UK: Competition Authorities Gear Up For Scrutinising Franchise Networks

Last Updated: 16 October 2014
Article by Gordon Drakes and Jessica Burns

A franchising agreement is at risk of infringing EU competition law (Article 101(1) of the Treaty on the Functioning of the European Union) if it has the object or effect of restricting competition and is capable of affecting trade within the EEA. The equivalent UK competition rules apply if trade in the UK is (or is capable of being) affected by the agreement in question. The Competition and Markets Authority ("CMA") – previously the Office of Fair Trading - is responsible for enforcing UK competition law.

An infringement of competition law can lead to substantial fines on the parties concerned. The non-financial implications are equally severe, including damage to business reputation, the unenforceability of contracts, the risk of third party damages actions and even personal sanctions (fines, director disqualification and imprisonment) imposed on executives of the parties concerned.

The decision taken by the CMA in 2013, in which it fined Mercedes-Benz (a franchisor) and five of its dealers (each a franchisee) over £2.8 million for infringing UK competition law, serves as an important reminder that franchisors and their networks – irrespective of their market shares and geographic scope – may infringe the competition rules. The level of the fine imposed on the franchisor and its five franchisees also demonstrates that the CMA is starting to pay much closer attention to the activities of small and medium sized enterprises ("SMEs"), a category which includes the majority of franchisors and franchisees.

The Mercedes-Benz Case

The infringement in this case involved a collusive agreement amongst the dealers of Mercedes-Benz, each of whom was a small player on the market for the supply of commercial vehicles, on how to respond to requests for quotations from customers in each other's geographic 'zones' of business. The aim was to ensure that the local dealer would win the business from his local geographic zone.

This arrangement was found by the CMA to constitute a serious restriction on competition between the dealers, who in common with most franchisees were independent commercial businesses, involving at least some element of market sharing, price fixing and/or the exchange of commercially sensitive information. The dealers were each fined between roughly £116,000 and £660,000.

Of particular interest to franchisors, however, is that Mercedes-Benz was also found to be a party to the anti-competitive conduct for its role as a 'facilitator' to the arrangement. The CMA imposed a fine on Mercedes-Benz amounting to more than half of the total fines imposed. This was because an employee of Mercedes-Benz organised (for a legitimate commercial purpose) and attended a meeting between two of the culpable dealers at which the collusive agreement between dealers as to their geographic zones came to be discussed. By attending, that employee gave the dealers the impression that Mercedes-Benz approved of the arrangement. Unfortunately for Mercedes-Benz, she made no statement that Mercedes-Benz did not condone the arrangement and she did not intervene to prevent discussions or leave the meeting.

Key Takeaways for Franchise Networks

This case is a good illustration of how easy it is to cross the line between legitimate and illegitimate behaviour where competition law is concerned. It offers a number of important "rules of engagement" for franchisors, franchisees and the way in which they should interact with each other as part of a franchise network:

  • franchisees must always remember (and be reminded) that they are independent competing businesses and must set their business strategies independently of both their competitors operating under different brands and franchisees of the same network;

  • an infringement of competition law can arise even if the franchisor or franchisee's involvement is relatively limited, or even if it is not active on the affected market (Mercedes-Benz did not sell direct to customers in its dealers franchised territories);

  • an infringement can arise if the franchisor or franchisee merely accepts competitively sensitive information disclosed by another party (even if it does not itself disclose any information);

  • a franchisor or franchisee can be implicated through an employee's actions (even if that employee fails to tell those more senior about the illegal activities);

  • a franchisor should display particular vigilance for anti-competitive conduct between franchisees and take immediate, documented steps to prevent any anti-competitive conduct from continuing and to distance itself from it. This, Mercedes-Benz failed to do and it paid the price; and

  • in the case of more serious "hard-core" infringements, such as that in issue in the case of Mercedes-Benz, SME franchisees can be implicated regardless of the size of their market shares. (click here to see our Competition Blog on "European Commission tightens application of 'De Minimis' safe harbour").

Franchise agreements must be carefully drafted and regularly reviewed by an experienced lawyer to ensure they adhere to competition law. It is equally important for franchisors to put in place (and keep under regular review) a system of policies, procedures and training to enable their own employees to be aware of and identify potentially anti-competitive conduct by franchisees (or by the franchisor itself) and to take appropriate action where any such conduct is suspected. It is also recommended that franchisors proactively alert franchisees to the importance of competition law compliance and the risks of getting it wrong.

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.

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Gordon Drakes
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