In all Italian franchise agreements, franchisees are required to pay a consideration to the franchisor, which constitutes the remuneration paid by the affiliate for the granting of the so-called franchise package. In Italian franchise practice, thea) on a fixed basis, according to a specific period of time (for example monthly);main forms of consideration that the franchisee undertakes to pay to the franchisor are entry fees and royalties, which must be communicated to the franchisee candidates in the disclosure document and regulated in the franchise agreements, although they are not considered binding by Italian Franchise Law. Other forms of consideration in Italian franchise agreements include service fees and surcharge price received for the products supplied to the franchisees. Franchisors cannot neither impose a minimum resale price of the goods to the public nor impose to charge a fixed price, although there are some exceptions.
1.The forms of consideration in Italian franchise agreements
Like all contracts for consideration, also in all Italian franchise agreements the franchisee is required to pay a consideration to the franchisor, under different forms.
This consideration substantially constitutes the remuneration paid by the affiliate for the granting of the so-called franchise package (license to use the franchisor’s trademark, know how license, training, assistance services, etc.) and for the advantages that the franchisee benefits from being part of a franchise network (exclusive, advertising promotion, possibility to sell certain products, etc.).
In Italian franchise practice, the main forms of consideration that the franchisee undertakes to pay to the franchisor are entry fees and royalties.
2.The entry fees
Entry fees are defined by art. 3 of Italian Law no. 129/2004 on franchising as “a fixed amount related to the economic value and development capacity of the network, which the affiliate pays at the time of signing the franchise contract“. This amount is justified in the goodwill that the franchisee gets to use by entering the franchise network and in the expenses incurred by the franchisor for the experimentation of the franchise system, the management of the network. the search for new affiliates, etc.
According to the Italian Law no. 129/2004 on franchising, prospective franchisees must be informed by franchisors, in the disclosure document , about the entry fee requested.
The entry fee is usually requested as a one-off payment by the franchisee at the beginning of the relationship. However, the entry fee is not considered binding by Italian Franchise Law; in fact, sometimes it is not requested by the franchisor, as it usually happens in the franchises for the distribution of goods, since it is absorbed in the sale price of goods (as we will see below).
Royalties are defined by art. 1 of the Italian Law no. 129/2004 on franchising as “a percentage that the franchisor requires from the franchisee commensurate with the turnover of the same or in a fixed amount, to be paid also in fixed periodic amounts“. This is an amount, to be paid periodically, which basically constitutes the consideration for the franchisor’s concession of the franchise package (trademark use license, know how license, assistance services, training, etc.).
Royalties can be basically calculated in two different ways:
- on a fixed basis, according to a specific period of time (for example monthly);
- as a percentage, usually calculated on the turnover developed by the franchisee in the course of its business.
These two forms of royalties may intersect with each other, resulting in various combinations. For example, it is possible for the franchisee to pay a fixed monthly royalty, and at the same time a royalty as a percentage of the franchisee’s turnover, which will be equalized (if higher) with the first to the end of the year.
It is also common in Italian franchise practice – especially in service franchising, in which the franchisee does not purchase goods from the franchisor, so that the extent of the royalties due from the former directly depends on the collections made – contractual clauses according to which the franchisee, without prejudice to a calculation criterion of royalties on a percentage basis, is in any case obliged to pay a minimum amount of royalties to the franchisor, on an annual basis, regardless of the actual turnover developed (or to develop a specific minimum turnover, on which the royalties are calculated ).
The provision of a minimum royalty (or a minimum turnover) is mainly functional to the achievement of three different objectives:
- ensure the franchisor a guaranteed minimum return;
- ensure that all affiliates pursue a minimum – and therefore homogeneous – standard return from an economic point of view, avoiding inequalities that could unbalance the franchise network as a whole;
- avoid the risk of opportunistic conduct on the part of the franchisees, who could otherwise (i.e. with fixed royalties) be induced to reduce their turnover (using their resources in another way, perhaps in competitive activities).
The obligation to pay royalties, especially when they are calculated on franchisee’s turnover, makes it appropriate to provide in the franchise contract an obligation to report by the franchisee about the progress of sales, and the possibility of the franchisor to monitor the activity and inspect the accounting of the franchisee, also through specific audits. It is quite common in Italian franchise agreements a clause according to which, in the event that, following the audit of the franchisor, more or less significant differences should emerge from what was declared by the franchisee, without prejudice to the latter’s obligation to pay the difference on royalties to the franchisor (as well as to refund the costs incurred to carry out the audit), the latter reserves the right to terminate the contract.
According to the Italian Franchise Law, royalties must be mentioned in the disclosure document, and must be regulated in the franchise agreement. However, this does not mean that the payment of royalties is an essential element of the franchise. In fact, such rule is limited to requiring the parties to regulate royalties in the franchise contract – if they are actually provided – but does not prevent the parties from providing other forms of consideration from the affiliate to the franchisor, other than royalties.
4.Other forms of consideration: service fees, purchase prices
In fact, another common form of remuneration for franchisors is to receive, in the face of the transmission of the franchise package to franchisees, periodic service fees for assistance, consultancy and training, independent of the franchisee’s turnover, and in general from sales.
In addition, very frequently, especially in franchise contracts for the distribution of goods and retail, franchisees, in addition or as an alternative to royalties and services’ fees, are obliged to purchase from the franchisor and/or from its suppliers a minimum quantity of goods, to a fixed given price, in which the franchisor’s remuneration is incorporated. In such case, franchisors are remunerated by the surcharge received for the products supplied to the franchisees (so-called indirect or hidden royalty).
This form of indirect consideration (not based on royalties or fees) generally encourages the franchisee to maximize sales (and generate greater profits), which also produces positive effects on the franchisor’s turnover. On the other hand, usually franchisors are naturally driven to concentrate its resources on the production/distribution of goods (which in this case is the only source of their income), rather than in the development of the franchise package (trademarks, services, know-how etc.).
Franchisors can, of course, freely determine – and therefore impose on the franchisee – the purchase price of their goods or services. Frequently franchisors expressly reserves the right to unilaterally vary (usually increasing) the prices of the goods sold to the franchisees, during the course of the contract. This provision is valid according to Italian Law, provided that the franchisor does not abuse it, for example by suddenly and without warning or unjustifiably increasing prices. However, this is considered a vexatious clause for the affiliate, and therefore as such it must be expressly accepted in written by the latter, pursuant to the Italian Civil Code.
On the other hand, franchisors cannot, in general, oblige the franchisees neither to charge a certain minimum price of the goods to the public (imposed resale price), even indirectly (e.g. guarantee discounts or reimbursements of promotional costs provided that it is observed a certain price level), nor to charge a fixed price. This is in fact prohibited by both Italian and EC competition law.
This prohibition conflicts with the franchisor’s need for the affiliates participating in the network to practice uniform prices, or at least not below a certain limit. This need is aimed at maintaining enough degree of control over the whole franchise commercial strategy, since the diversity of prices charged by the affiliates could harm the reputation of the network and the brand.
These franchisors’ legitimate interests can be satisfied by giving them the contractual right to indicate to the franchisees a reference parameter for the determination of the retail price, or to suggest such price, in a non-binding way.
However, EC Regulation no. 330/2010 on vertical agreements expressly allows franchisors to impose resale prices to the public on franchisees in two cases, namely:
- when the franchisor intends to introduce a new product on the market (so-called new entrant exception);
- when the franchisor organizes a short-term promotional campaign (up to 6 weeks).
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.