Getting to Grips with Pre-Contractual Disclosure in Europe
One size will not fit all
It is a common misunderstanding that the European Union (EU) is a genuine single market with a fully harmonised legal system.
The EU is a union of 28 (soon to be 27) different member countries (called Member States), that share common political, economic and social objectives. The EU promotes the free movement of goods, capital, services and labour and operates a ‘harmonized’ legal regime designed to ensure consistency between Member States’ laws.
However, significant differences remain between the national legal, regulatory and cultural regimes of individual Member States that prove challenging to businesses entering into or expanding across the EU market. In addition, some countries often considered “European” (like Switzerland) actually sit outside the EU and are subject to wholly independent national regimes.
The disparity between the legal systems of Member States applies to franchising. Perhaps the first important lesson for any franchisor assessing their options for expansion in Europe is that one size will not fit all.
What is pre-contractual disclosure?
Pre-contractual disclosure means the sharing of material information about the franchise opportunity prior to the formalisation of the legal relationship. Its purpose is to ensure that the sales process is grounded in fact and that the parties can make a sober and objective assessment of the commercial opportunity.
Some Member States have franchise specific laws which cover pre-contractual disclosure (such as Belgium, France, Italy, Romania, Spain and Sweden) whilst others regulate all stages of the franchise relationship through more general commercial laws or codified principles of good faith (such as Germany, Austria and Portugal). The UK has, by comparison, a very light regulatory regime and no franchise-specific laws.
Key disclosure issues include the range of information which must be disclosed, how it should be presented, for how long it should be disclosed before the parties can sign the franchise agreement, the interplay between disclosure and discussing commercial terms and taking a deposit and whether "cooling off" periods apply after the franchise agreement has been signed or between agreeing the final version of the franchise agreement and its signature.
Why do it?
The legal consequences of a failure to comply with disclosure requirements vary. Non-compliance generally entitles the franchisee to walk away from the franchise agreement without restrictions provided it acts within a reasonable period of entering into the franchise agreement. The franchisee can also rescind the contract and sue the franchisor for damages and in some jurisdictions the authorities may also impose fines for failure to comply.
In European countries such as the UK, there is no franchise-specific law or general duty obliging a franchisor to make some form of pre-contractual disclosure. However, making some from of formal pre-contractual disclosure is widely regarded as best practice, whatever the actual legal requirement.
The European Franchise Federation ("EFF") is the non-profit international association set up in 1972 to govern and oversee the franchising industry in Europe. The EFF's "Code of Ethics" is designed to promote ethical franchising in Europe and provides the franchise industry’s foundation for voluntary self-regulation. National franchise associations across Europe (such as the British Franchise Association in the UK) adopt the EFF's code of ethics into their own national codes and a core tenet of these national codes is that franchisor members issue a full and accurate written disclosure of all information material to the franchise relationship prior to signing the franchise.
In reality, in markets such as the UK which do not regulate disclosure, a number of franchisors do not make adequate disclosure and there is more that the national franchise associations can do in this regard. In markets where it is regulated, the regulations tend to lack teeth and there may be a self-perpetuating lack of awareness over their existence, which again combines to result in less than perfect levels of compliance. Nevertheless, responsible franchisors should take disclosure seriously, both as a means to improve the health of their relationships with franchisees and to reduce the accretion of systemic legal risk.
Overview of the nature of pre-contractual disclosure laws
Due to the various different franchise specific disclosure laws as well as the disclosure obligations imposed by general contract law and the duty of good faith in some EU countries, there is no "one size fits all" disclosure. However, a closer look at the disclosure requirements does show that there are certain disclosure items which always need to be covered:
1. Trade marks. A disclosure document should contain details of the relevant intellectual property rights which the franchisor will license to the franchisee. In most European jurisdictions, it is legally permissible to grant a licence to unregistered rights, including unregistered trade marks. However this would be highly unusual in the context of a franchise system where the brand is a core asset. In France, failure to register the trade marks relevant to the franchise will in fact invalidate the franchise agreement. In the UK, until such time as there is clarity on the terms of Brexit and the UK's future relationship with the EU, it is advisable to register national trade marks as reliance on EU trade marks (EUTM) without any prior usage in the UK may not be sufficient to ensure that a franchisor has an enforceable trade mark in the UK after Brexit. In the event that a franchisor does not own the rights to relevant trademarks, it is generally sufficient to provide details of the legal basis on which the franchisor sublicenses a franchisee the right to use the trademarks.
2. Form and Content. Disclosure documents generally cover three types of information; (i) information on the franchise system, such as the number and geographic spread of franchisees (ii) information of the franchisor, such as its corporate history, ownership etc. and (iii) information on the key terms of the franchise agreement, such as the grant of rights, fees, termination, and non-competes. In addition to these more general requirements, certain EU countries prescribe quite specific disclosure items that can be quite onerous, such as French law which requires a franchisor to provide the franchisee with two (2) types of "market survey" (a local and a general) as part of the disclosure.. Although it is neither possible nor desirable to draft a disclosure document which covers all EU markets, it is advisable for international franchisors to develop a "base line" standard disclosure document which can then be adapted for each market by adding country specific schedules which will deal with more onerous disclosure requirements that a franchisor will not want to form part of its base document, such as a market study or an overview of the investment costs that a franchisee will face as required in Spain for example.
3. Timing. Typically a disclosure document needs to be served on the franchisee prior to signing the franchise agreement or in some cases before the franchisee is required to make a payment to the franchisor. In France and Spain, the period is set at twenty (20) days. Belgian law requires that a copy of the negotiated franchise agreement is provided at least one month prior to execution of the franchise agreement. In Germany, the rule of thumb is four (4) weeks. In addition, there is also a "cooling off" period in Germany which applies if a franchisee is deemed to be a "consumer" (for example, an employee before becoming a franchisee). This means the franchisee can revoke the franchise agreement without liability up to fourteen (14) days after signing the franchise agreement.
4. Financial statements. This is key area of risk for franchisors. Whilst it is reasonable to expect a franchisor to disclosure evidence of their financial performance, if a franchisor is not operating in the territory, the disclosure should make it clear that the figures relate to a different market as differences in variables such as real estate and labour costs can be significant. French law requires disclosure of two (2) years of financial statements.
5. Translations. If a foreign franchisor is disclosing to a franchisee that is at the "consumer" end of the franchisee spectrum, it is highly recommended to translate the disclosure document, even though not strictly speaking a legal requirement in most markets as the franchisor has the burden of proof that the franchisee had sufficient English language capabilities to read and understand the disclosure document. The same applies in respect of the franchise agreement.
6. Interplay of disclosure with non-disclosure agreements and letters of intent. Non-disclosure agreements and letters of intent are commonly used prior to any formal disclosure in high value unit or multi-unit franchising deals. However, in markets such as France it is not possible to take a non-refundable deposit under a letter of intent prior to signing the franchise agreement because disclosure has to be made prior to the payment of any monies to the franchisor. In Spain, disclosure should be made if any material aspect of the letter intent is legally binding. In the UK and Germany, taking a deposit is permissible and does not trigger a disclosure requirement, but the legal mechanism which is used to take the deposit should be drafted carefully.
Pre-contractual disclosure should form part of every franchisor's tool kit, irrespective of whether or not it is legally required in any particular jurisdiction.
For franchisors which are looking to enter into or expand across Europe, until such time as the EU takes meaningful steps to harmonise the current patchwork of national franchise laws, it is necessary to look at each country on its own merits to ensure that a franchisor is meeting its disclosure obligations.
The best approach for now is for franchisors to invest in developing and maintaining a base line standard international disclosure document, which can be customised for markets with either general or franchise specific laws. Franchisors therefore should choose expert European franchise counsel with a strong platform across Europe in order to ensure that the benefits of disclosure are maximised, and the risks are minimized.
By Gordon Drakes