franchisees must be limited in time and geographic scope, and their restrictions must be proportionate to the legitimate interests of the franchisor. See Cass. Com., 4 January 1994 n° 92-14121, D. 1995, p. 260; Cass. Com., 16 December 1997 n° 96-10859, Contr. Conc. Consom., March 1998, n° 39 ; Cass. Civ. 1e, 11 May 1999 n° 97-14493, Contr. Conc. Consom., October 1999, n° 137.
Trends in court judgments suggest that France in the future will follow the German example and rule that a franchisor may not enforce a non-compete covenant against a franchisee unless it compensates the franchisee, as is currently required with post-termination non-competes in the employment context. For now, however, this is not yet the law. In 2002, the Supreme Court ruled that a franchisee is an ongoing business, not an employee. Thus, in that case, the franchisee was barred from claiming post-termination compensation. See Cass. Civ 3e, 27 March 2002, Bull III, no 77 p.66.
The laws of the Czech Republic provide that although the parties can decide the grounds on which a franchise agreement may be terminated, post-termination restrictions must comply with the limitations set forth in the EU VABE Regulation. See Reg. 330/2010 of 20 April 2010 (OJ 2010 L102/1.23.04.2010) (discussed below), and may not exceed one year after the termination of the agreement.
Finnish law provides that a contract that unreasonably prevents or restricts competition through a post-term non-compete covenant will not be effective against the party that accepted the obligation. See Sec. 38 of the Contracts Act (228/1929).
In Greece, after the expiration or termination of a franchise agreement, the franchisee may no longer take advantage of the franchise system, see Section 719, Greek Civil Code, and the franchisee’s freedom to compete is subject to Greek law on unfair competition, see Article 919, Greek Civil Code; Law 146/14 on Unfair Competition. Covenants not to compete are prima facie valid unless they are contrary to public policy. See Article 178, Greek Civil Code. Greek courts will enforce non-compete provisions as long as they are considered reasonable and in accordance with general principles of law, such as good faith, ethical conduct, and protection from abuse of rights. Because there is no definition of what is “reasonable” in this context, courts will determine reasonableness on a case-by-case basis. As long as a covenant not to compete is of limited duration and applies only to a specific restricted territory, it should be valid under Greek law. See F.I.C. of Athens 11486/80 JCL (1981) 50,131, F.I.C. of Athens 14284/81, JCL (1982) 144, F.I.C. of Heraklion 158/86, JCL (1987) 38.
After termination of a franchise agreement, the franchisor may be required to repurchase some of the franchisee’s inventory. The franchisee is barred from disclosing confidential information by an implied duty of confidentiality that continues after termination, based on the principles of good faith, commercial practice, and the special nature of the franchise relationship.
The Common Law Approach in the UK
Courts in the UK will enforce post-termination covenants against competition in franchise agreements if they are reasonable in both duration and geographic scope. In Dyno-Rod plc and Zockoll Group Ltd v. Reeve,  FSR 148, the court upheld a restriction against competition that lasted one year and covered the original territory granted to the franchisee. This was also considered reasonable by the Court of Appeal in Office Overload Ltd v Gunn  FSR 39. See also Prontaprint plc v. Landon Litho Ltd  FSR 315 (upholding restriction against competition lasting three years and covering half a mile); KallKwik Printing (UK) Ltd v. Bell,  FSR 674 (upholding restriction against competition lasting 18 months and covering radius of 700 meters from the franchised unit). The franchisor bears the burden of proving that a restriction is reasonable.
If a covenant against competition is stricken, that does not invalidate the remainder of the contract. See Wallis v. Day [1835-42] All ER Rep 426. There is debate, however, regarding whether portions of a covenant that are deemed unreasonable can be severed, so that the remainder of the covenant is enforceable. In some cases, courts have achieved this by construing the covenant according to circumstances existing when the contract was made, rather than relying on the contract’s literal meaning. See Littlewoods Organisation Ltd v. Harris  1 All ER 1026.
The EU’s Vertical Agreements Block Exemption
Enforcement of post-termination non-compete covenants in franchise agreements also may be affected by the EU’s Vertical Agreements Block Exemption (“VABE”) Regulation, see Regulation 330/2010 of 20 April 2010 (OJ 2010 L102/1.23.04.2010), and accompanying Guidelines on Vertical Restraints. This Block Exemption provides that for a franchise agreement to come within the exemption to Article 101 of the Treaty on the Functioning of the EU (the EU’s primary anti-trust provision, which prohibits any conduct that “prevents restricts or distorts competition or may have such an effect”), certain conditions must be satisfied, including a maximum post-term non-compete clause of one year.
This limit is not relevant to most franchise agreements, given the European Court of Justice’s judgment in Pronuptia de Paris GmbH v. Pronuptia de Paris Irmgard Schillgallis, (Dec. 17, 1986; OJ EEC L 13/39, Jan. 15, 1987) (holding that restrictions in a franchise agreement that are strictly necessary to preserve the unique nature of franchising are justified). Nevertheless, the courts of the member states have jurisdiction to apply EU competition law, and, as commentators have noted, some national courts seem to miss this point and use the one-year threshold as a starting point when considering post-term non-competes in franchise agreements. (Editor’s Note: The block exemption is discussed in detail in “The New Vertical Agreements Block Exemption Regulation,” in our Fall 2010 issue, Vol 13, No. 4.)
The EU has no uniform law across the 28 member states regarding post-termination covenants against competition in franchise agreements. Covenants can be much more difficult to enforce in Germany and Austria than they are in the UK, for example. As a result, covenants must be carefully considered in light of the law of the member state that governs the franchise relationship.