Goodwill compensation upon termination of a German franchise agreement – Do franchisors always have to pay up?
German law and the German courts have a reputation of being rather protectionist in respect of franchisees. One of the prime examples is the goodwill compensation set out in Section 89b of the German
German law and the German courts have a reputation of being rather protectionist in respect of franchisees. One of the prime examples is the goodwill compensation set out in Section 89b of the German Commercial Code which sets out an entitlement of a commercial agent to goodwill compensation at the end of the commercial agency contract. This has been applied various times by the lower German courts by analogy to other types of agreements, such as distribution and franchise agreements, even though we are still waiting for a decision by the German Federal Supreme Court as to whether or not the Section 89b provisions of the German Commercial Code can apply to franchise agreements if certain conditions are met..
However, it would be wrong to say that every franchisee in Germany is automatically entitled to a compensation payment at the end of the franchise relationship.
One of the most important factors to determine whether a franchisee may be entitled to a compensation payment is, whether or not there is a contractual obligation to transfer the customer base after the termination of the contract to the franchisor or if the franchisor is able to get a hold of the customer list by other means, such as monthly reporting obligations or loyalty programmes where customer information is shared with the franchisor.
The transfer of the customer list is important because unlike in an agency situation where the customers acquired by the agent are always the customers of the principal, a franchisee’s customers are generally his/her own due to the franchisee being an independent entrepreneur.
Following an important decision by the German Federal Supreme Court on 5 February 2015 which, although it does not comment on whether Section 89b of the German Commercial Code generally applies to franchise agreements, has clarified that:
are not sufficient to justify a compensation claim.
Below we will take a closer look at some of the German court decisions dealing with goodwill compensation payments, culminating in the latest decision by the German Federal Supreme Court and will analyse the factors that a German court will take into account when deciding whether a franchisee will be entitled to goodwill compensation at the end of a relationship or not.
In 1999 the Regional Court in Frankfurt held that a franchisee may claim compensation even if the franchise agreement itself does not oblige him to transfer the customer base provided that after termination the customer base is transferred de facto to the franchisor. This specific case dealt with a bakery shop in a pedestrian zone. The Court considered that because of the anonymity of the transactions involved there could never be a customer list which the franchisee could surrender to the franchisor. For that reason the de facto transfer of the customer base was sufficient in the court’s opinion to satisfy the requirement. It is unlikely that this argument will be successful any longer in light of the most recent decision by the German Federal Supreme Court.
2. Decision by the Regional Court in Hanau (28 May 2002 – 6 O 106/2001)
The Regional Court in Hanau came to a similar conclusion in 2002 when it held that compensation was payable to a franchisee although there was no contractual obligation to transfer the customer base to the franchisor at the end of the relationship.
However, it is important to keep in mind that this case did not deal with a typical franchise relationship. The franchisor had developed a special system for the cleaning of automobiles. The franchisee’s task was to enter into contracts with car dealers as representative of the franchisor and to perform the cleaning thereafter. All third party contracts were therefore concluded directly between the franchisor and the third party customers. As the franchisee did not have its “own” customers (the contracts were with the franchisor) the position of the franchisee was very similar to the position of a commercial agent and the court did not comment on any de facto transfer of a customer base as there was none.
The Regional Court of Berlin was the first of the lower courts that opposed the judgments mentioned above. In 2004 it held that the de facto transfer of the customer base is not sufficient to justify the application of Section 89b of the German Commercial Code. It explained in its decision that the right to compensation stems from the commercial agent or franchisee not being able to use the customer base it acquires. In the case of a commercial agent this is because the agent never owns the customer base to begin with as they are customers of the principal and in respect of other sales intermediaries, such as distributors or franchisees, where they lose the right to use their customer base due to a contractual obligation to hand over such customer base to the franchisor on termination. The court further held that in the absence of an express provision to transfer the customer base upon termination, post-term non-compete obligations commonly used in franchise agreements whereby the former franchisee is prevented from opening up another business on the same spot or in the vicinity of its former franchised business cannot be interpreted as including a silent obligation to transfer the customer base.
The Regional Court in Mönchengladbach came to a similar conclusion and rejected a franchisee’s claim for compensation upon termination of the franchise agreement due to a lack of a contractual obligation to transfer the customer base to the franchisor.
The franchisee in question operated yet another bakery in a pedestrian zone under a franchise agreement with a wholesale bakery chain (just like the first decision we looked at). The agreement was silent on whether the franchisee - after the termination of the agreement - had to transfer the customer base to the franchisor or not. After the termination of the franchise agreement the franchisee sued the franchisor for compensation. As the franchisor had taken over the franchisee’s bakery and continued to run it with another franchisee the former franchisee argued that the franchisor still benefited from the customers he himself had acquired.
The Regional Court held in its decision that this was not sufficient to trigger a compensation payment. Unlike a commercial agent, who does not have a customer base, a franchisee was only prevented from exploiting its own customer base after the termination of the franchise agreement, if the franchise agreement contained an express obligation to hand over such customer base.
This decision also dealt with a bakery franchise where the liquidator of the franchisee's business asserted a claim for compensation against the franchisor. The franchise agreement did not contain a contractual obligation to transfer the customer base of the franchisee's business to the franchisor on termination, but the franchisee had to hand back the premises which it leased from the franchisor.
The Federal Supreme Court held, as some lower courts had previously, that a de facto continuity of the customer base, when dealing with anonymous mass market transactions is insufficient to support a compensation claim. It further held that an obligation to hand back the former business premises which enables the franchisor to place another franchisee in the same location does not change this assessment. This is because German lease law does not acknowledge any goodwill payment at the end of a lease when a tenant returns leased premises. Any goodwill that a tenant builds up during the lease term is entirely to the benefit of the landlord.
Although this decision still leaves the question open whether Section 89B of the German Civil Code can be applicable to franchise agreements if certain conditions are met, it clarifies the situation for premises-based franchises who conduct anonymous mass market transactions and certainly signals a step in the right direction as far as franchisors are concerned.
However, it would be wrong to say that every franchisee in Germany is automatically entitled to a compensation payment at the end of the franchise relationship.
One of the most important factors to determine whether a franchisee may be entitled to a compensation payment is, whether or not there is a contractual obligation to transfer the customer base after the termination of the contract to the franchisor or if the franchisor is able to get a hold of the customer list by other means, such as monthly reporting obligations or loyalty programmes where customer information is shared with the franchisor.
The transfer of the customer list is important because unlike in an agency situation where the customers acquired by the agent are always the customers of the principal, a franchisee’s customers are generally his/her own due to the franchisee being an independent entrepreneur.
Following an important decision by the German Federal Supreme Court on 5 February 2015 which, although it does not comment on whether Section 89b of the German Commercial Code generally applies to franchise agreements, has clarified that:
- an obligation to hand back leased premises on termination; and
- a purely de facto continuity of the customer base in the context of anonymous mass market transactions (for example, customers continuing to shop at the retail location where the franchisee previously operated its franchise business)
are not sufficient to justify a compensation claim.
Below we will take a closer look at some of the German court decisions dealing with goodwill compensation payments, culminating in the latest decision by the German Federal Supreme Court and will analyse the factors that a German court will take into account when deciding whether a franchisee will be entitled to goodwill compensation at the end of a relationship or not.
- Decision by the Regional Court in Frankfurt (19 November 1999 – 3/8 O 28/99)
In 1999 the Regional Court in Frankfurt held that a franchisee may claim compensation even if the franchise agreement itself does not oblige him to transfer the customer base provided that after termination the customer base is transferred de facto to the franchisor. This specific case dealt with a bakery shop in a pedestrian zone. The Court considered that because of the anonymity of the transactions involved there could never be a customer list which the franchisee could surrender to the franchisor. For that reason the de facto transfer of the customer base was sufficient in the court’s opinion to satisfy the requirement. It is unlikely that this argument will be successful any longer in light of the most recent decision by the German Federal Supreme Court.
2. Decision by the Regional Court in Hanau (28 May 2002 – 6 O 106/2001)
The Regional Court in Hanau came to a similar conclusion in 2002 when it held that compensation was payable to a franchisee although there was no contractual obligation to transfer the customer base to the franchisor at the end of the relationship.
However, it is important to keep in mind that this case did not deal with a typical franchise relationship. The franchisor had developed a special system for the cleaning of automobiles. The franchisee’s task was to enter into contracts with car dealers as representative of the franchisor and to perform the cleaning thereafter. All third party contracts were therefore concluded directly between the franchisor and the third party customers. As the franchisee did not have its “own” customers (the contracts were with the franchisor) the position of the franchisee was very similar to the position of a commercial agent and the court did not comment on any de facto transfer of a customer base as there was none.
- Decision by the Regional Court in Berlin (6 September 2004 – 101 O 23/04)
The Regional Court of Berlin was the first of the lower courts that opposed the judgments mentioned above. In 2004 it held that the de facto transfer of the customer base is not sufficient to justify the application of Section 89b of the German Commercial Code. It explained in its decision that the right to compensation stems from the commercial agent or franchisee not being able to use the customer base it acquires. In the case of a commercial agent this is because the agent never owns the customer base to begin with as they are customers of the principal and in respect of other sales intermediaries, such as distributors or franchisees, where they lose the right to use their customer base due to a contractual obligation to hand over such customer base to the franchisor on termination. The court further held that in the absence of an express provision to transfer the customer base upon termination, post-term non-compete obligations commonly used in franchise agreements whereby the former franchisee is prevented from opening up another business on the same spot or in the vicinity of its former franchised business cannot be interpreted as including a silent obligation to transfer the customer base.
- Decision by the Regional Court in Mönchengladbach (29 June 2010 – 3 O 324/09)
The Regional Court in Mönchengladbach came to a similar conclusion and rejected a franchisee’s claim for compensation upon termination of the franchise agreement due to a lack of a contractual obligation to transfer the customer base to the franchisor.
The franchisee in question operated yet another bakery in a pedestrian zone under a franchise agreement with a wholesale bakery chain (just like the first decision we looked at). The agreement was silent on whether the franchisee - after the termination of the agreement - had to transfer the customer base to the franchisor or not. After the termination of the franchise agreement the franchisee sued the franchisor for compensation. As the franchisor had taken over the franchisee’s bakery and continued to run it with another franchisee the former franchisee argued that the franchisor still benefited from the customers he himself had acquired.
The Regional Court held in its decision that this was not sufficient to trigger a compensation payment. Unlike a commercial agent, who does not have a customer base, a franchisee was only prevented from exploiting its own customer base after the termination of the franchise agreement, if the franchise agreement contained an express obligation to hand over such customer base.
- Decision by the Federal Supreme Court (5 February 2015 – VII ZR 109/13)
This decision also dealt with a bakery franchise where the liquidator of the franchisee's business asserted a claim for compensation against the franchisor. The franchise agreement did not contain a contractual obligation to transfer the customer base of the franchisee's business to the franchisor on termination, but the franchisee had to hand back the premises which it leased from the franchisor.
The Federal Supreme Court held, as some lower courts had previously, that a de facto continuity of the customer base, when dealing with anonymous mass market transactions is insufficient to support a compensation claim. It further held that an obligation to hand back the former business premises which enables the franchisor to place another franchisee in the same location does not change this assessment. This is because German lease law does not acknowledge any goodwill payment at the end of a lease when a tenant returns leased premises. Any goodwill that a tenant builds up during the lease term is entirely to the benefit of the landlord.
Although this decision still leaves the question open whether Section 89B of the German Civil Code can be applicable to franchise agreements if certain conditions are met, it clarifies the situation for premises-based franchises who conduct anonymous mass market transactions and certainly signals a step in the right direction as far as franchisors are concerned.