Investments in franchising: how they are regulated in Italy from a legal point of view
The issue of investments that the franchisee must make to carry out his business within a franchising network is very important from a legal point of view. The investments are taken into consideration by Italian Law no. 129/2004 on franchising under two distinct profiles: on the one hand, the amount of investments requested from the franchisee is relevant for the purpose of determining the minimum duration of the franchise agreement; on the other hand, the franchise agreement must indicate, among other elements, the amount of investments that the franchisee must make before starting the business. Italian Franchise Law does not refer to all the costs that the franchisee has to bear, but only to those specifically relating to the franchise network in which he operates, which must be clearly illustrated to the aspiring franchisee before signing the franchise agreement.
1.The importance of the information to be provided to the prospective franchisee before signing the franchise agreement
The phase preceding the conclusion of a franchise agreement is particularly delicate, and for this reason it is carefully regulated, both in Italy and abroad. The purpose of this regulation is essentially the need to rebalance situations of “information asymmetry”, which are typical of franchising relationships.
Despite the fact that franchise agreements are concluded by two subjects who are both entrepreneurs, falling within the scope of the so-called business-to-business relationships (B2B) – since franchisees are not considered consumers from a legal point of view – in reality the position of the two parties is by no means equal. While the franchisor is usually an expert in the sector, with experience and economic capacity – and therefore a “strong” contractor – the franchisee generally does not have the knowledge and experience that the franchisor has – often being his first experience, or at least its first experience in that particular sector – and therefore can be considered a “weak” contractor.
It is therefore no coincidence that the obligation to disclose information (duty of disclosure) relating to the franchisor’s sphere of activity, before the establishment of the actual contractual relationship, constitutes the most important aspect of the disciplines enacted so far in the various legal systems on franchising, which are essentially disclosure laws, while granting the parties, as regards the substantial aspects of the contractual relationship, ample freedom; as in the case of Italian Franchise law no.129/2004.
2.The relevance of the investments that affiliates must make to enter the network
A particular source of vulnerability of the franchisee derives from the investments it is required to make for the exercise of the business in a franchise network. In fact, if the franchisee – as often happens – is required to carry out, as a condition for his entry into a specific network and/or stay in it, specific economic investments – that is, specifically relating to the activity that must be carried out as an affiliate in that given franchise network – the same franchisee inevitably finds himself in a situation of subjection, which can lead to real dependence on the franchisor, favoring possible opportunistic behavior of the latter.
In this case, the franchisee must bear costs, required to be part of that specific network, which are difficult to convert (i.e. reusable) for the exercise of other activities (both on their own and in other networks), once the relationship with the franchisor ends (sunk costs), being associated only with that specific activity carried out within the network, or, even more so, referring to activities that cannot be carried out upon termination of the contract by virtue of a post-contractual non-competition agreement, which prevents the affiliate from carrying out the same or similar activity for a certain period after the termination of the contract.
Just think, to give some examples, of a specific management software, which the affiliate must purchase or, more frequently, use under license; or to certain interior furnishings that the franchisee must set up, in compliance with the standards required by the network (often with the obligation to contract with certain suppliers, indicated by the franchisor); or to certain machinery that the franchisee must purchase and use to carry out a specific activity within the network. These are costs that the affiliate would not have incurred if he had conducted his own business independently, or in any case on which he would have had freedom of choice; and which, at the end of the franchise agreement, are difficult to recover from the franchisee.
3.The regulation of investments in Law 129/2004 on franchising
The issue of investments that the franchisee must make to carry out his business within a franchising network is therefore very important, and has been taken into consideration by Italian Franchise law no.129/2004 on franchising under two distinct profiles.
On the one hand, the amount of investments requested from the franchisee is relevant for the purpose of determining the minimum duration of the franchise agreement. Art. 3, paragraph 3, of the law no. 129/2004 provides that, if the contract is stipulated for a fixed term – as happens in the vast majority of cases – “the franchisor must in any case guarantee the franchisee a minimum duration sufficient to amortize the investment and in any case not less than three years“. Franchise contracts must therefore have a minimum duration of at least three years, or in any case not less than that (possibly greater) sufficient to guarantee the franchisee the amortization of the investments made to become part of the network.
Italian regulation therefore introduces a recovery period, such as to ensure a minimum duration of the relationship, in order to rebalance the disparity in contractual power that may manifest itself in the phase following the stipulation of the franchising contract. In particular, the objective of the forecast is to avert the danger that the franchisee, having made the initial investments required by the franchisor – specific, and therefore difficult to reconvert at the end of the contract – may be at the mercy of the franchisor; who, by threatening to terminate the contract early (through the exercise of the right of withdrawal), or not to renew the contract, would otherwise be able to impose burdensome contractual conditions for the franchisee himself.
From a different point of view, art. 3, 4th paragraph, lett. a) of the Law no. 129 of 2004 provides that the franchise agreement must necessarily indicate, among the various elements, also “the amount of investments (..) that the franchisee must support before starting the business“.
In this regard, art. 4 of Law no. 129/2004 provides, for the franchisor, a series of pre-contractual information obligations. That is, information obligations that precede the signing of the franchising contract. This provision is precisely aimed at ensuring that the future franchisee has all the useful and/or necessary elements to evaluate the content of the transaction that is about to conclude – making use, if necessary, of the advice of experts in the sector – and, at the same time , has a sufficient time frame to carry out this assessment (the so-called cooling-off period).
In particular, such rule provides for the obligation for the franchisor to deliver to the aspiring franchisee, at least 30 days before the signing of the franchise agreement, the complete copy of the contract to be signed, and a series of “attachments”, containing a number of information (including data of the franchisor, indication of the brands used, list of affiliates, etc.).
Therefore, the franchisor must communicate to the aspiring franchisee, among other information, the amount of investments that the latter will have to make, so that also this important element is subject to an adequate evaluation by the affiliated candidate (who can, for example, compare the investment requested with that requested by other competing networks, evaluate any request for funding, etc.). The franchisor will face responsibility towards the franchisee, if he has not accurately informed the aspiring franchisee about the required investments.
4.Specific and non-specific investments
Italian Franchise Law does not refer to all investments in general necessary or appropriate for the franchisee’s activity to be launched, but only to the specific investments that the franchisee is contractually obliged to make, at the request of the franchisor, to start of the business within the franchise network. In other words, according to Italian Franchise Law the franchise contract – that must be given to the aspiring affiliate before the contract is signed – all the costs relating only to the goods or services provided by the franchisor (or by the mandatory suppliers, indicated by the latter). and that obligatorily the affiliate must purchase and use, in order to adapt to the affiliation system.
In fact, the franchisor is generally not able to identify and determine the cost of the investments decided and carried out independently by the franchisees, which vary, to a large extent, in relation to the subjective conditions of the latter and their discretionary choices. Just think, for example, the purchase or rental of properties, or the renovation of premises, beyond the minimum specifications required by the franchisor; the purchase of licenses that in any case the affiliate would have had to obtain to carry out a specific activity; expenses relating to personnel, whether employed or not, that the affiliate would have faced in any case, etc.
If the franchisor omits or incorrectly indicates to the (aspiring) franchisee “specific” cost items – or, as mentioned, specifically and compulsorily requested by the franchisor himself as a condition for starting the franchise business – the same will be exposed to liability towards the affiliate; who may, for this reason, make claims for compensation, and/or ask for the termination of the contract.
5.Investments and business plans
This does not mean, however, that the franchisor is exempt from liability if he incorrectly indicates to the (aspiring) franchisee “non-specific” cost items, falling entirely within the autonomous decision-making sphere of the latter. Think of the costs relating to personnel, the rent of the premises, the procurement of raw materials, etc. Indeed, these types of costs are frequently included in business plans, which often franchisors deliver to aspiring affiliates to entice them to join a franchising network, and which contain a forecast – formulated in the most varied way, with greater or lesser degree of detail, with greater or lesser reference to the actual market in which the affiliate, etc. – about the profits that they will be able to achieve as a result of joining the network, in light of the costs that will have to be incurred.
Invariably, a business plan contains positive and encouraging projections about the affiliate’s profits, in order to positively influence their decision; and very often, during the franchise relationship, a more or less significant deviation occurs between the data indicated in the business plan and the profits actually achieved by the franchisee, for example because the costs (specific or, in this case, non-specific) are been underestimated.
In this case, although there is no legal obligation for the franchisor to provide the aspiring franchisee with a business plan before signing the franchise agreement – given that Law no. 129/2004 does not contemplate the obligation to communicate profitability forecasts to the aspiring franchisee – and while the franchisor does not have a contractual liability towards the franchisee if the latter does not actually achieve the profits that were foreseen in the business plan – as the franchisor does not assume any legally binding result obligation towards the franchisee – the failure to realize the forecasts of a business plan can place the franchisor in a risk situation, if the business plan delivered to the franchisee contains incorrect data or information.
In this case, in fact, given that the franchisee inevitably relies on the business plan in the course of negotiations with the franchisor – and indeed it is an often decisive element to push a subject to become affiliated with a certain franchise network – the same could obtain the termination of the franchise agreement, with consequent compensation for damage, if he can prove that he has been misled or mistaken.
From another point of view, since the business plan is legally considered as advertising, if it contains false statements, or in any case the truthfulness of which is not objectively demonstrable, about the costs and/or profits deriving from the commercial affiliation, the franchisor could expose itself to a sanction by the Italian Antitrust Authority (AGCM) for misleading advertising, also exposing itself to brand damage due to the consequent negative advertising (given that the provisions of the AGCM are published on the website of the Authority and they are widely disseminated in the media).
Avv. Valerio Pandolfini
For other in-depth articles on issues relating to franchising: visit our blog.
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.