Several countries - including Australia, Canada, France, Italy, Spain and the United States - have special legislation which protects franchisees by regulating the scope of the franchisor's pre-contractual duty to provide information. Although there is no such legislation in Germany, the general principle of liability for culpable acts performed during contractual negotiations (culpa in contrahendo) has evolved in German case law. In case law, it is assumed that an obligation is created simply by the commencement of contractual negotiations, which imposes on both sides a duty to take due care. Following the 2002 revision of the law of obligations in Germany, the relevant claim now arises on the basis of statutory provisions (Sections 280(1), 311(2) and 241(2) of the Civil Code).
The duty to take due care is breached where incorrect information is culpably provided, since Germany's highest courts have held that nobody may be pressed to enter into a contract on the basis of untrue statements. The other instances of such a breach concern core duties to provide information. According to these duties, the franchisee must be provided with all information of decisive significance for his investment before the contract is concluded. This is linked to a reversal of the burden of proof against the franchisor, so that the franchisor must prove that the information provided was comprehensive and correct. The franchisee's commercial experience plays an important part in determining the scope.
Where the franchisor breaches its pre-contractual duties to provide information, a damage claim accrues to the franchisee. In the worst case scenario, the franchisee may require reimbursement of:
- the one-off franchise entry fee;
- the regular franchise fees; and
- all costs and expenses (where appropriate, subject to the deduction of profits) incurred as a result of entering into the agreement.
This means that a franchisee who has suffered a loss can demand to be restored to the position he would have been in if the breach had not occurred. However, a franchisee cannot claim compensation for profits he had hoped to make through performance of the franchise agreement.
In a decision of May 26 2004 the Regional Court of Kaiserslautern held that there had been a breach of the pre-contractual duty to provide information and awarded damages to the franchisee.
The franchisor and franchisee entered into negotiations on a franchise agreement for the operation of an educational institution which provided private tuition, computer courses and the like. During the course of the negotiations, the franchisor provided the potential franchisee with several sheets of information about expected profits and profitability. The figures shown were not obtained through research into the successful operations of other franchisees, but were rather based on figures deriving from the franchisor's own educational institutions which were over 10 years old. The potential franchisee was not informed about the origin or age of the figures, and assumed that the figures were current figures calculated on the basis of selected franchise businesses. There were no obvious indications which would have cast doubt on the reliability of the figures. It later emerged that the average franchisee turnover at the time the agreement was concluded was lower than the figures contained in the information provided. Almost a year after the conclusion of the agreement, the franchisee gave notice of termination and sought damages in court.
The Regional Court of Kaiserslautern ordered the franchisor to pay damages to the franchisee. It held that the franchisor had breached its pre-contractual duties to provide information to the potential franchisee. In accordance with the established case law, the court held that the franchisor had to provide information on all circumstances of which it alone was aware, and which were of material significance to the franchisee's decision. In the court's view, these circumstances included, in particular, information on expected profits and a calculation of profitability. In the case at hand, the judges found that failure to inform the franchisee about the topicality and relevance of the figures presented during the negotiations and in the brochure constituted the breach. It was not considered sufficient for the franchisee to have had the opportunity to visit other businesses within the system in order to gain his own impression.
The court held that there was no contributory fault on the part of the franchisee, as there were no indications that would have given rise to doubts as to the topicality or origin of the figures. Nor was the franchisee's failure to sell his business viewed as contributory fault. This question concerns the duty to reduce a loss after it has been sustained and, therefore, is not causal. In addition, the franchisee was not subject to restrictions on his financial freedom to dispose, following termination of the agreement.
The case has confirmed the jurisprudence of the higher regional courts with regard to the pre-contractual duty to provide information. So far, however, the higher regional courts have not required an express calculation of profitability from the franchisor. The Regional Court of Kaiserslautern judgment could be understood to mean that a calculation of profitability must be undertaken within the context of the pre-contractual duty to provide information. However, calling for the franchisor to provide an express calculation of profitability is arguably taking things too far. It is sufficient to put the franchisee in a position where he can forecast the overall progress of commercial operations on the basis of pertinent figures and information, so that he can estimate the profitability of the franchise business, his initial losses and potential profits. In this respect, the opinion of the higher courts is eagerly awaited. In the meantime, however, franchisors are advised to disclose expressly to potential franchisees both the origin and the age of the figures provided during contractual negotiations with regard to expected profits and profitability. The franchisor's argument that there had been contributory fault on the part of the franchisee will not prevail in most cases.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.