Termination of a Franchise Agreement without Notice

OLG Munich, judgement of 14 October 2014, File No. 7 U 2604/13

Background

A uniform presentation and quality of its products or services is crucial for the success of a franchise system. Not only are customers thereby enabled to recognise each franchise of the system and thereby develop a loyalty thereto, but breaches by individual franchisees against such regulations in the franchise agreement can have adverse and even damaging effects on the image or reputation the entire franchise system. In any event from the point of view of the customer, the products or services come “from the same source” in franchising. If the franchisee is in breach therefore, the franchisor’s only recourse is to termination of the franchise agreement without notice in order to prevent further damage to the franchise system and to restore its uniformity and recover the trust of the customers.

The Higher Regional Court (Oberlandesgericht – hereinafter “OLG” ) Munich (judgement of 14 October 2014 – 7 U 2604/13) had to deal with a case of termination without notice because of such breaches of the agreement by a franchisee.

Facts

The franchisee of a fast-food restaurant sued for damages for, in his view, unjustified termination without notice issued by the franchisor due to multiple breaches by the franchisee. The breaches which were ascertained mainly in three audits by the franchisor consisted in particular of breaches of the clothing, food and hygiene regulations and cooking regulations prescribed by the franchisor.

Main grounds for the judgement

The OLG Munich dismissed the claim of the franchisee since the termination without notice by the franchisor was ultimately valid. There was no causal breach in the meaning of Sec. 280 ss. 1 Civil Code – in the present case an invalid termination – by the franchisor which was a requirement for the damages claim of the franchisee.

The OLG Munich firstly stated that the provision on termination without notice was not, due to the use of the word “in particular” in the franchise agreement, conclusive. This means that, apart from the contractual provisions, the statutory provisions on termination without notice also apply such as the general civil law provision of Sec. 314 Civil Code or Sec. 89a Commercial Code in commercial agency law (whether this provision for commercial agents could really be applied to the present franchise agreement was left open by the Senate). It follows that a number of individual breaches of the franchisee, even though each in itself did not satisfy the contractual requirements or did not reach the threshold of significance, could justify the franchisor in terminating according to Sec. 314 I Civil Code if in the overall view taking all circumstances of the individual case into account and weighing the interest of both sides, the continuation of the contract would not be reasonable for the franchisor.

The individual breaches are not “mere trifles” because they expose the franchisor to the risk of reputational damage or damage to the brand image since the foreseeable reaction of the public if the individual breaches became known would affect not only the franchisee but above all the franchisor and other franchisees. It is inherent in the franchise system that the customer expects a uniform standard in each participating restaurant and that therefore negative deviations from the standard in a single restaurant are attributed to the entire system and therefore each individual participating restaurant.

The OLG Munich, ultimately taking account of the interests of both parties, comes to the conclusion that not each of these breaches would justify termination without notice even though the individual breaches were not merely “trifles”. In fact, only on an overview of all breaches together over a longer period does the termination without notice appear to be “defensible”. The interest of the franchisee in the continuation of the agreement is secondary. The requirement of a warning was also satisfied here because the franchisor in earlier letters in relation to events of a similar nature – although not listed in detail – adequately expressed that the agreement may be ended.

Conclusion

The delegation of operative business to individual franchisees is simultaneously a blessing and a curse for the franchise system. By granting franchises, the system headquarters itself can concentrate on the further development of the know-how and the products and services while the operative business is usually delegated to franchisees who successfully operate a franchise as independent businesses in their own responsibility. This however is also associated with the risk, in cases of breaches of the franchise agreement, that it may not be possible to so influence the franchisee that he rapidly and without complications remedies irregularities as for example would be the case if the business was operated by the franchisor itself.

The judgement of the OLG Munich shows that breaches, which though individually not mere “trifles”, may only be seen by the court as justifying termination without notice when considered together. This is unfortunate if the breaches are individually already so serious that they would place in question or risk the reputation and image of the franchise system. Precisely in such cases must the franchisor be able to react rapidly and effectively in order to avert damage to the system and other franchisees.