Abuse of economic dependence and franchising: the AGCM opens a procedure against Mc. Donald’s in Italy

The Italian Competition and Market Authority (“AGCM”) initiated an investigation against McDonald’s for alleged abuse of economic dependence, upon reporting by some former franchisees in the McDonald’s network, who had managed restaurants in different Italian regions through company leasing and / or franchising contracts. These reports concern a series of conducts implemented by McDonald’s in all phases of the commercial relationship with affiliates, from the one before the signing of the contract to the one after its termination. The proceeding initiated by the AGCM unequivocally testifies to the renewed interest of the Italian Authority against the abuse of economic dependence, in particular in the franchising sector. We analyze the characteristics of the abuse of economic dependence and its applications in Italian case law, in particular applied to franchising contracts.

1.The investigation by the AGCM for abuse of economic dependence

With a decision of 27 July 2021, the Italian Competition Authority (“AGCM“) initiated an investigation against McDonald’s Development Italy LLC (McDonald’s) for alleged abuse of economic dependence.

The AGCM took action on the recommendation of some companies that had operated as franchised affiliates of the McDonald’s network, managing restaurants in various Italian regions through company and / or franchising lease agreements, which were then discontinued.

These reports concern a series of conducts implemented by McDonald’s in all phases of the commercial relationship with affiliates, from the one before the signing of the contract to the one after its termination.

The proceeding initiated by the AGCM against McDonald’s – which should be completed within the current year – follows a similar proceeding against the Benetton group  within a few months, (not yet concluded to date), and it unequivocally testifies to the renewed interest of the Italian Authority against the abuse of economic dependence, in particular in the franchising sector.

1.2 The conduct of the franchisor in the phase preceding the conclusion of the franchise agreement

In the phase prior to the establishment of the franchise relationship, a series of behaviors were highlighted by the reporting parties, which highlight how the future franchisees of the McDonald’s network were already in a condition of total absence of negotiating power and alternatives of choice. In particular, in this phase the following were highlighted:

• the obligation imposed on future affiliates to carry out, entirely at their own expense, a full-time training period in restaurants of the McDonald’s group, lasting between six months and two years and considerably onerous, as a result of which there would be no however, there was no guarantee that he could actually become a franchisee;
• the lack of information, during the training period, relating to the economic and financial management of the restaurants, the average profitability, the terms and conditions of the contract, the location of the assigned restaurant;
• the possibility of viewing the contract only at the time of signing it at a notary’s office, and the impossibility of negotiating its contents or making changes.

1.3 The clauses of the franchise agreement

The reporting parties complain about a series of particularly burdensome contractual conditions, contained in the franchise and/or business rental agreement, such as to significantly limit the margins of autonomy of the franchisees in their business management choices, despite the high risk capital invested.

In particular, the following was highlighted:

• heavy fees in favor of the franchisor, by way of entry fees, royalties, promotional contributions, economic-financial and operating conditions, overall investment costs, including requests for sureties, maintenance and repair of goods purchased by the franchisee, expenses condominium of the premises in use, etc .;
• participation in training activities and related travel, allowance and accommodation expenses; obligation of minimum advertising investments calculated on gross turnover;
• obligation to maintain one’s residence within certain mileage limits;
• obligation to devote all one’s work activity exclusively to the management of the premises;
• obligation to comply with the non-compete prohibition for the entire duration of the contract and for one year from the date of termination of the latter, throughout the national territory;
• obligation to comply with the prohibition to change the franchisee’s shareholding structure, unless with the prior approval of the franchisor;
• absence of territorial exclusivity and waiver of any claim regarding any prejudice deriving from the opening of other McDonald’s restaurants;
• obligation to comply with all the franchisor’s company policies, practices and techniques, for a uniform and homogeneous management of all restaurants;
• obligation to use the IT tools necessary to comply with the rules, practices, procedures and the McDonald’s system;
• obligation to comply with the uniform pricing policy for all network affiliates and to comply with the recommended prices, as well as to notify the franchisor in advance of any changes;
• obligation to comply with the terms and conditions of the promotions proposed from time to time by the franchisor and to use only the advertising and promotional materials and programs provided by the franchisor and previously approved by it;
• lack of right to indemnity or compensation for any cause and reason, upon termination of the contractual relationship, including loss of goodwill;
• granting of the option right in favor of the franchisor for the purchase of material assets owned by the franchisor, with the renunciation of the latter of any right relating to positive differences between the value of the equipment and the value of these upon expiry, termination or early dissolution of the contract.

1.4 The contractual conduct of the franchisor during the relationship

In the reports received it is highlighted that, during the contractual relationship, the affiliates of the McDonald’s network were obliged to comply with the pervasive dictates, indications, instructions and directives of the franchisor concerning the management of the leased restaurants, which would have produced the effect of ” completely eliminate any margin of decision-making autonomy in the exercise of business activity “.

In particular, in this regard it was reported:

• the obligation to strictly and punctually comply with the decisions taken regarding the selling prices of the products offered to consumers, regardless of the specific market situation and location of the restaurants;
• the obligation to use, with reference to equipment, raw materials and all products necessary for the exercise of the activity, exclusively the suppliers authorized by the franchisor, at costs far higher than those applied by other suppliers;
• the obligation to purchase and restock quantities of products predetermined at the discretion of the franchisor, with orders managed centrally and automatically, always from suppliers authorized by the franchisor and at costs that are also higher than those of the market;
• the limitation of the franchisees’ freedom of choice with reference to the consistency of the restaurant staff, qualifications and working hours, even independently of the actual needs of the premises;
• compliance with certain financial parameters in management (debt to equity ratio, ratio between cash flow and loans, ratio between sales and current liabilities), which would induce the franchisee to allocate profits to increase capital.

1.5 Conduct of the franchisor at the end of the contractual relationship

Finally, it was reported that at the time of expiry, termination or early termination of the contract, the affiliates of the McDonald’s network were unable to recover in any way the investments made, with reference to both tangible assets and goodwill.

In particular, in this regard it was reported that:

• it would be impossible to “reconvert” the technical equipment in favor of other affiliations or commercial activities, as it is only possible to buy them back from the franchisor at ridiculously low prices (book value), allowing the same franchisor to be able to subsequently resell the same equipment to a new successor franchisee , making a profit on the investments made by the previous affiliate;
• no indemnity or compensation for any reason whatsoever would be allowed upon termination of the contract.

1.6 The preliminary assessments of the AGCM

In light of these reports, the AGCM decided to open an investigation, as the conduct highlighted above is likely to constitute an abuse of economic dependence on the part of McDonald’s towards its affiliates.

These conducts would, in fact, on the one hand, significantly erode the spaces of entrepreneurial autonomy of the affiliates and, on the other hand, would have compressed their profitability margins, preventing them from switching to other catering networks or other similar, more profitable activities.

In the opinion of the Authority, there seems to be an “excessive imbalance of rights and obligations” in the relations between the franchisor and its affiliates, in the light of various symptomatic elements regarding particularly:

• the different market position of the parties to the contract;
• the stipulation of a contract to which the affiliate could only adhere, without the possibility of changes;
• the extended duration of the contract (twenty years);
• the difficulties for the franchisee, upon termination of the relationship, to recover the investment made, also through affiliation with another chain, with the consequent impossibility of finding alternatives on the market to the contractual relationship with the franchisor.

The AGCM therefore intends to verify whether these conditions and obligations may be “unjustifiably burdensome” and “not essential to the organization of the McDonald’s network and the protection of its brand or other assets in the system”.

Furthermore, according to the AGCM, the uniformity of commercial policies imposed on franchisees could limit Interbrand competition between McDonald’s chain restaurants and the conducts that have the effect of transferring the economic returns of the investments made by the franchisees to the franchisor would determine an illicit advantage. in favor of McDonald’s, potentially capable of affecting Interbrand competition as well.

2.What is the prohibition of abuse of economic dependence?

The abuse of economic dependence is described by art. 9 of the Italian Law no. 192/1998 as the situation in which a company is able to determine an excessive imbalance of rights and obligations in commercial relations with another company, also taking into account the real possibility for the abused company to find satisfactory alternatives on the market. Therefore, this situation tales place when two conditions are met:

• the possibility of determining in commercial relations with the counterpart an excessive imbalance of rights and obligations, by virtue of the power of domination that one company is able to exercise over the other as a result of existing commercial relationships; And
• the real possibility for the employee company to find satisfactory alternatives on the market.

Ultimately, economic dependence is the translation, in legal terms, of a monopolistic, or almost monopolistic, situation in which one firm finds itself vis-à-vis another. It consists of a deficit of contractual power – that is, in the reduced or canceled ability to obtain favorable contractual conditions – determined by the difficulty or impossibility of finding alternatives on the reference market, which corresponds to the power of the contractually strong firm, to determine an excessive imbalance of rights and obligations between the parties.

The rule in question typifies three hypotheses that constitute the most relevant manifestations of the abuse of economic dependence, namely:

• refusal to sell or buy;
• the imposition of unjustifiably burdensome or discriminatory contractual conditions;
• the arbitrary interruption of commercial relations.

3.What are the consequences of the abuse of economic dependence

When a situation of abuse of economic dependence arises, there are two types of consequences:

• on the civil law level, the agreement with which the abuse of economic dependence was carried out is void, with the consequent right to compensation for the damage of the company that has suffered the abuse;
• on the administrative level, the Antitrust Authority may, pursuant to Law no. 287/1990, impose on the company that has abused the economic dependence of another pecuniary sanctions up to 10% of the total turnover of the same company, if it does not complete the formal notice issued by the same Authority.

4.Abuse of economic dependence and franchising

Although the Italian Law n. 192/1998 concerns industrial subcontracting, the abuse of economic dependence is now considered a figure applicable, in a general and transversal way, to any contractual relationship between companies supported by logic of productive decentralization, in which a situation of negotiation asymmetry is found ( as is, among other things, unequivocally confirmed by the original location of the provision within the antitrust law). Franchising contracts therefore fully fall within the scope of application of the standard in question.

In fact, franchising contracts very often contain clauses that are significantly restrictive of the competition and entrepreneurial autonomy of the franchisee; the aforementioned list, on which the AGCM’s attention was focused in the case of the contract used by McDonalds, is a good example of the situation of evident contractual imbalance that characterizes, in a general and structural way, most of the franchising contractual models used for some time in practice (very often of Anglo-American derivation, in line with the geographical context in which the institute has historically developed).

Franchise agreements are therefore physiologically characterized by the economic dependence of the franchisees on the franchisor. The franchisee is asked to adapt to the particular production and distribution system that characterizes the franchising network, and therefore to adapt to the directives of the franchisor as regards the products and services to be purchased, resold and supplied, the setting up of the premises, the ‘use of software, advertising, brand use, and so on.

Not surprisingly, one of the characterizing traits of franchising is precisely the homogeneity of the franchising network itself; the franchisees are closely connected with the franchisor, and are vertically integrated with the latter, so much so that in the eyes of the public the franchisee appears as the franchisor’s alter ego.

The situation of economic dependence of the franchisee is then accentuated by the presence (almost inevitable) within the franchise agreements of an exclusivity clause   in favor of the franchisor, which prevents the franchisee from finding alternatives on the market to the relationship with the counterpart, determining or strengthening the franchisor’s relative dominance position

Therefore, it is possible to state that any franchising relationship is intrinsically characterized by a situation of economic dependence of the franchisees towards the franchisor. But this does not mean, of course, that this addictive situation should be considered illicit. On the contrary, it must be presumed to be absolutely lawful; as is unequivocally confirmed not only by the typification of the institution operated by  Italian Franchise Law no.129/2004  but also, and above all, from the legitimacy license that franchising has always received from the community authorities, in the antitrust field.

Indeed, since the Prenuptial judgment of 1986, the (numerous) clauses restricting competition contained in most franchise agreements – such as for example the obligations imposed on the franchisee to protect the franchisor’s trademark and intellectual property, the imposition of certain procedures for the sales activity, the exclusive obligations, etc. – shave always been deemed compliant with antitrust principles, and indeed considered with particular favor in terms of integration of national markets.

This is essentially because, upon the outcome of a balancing, based on the so-called rule of reason, the competitive restrictions present in franchising contracts are considered as a whole capable of bringing benefits to the market, thus being allowed to entrepreneurs without experience necessary to make use of methods that they could have acquired only after a long and laborious research and to benefit from the reputation of the franchisor’s distinctive sign.

On the other hand, it is not without significance that these clauses are not only freely accepted by the affiliate – who, it should be remembered, always has the legal status of entrepreneur, and not of consumer – when he signs (freely) a franchise agreement, but which have been (should be) adequately assessed and weighed by the aspiring franchisee before signing the agreement, given that Italian Franchise Law no.129/2004 – with a rule that represents a unicum in the context of business contracts – requires the franchisor, as is known, to provide the future franchisee with a series of information, as well as a copy of the franchise agreement, at least 30 days before the actual signing of the contract itself.

5.The typical cases of abuse of economic dependence in franchising

The fact that franchise agreements are physiologically characterized by the economic dependence of the franchisee does not mean, however, that this situation can always be considered lawful. The art. 9 of Law no. 192/1998 in fact prohibits (not economic dependence as such, but) the abuse of the economic dependence of one company to the detriment of another. It is therefore necessary to analyze when this abuse can be carried out by the franchisor to the detriment of the franchisee, thus integrating the case envisaged by the law.

In the context of franchising, two of the typical cases described by art. 9 L. n. 192/1998 in which the abuse of economic dependence of the franchisor may occur to the detriment of the franchisee:

• the arbitrary interruption of commercial relations;
• the imposition of unjustifiably burdensome contractual conditions.

The first case – which can occur when the franchisor withdraws ad nutum from the contract (making use of an option provided for in the contract itself), or refuses to renew the validity of the contract – once the first period of validity of the same has expired, or one of the subsequent periods – is not the subject of the investigation opened against Mc. Donald’s.

The second case of abuse of economic dependence that can occur in the context of franchising contracts – which is precisely the case taken into consideration by the AGCM in the McDonald’s case – is the consistent one the imposition of unjustifiably burdensome contractual conditions.

From this point of view, not so much – or at least not only – the severity of the contractual conditions, but also (and above all) their unjustifiability are relevant. It is therefore essential to consider whether the restrictions on contractual freedom imposed by the franchisor on the franchisee are justified by the legitimate needs of the franchisor to ensure the stability and uniformity of the franchise network, and, in particular, aimed at protecting the know-how transmitted. the franchisees, whose existence and validity constitute the architrave on which the legitimacy of the franchise is based.

In other words, it is necessary to assess whether these clauses are actually functional to the achievement of the purposes inherent in the franchising contract – and therefore to protect the uniformity and image of the network, as well as the know-how developed by the franchisor – or if instead they are aimed at ensuring an unjustified enrichment of the franchisor to the detriment of the franchisee.

In this sense, for example:

• the prohibition of the franchisee from carrying out a competing activity, while severely limiting their entrepreneurial freedom, is not unjustifiably burdensome if functional in order to prevent the disclosure of the network’s know-how and protect the franchisor from the danger of customer diversion in favor of competitors;
• the obligation for the franchisee to sell exclusively products supplied by the franchisor and the right of the latter to control the assortment of product types offered to the franchisee, is not unjustified if necessary to ensure that the customer can find goods at each affiliated shop of the same quality, and therefore to protect the reputation of the network;
• the franchisor’s obligation not to sell the business without the franchisor’s consent is not excessively burdensome if it aims to prevent competitors from indirectly benefiting from the know-how and assistance of the franchisor, by opening a store in the same premises in which the affiliate previously operated;
• the obligation for the franchisee to apply exclusively the commercial methods developed by the franchisor is not excessively burdensome if it is justified by the need to ensure the unity of the network,

and so on.

6.The abuse of economic dependence in jurisprudence

So far the Italian case law, while recognizing, in its majority part, the applicability of art. 9 L. n. 192/1998 also to franchising contracts, has always denied the existence of a position of economic dependence of the franchisee towards the franchisor, not recognizing the extremes of the abuse of economic dependence in the terms indicated in the law and consequently rejecting the relative questions proposed by franchisees.

The main reason why the applications for the protection of the affiliates were disregarded by the judges – beyond the lack of familiarity and/or the incorrect or superficial application and interpretation of the rule on the abuse of the prohibition of economic dependence – lies in the negative evaluation about the possibility for the affiliate to find satisfactory alternatives on the market. In other words, Italian judges have so far held – albeit with often very concise, superficial and approximate reasons – that the franchisee, even in the presence of a situation of objective excessive contractual imbalance, had the possibility of finding better alternatives or in any case valid on the market, compared to those represented by the franchisor.

In fact, the analysis of many franchise agreements used in practice shows how the affiliate is often required to make investments that are not easily reinvested or convertible into another future and possible relationship. Each franchisor, in fact, generally adopts a different distribution system compared to that of the other franchisors existing on the market, for which the franchisee is forced to acquire knowledge and make investments that will be useful only in relations with that particular franchisor, and difficult to reuse in relation to of other entrepreneurs who make use of different systems.

In other words, the franchisee – physiologically – finds himself in the situation of not being able to profit from satisfactory alternatives on the market. These alternatives, although present in the abstract, would require the loss of those investments and knowledge, and therefore become substantially inaccessible to the affiliate.

Furthermore, the affiliate is often an entrepreneur who is not very experienced or shrewd, if not a real new-comer of the market, and therefore is unable to assess the actual presence of other offers on the market. Indeed, this evaluation requires skills and abilities that are not always within the reach of the affiliates, or in any case the need to appoint external consultants, whose costs are often not affordable for the affiliates.

However, the analysis of the possibility of franchisees to find valid and satisfactory alternatives on the market – for the purpose of ascertaining the condition of economic dependence towards the franchisor – must be conducted not abstractly but on a case-by-case basis, and in a rigorous manner, through an objective and subjective assessment of the relevant market – under the dual profile of the commodity market and the geographic market – and the ascertainment of the presence in it of alternatives – in terms of alternative distribution or purchase channels – with the criteria of antitrust law.

For the purposes of this analysis, it is therefore necessary to evaluate:

• from an objective point of view, the economic characteristics of the individual franchise network and of the market in which it takes place;
• from a subjective point of view, whether the franchisee can consider – on the basis of economic and entrepreneurial criteria – the alternative present on the relevant market as reasonable, in light of the costs that may be necessary to change commercial partners or distribute the product through different channels.

It being understood that, as evident, the larger the reference market, the greater the chances that there are alternatives on it. Basically, the assessment of the franchisee’s economic dependency situation presupposes, once the alternative on the market has been identified, the determination of the competitive cost that the same would have to face in order to use this alternative, or the reconstruction of the overall switching costs (transport, loss of customers, conversion of machinery, etc.), which the franchisee would have to face in order to become affiliated with another franchise network.

In practice, therefore, the economic dependence of the franchisee will exist not only if the costs of the alternative with respect to the franchisor are such as to jeopardize the very survival of his business, but also when these costs are higher than those ordinarily borne by the competitors of the franchisor. affiliate, and, therefore, the alternative can be pursued only on condition of accepting a competitive disadvantage.

 

Avv. Valerio Pandolfini

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The information contained in this article is of a general nature and is not to be considered an exhaustive examination of the various issues, nor is it intended to express an opinion or provide legal advice. Specific legal advice must be provided with regard to individual cases.