Under Italian law, a franchise agreement can be stipulated either for a definite or indefinite period of time. However, in Italy franchising agreements have usually a fixed term. According to Italian Franchise Law, franchising agreements must have a minimum duration of three years. Franchise agreements can also be renewed, at given conditions regulated in the agreement. In fixed-term franchising contracts the parties cannot freely withdraw, unless this is expressly provided for in the contract. Franchise agreements can be terminated in case of serious default by one of the parties.
1. Duration of franchising agreements according to Italian Franchise Law
Under Italian law, a franchise agreement can be stipulated either for an indefinite period of time (i.e. without a deadline) or for a fixed term (i.e. with a specific expiry date, after which. the contract ceases).
However, in Italy franchising agreements have usually a fixed term. The provision of a contractual deadline is justified, on the one hand, by the possibility that any failure to renew constitutes a stimulus for the activity of the franchisee, and, on the other hand, by the fact that the franchisor can negotiate the possible renewal of the contract from a position of strength, on the assumption that the franchisee, rather than facing the risks of a new activity and of losing the investments already made, will be willing to accept the new conditions asked by the franchisor.
The duration of the franchise agreement is not entirely subject to the contractual freedom of the parties. In fact, article 3 of the Italian Law 129/2004 on franchising provides that franchise agreements must have a duration of not less than three years, or even more if this is necessary for the franchisee in order to depreciate the investment made to join the franchise.
According to Italian Franchise Law, therefore, franchising agreements must have a minimum duration of three years. Such rule aims to avoid that the franchisee, having made investments in the initial phase of the relationship, is forced to accept heavy contractual conditions by the franchisor, who threatens to terminate the contract early (through the exercise of the right of withdrawal), or not to renew the contract itself.
At the same time, under Italian law franchising contracts must in any case have a sufficient duration to amortize the investments made by the franchisee. By way of example, if the franchisee was required by the franchisor to renovate the building used as a point of sale, according to the franchisor’s standards, and the investments made by the franchisee for such purpose can be depreciated in 4 years, then the minimum duration of the franchise agreement will be 4 years.
The determination of the effective minimum duration of the franchising contract is therefore not exactly established by law, if the amortization of the investments requires more than three years; such situation happens quite frequently (think for example of hotel franchising, where depreciation does not generally occur before 5 years).
Usually, however, in common practice the average duration of a franchise contract in Italy is about 5 years.
2. Renewal of franchise agreements
After the first duration period of the franchise agreement is expired, frequently franchise agreements stipulate that there is an automatic contract extension for other periods of time, unless one of the parties sends to the other a written notice of termination, within a certain period before the expiration of the agreement (usually six or 12 months).
Once the franchise agreement is expired (after the first period of duration or after a termination notice), such agreement can be renewed. Renewal clauses are frequently contained in franchise agreements in Italy, although not always.
In fact, the basic principle of freedom of contract implies that a franchisor has no obligation to renew a contract when it has come to an end (Article 1322 of the Italian Civil Code). However, the franchisee can be protected against the non-renewal of a franchise contract by the provision prohibiting situations of abuse of economic dependence, which includes arbitrary or unfair termination of contracts (Article 9, Law n. 192/1998).
The parties are free to determine the renewal conditions in the franchise agreement. If the parties decide to renew the agreement, they are free to change the conditions provided in the franchising agreement, since the renewed agreement can be considered as a new agreement, under a legal point of view. For example, the franchisor can increase the amount of the royalty, or change the targets to reach.
Contract renewal clauses can be of various types; for example, there are clauses providing for a deadline within which the franchisee must express his willingness to renew the contract, and the possibility of the franchisor to adhere to the request, based on a discretionary assessment or on the achievement of specific parameters (such as the achievement of certain sales volumes, or the correct fulfillment of contractual obligations).
Sometimes, the franchisee’s obligation to pay the franchisor a specific renewal fee, generally lower than the initial amount, is required.
A franchisee has no statutory right to any compensation or indemnity on termination or non-renewal of the franchise agreement. This right only exists for commercial agents (article 1751 of the Italian Civil Code) and there is no case law that applies this provision by analogy to distributors or franchisees.
3. Withdrawal from franchise agreements
Franchise agreements usually contain a withdrawal clause, giving the right to terminate the contract by virtue of the mere will of one of the parties, regardless of the existence of any default by the other party. Withdrawal clauses have a different discipline depending on whether the franchise contract is for an indefinite period or for a fixed term.
In the first case, each of the parties may always withdraw at any time, even in the absence of an express contractual clause, subject to adequate prior notice, by virtue of the general principle that excludes the perpetuity of the mandatory obligations. In general, the minimum duration of the notice period is left to the autonomy of the parties.
However, Italian Law n. 129/2004, providing for a minimum duration period of 3 yearsof the agreement, indirectly excludes the possibility of contractually providing for the possibility (at least for the franchisor) to withdraw from the contract before this deadline. Therefore, if the franchisor intends to withdraw from the contract, the franchisee must be given such advance notice as to allow the amortization of the investments.
If the parties have not provided for the period of notice in the contract, and a dispute arises on this point, the congruity of this period will be assessed by the judge, based on the general principle of contractual good faith. In practice, the judge will evaluate a series of elements, such as the duration of the pre-course relationship, the expectation of the counterparty to continue the relationship, the investments sustained by the party who suffers the withdrawal, the amount of the stock lying in the warehouse, etc. To eliminate the uncertainty related to the judge’s discretion, it is advisable to include in the contract the notice period for the withdrawal, quantifying it in a suitable measure.
In case of failure or insufficient notice, the withdrawal is still valid and effective, but the withdrawing party will be required to pay compensation in favor of the other party. If the franchisor withdraws without adequate notice, the compensation in favor of the franchisee will generally consist of the net lost profits that the franchisee would have realized during the period of notice and of the expenses incurred by the same for the organization and promotion of sales in anticipation of the longer duration of the relationship (non-recoverable investments, stock of products). Of course, it is possible (and indeed advisable) that the parties expressly foresee in the contract the consequences in the event of failure or insufficient notice, eg. providing for compensation for damages (penalty clause) against the withdrawing party.
In fixed-term franchising contracts – which as stated above represent the most frequent case in Italy – instead, the parties cannot freely withdraw, unless this possibility is expressly provided for in the contract. In this case, franchising agreements usually do not include the right to withdraw by the franchisee, because the franchisor has an interest that the franchisee remains bound by the contract for the entire duration of the agreement. Instead, it is common for the franchisor to reserve the right to withdraw from the contract. Even in this case, the withdrawal must in any case allow the minimum duration of the contract envisaged by the law, previously described.
4. Termination of franchise agreements in Italy
According to the Italian civil Code, franchise agreements can terminate in the following cases:
- in the case of fixed-term agreement, when the term of the agreement comes to an end (see par. 1);
- by mutual consent of the parties;
- by withdrawal of one of the parties, if provided for in the agreement (see par. 3);
- in case of default or non-performance by one of the parties.
In Italy, franchise agreements can be terminated in case of default by one of the parties, as it happens in general for all contracts. According to articles 1453 et seq. of the Italian Civil Code, the not defaulting party has the right to terminate the contract only in case of a serious breach by the other party, i.e., if the non-fulfillment by the other party is of such gravity and importance as to justify the termination of the contract.
As far as franchising contracts are concerned, the relevance of the non-fulfillment for the purposes of termination must be assessed with particular attention, in consideration of the effects that the resolution itself causes to both parties. In general, as with all duration contracts, a franchise contract can be terminated only if there is a breach such as to undermine the confidence in the regularity of future obligations, i.e., the trust between the parties, as determined by a case-by-case analysis.
In this sense, the sporadic non-fulfillment by the franchisee of pecuniary obligations (for example, royalties, or price of goods) or of obligations relating to compliance with minor provisions of the operating manual supplied by the franchisor, can hardly lead to a declaration of termination of the contract – causing, instead, the simple obligation of the franchisor to compensate the damage. On the contrary, the violation of any exclusivity rights on the product, the non-compliance with the franchisor’s standards (such as regarding the presentation of the goods or assistance to the client), which could affect the image of the whole franchise chain, constitutes a serious breach and therefore will usually lead to the termination of the contract.
On the other hand, the non-fulfillment by the franchisor of obligations relating to the transmission of distinctive signs and know-how, as well as assistance and collaboration with the franchisee, or exclusivity, is likely to cause the termination of the franchise agreement, since they usually affect the concrete possibility for the franchisee to carry out its business activity within the franchise.
The importance of non-performance must also be assessed in relation to any reciprocal breaches of the parties. In fact, if both the franchisor and the franchisee default on their contractual obligations, the judge will have to assess which of the two parties has been responsible for the most significant defaults, through a comparative judgment of the parties’ behavior, regardless of the chronological profile of the breaches themselves.
To eliminate the uncertainty about the possibility of terminating the contract due to non-fulfillment of the same, the practice of providing express termination clauses in the franchising agreement, with which the parties predetermine in advance which contractual violations are likely to cause the termination of the contract, is widespread in Italy, thus removing the discretion of the judge in establishing the importance of the breach.
The defaults that trigger the termination clause expressed in the franchise contracts are generally related to the franchisee’s obligations, such as:
- failure to purchase product minimums or failure to achieve minimum turnover;
- non-payment or delayed payment of the goods in the contractually established terms;
- violation of exclusivity or of the non-competition clauses;
- violations concerning the distinctive signs and industrial property rights of the franchisor;
- disclosure of confidential information.
Once the contract is terminated, the franchisor must take care to avoid that the clients tend to identify the former franchisee with the product and its manufacturing company and that, in the most serious cases, the former franchisee is diverting part of the clients towards the competitors. It is therefore appropriate, in the interests of the franchisor, to provide that the former franchisee will stop presenting itself to the clients as a member of the network, in order to avoid confusing the same customers about the subject to whom to turn to obtain the supply of products or technical assistance.
Franchise agreements usually include an agreed number of liquidated damages that must be paid in the case of a specific breach of contract (article 1382 of the Italian Civil Code). These liquidated damages must be paid regardless of whether the actual damage is proved by the damaged party.
Under Italian law there is no legal obligation for the franchisor to repurchase stock. However, in compliance with the principle of contractual good faith pursuant to art. 1375 of the Italian Civil Code, the franchisor could be obliged to buy back the stocks of the franchisee at the time of termination of the relationship, given that in this case the sacrifice of the franchisor for buying back the goods from the franchisee is far less than what the latter would face in the event of failure to repurchase. This obligation may in particular exist in the following cases:
- if the goods are held by the franchisee as a result of agreements imposed by the franchisor and under the latter’s directives;
- if the size of the stock has been set exorbitantly in relation to the financial capacity of the franchisee or with respect to the average turnover time of the sector;
- if the stock has been renewed by the franchisee near the contractual deadline, and the franchisee himself relied in good faith on the renewal of the contract;
- in the event of termination of the contract due to default by the franchisor.
In any case, it is appropriate to expressly regulate this aspect in the franchising agreement, providing, for example, an option to purchase the stock in favor of the franchisor at a predetermined price (for example equal to the original selling price), to be exercised within a given period of time, after which the franchisee can resell the products directly on the market, within a certain time limit, taking advantage of the distinctive signs of the franchisor.
Despite the fact that at the time of the termination of the relationship the franchisee is exposed to the risk of losing a large part of the clients he had at the time of the relationship – given that the more the franchisee has affirmed the name of the franchisor and its chain, the more the clients will seek probably the same product from other franchisees, nullifying goodwill – if nothing is provided for in the contract, under Italian law no claim by the franchisee can be made with respect to the loss of goodwill.
Consequences of non compliance with the Italian Franchise Law might be quite severe for foreign franchisors. Therefore, careful planning and adequate legal counseling from a local law firm is highly recommended.
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.