Termination of franchise agreements in Italy

In Italy, franchising 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, To eliminate the uncertainty about the possibility of terminating the contract due to non-fulfillment, 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.

Termination of franchise agreements in Italy

In Italy, franchising agreements can be terminated in case of default by one of the parties, as 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.

With regard to the franchising contracts, 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, and 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 (relating, for example, to the payment of royalties, or price of goods) or of obligations relating to compliance with the 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 non-compliance by the franchisee with the presentation of the goods or assistance to the client, which could affect the image of the whole distribution system, 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, 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 – and which must be indicated expressly and specifically in the clause – are generally related to the franchisee’s obligations, relating for example to:

1. a) failure to purchase product minimums or failure to achieve minimum turnover;
2. b) non-payment or delayed payment of the goods in the contractually established terms;
3. c) violation of exclusivity or of the non-competition clauses;
4. d) violations concerning the distinctive signs and industrial property rights of the franchisor;
5. e)  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 ceases to present 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.

One of the most significant problems that arise after the termination of a franchise agreement is constituted by any goods held by the franchisee at the time of termination of the relationship. It is not, in fact, rare that, at the end of the contract, even substantial quantities of unsold stocks (materials, raw materials, semi-finished products, finished products) remain at the franchisee. This situation can therefore represent a significant entrepreneurial risk for the franchisee, who, after having invested in the purchase of the assets object of his own activity, often finds himself unable to sell the inventories, as he is no longer able to use the distinctive signs of the franchisor, and being often bound by a post-contractual non-competition agreement.

As a general rule, in Italy 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:

1. a) if the goods are held by the franchisee as a result of agreements imposed by the franchisor and under the latter’s directives;
2. b) 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;
3. c) 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;
4. d) in the event of termination of the contract due to default by the franchisor.

On the other hand, the goods acquired on the initiative of the franchisee, or those purchased by the latter on pending the termination of the relationship, especially if in an anomalous measure with respect to the usually ordered items, are excluded from the obligation to repurchase.

It is however appropriate to expressly regulate this aspect in the franchising contract, 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.

Article 5 of Law n. 129/2004 establishes that the affiliate is obliged, both during and after the termination of the contract, to observe and to make his collaborators and employees observe an obligation of confidentiality regarding the content of the activity subject to the commercial affiliation. The rationale of the provision is to protect the secrecy of the franchisor’s know-how with respect to any fraudulent initiatives by the franchisee, who intends to illegally exploit the knowledge acquired during the duration of the contract.

The violation of this obligation will be the source for the franchisor of the right to compensation for damages, which, in the absence of a specific penalty clause, will have to be evaluated in the light of the specific violation and the consequences deriving from it, being, in any case, difficult to quantify. The affiliate is required to pay compensation to the franchisor in the event of violation of the confidentiality obligation regardless of the demonstration that the violation occurred due to the unlawful act of a third party (for example, an unfaithful former employee), except for the cases of force majeure or unforeseeable circumstances.

 

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.