France – Franchise and Distribution newsletter #23

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Pre-contractual disclosure and error on the profitability of the business

Court of Cassation, Commercial Chamber, 10 June 2020, No. 18-21536

In the case at stake, the franchisee had asked for the annulment of the franchise agreement and for the attribution of damages because of the communication by the franchisor of an erroneous P&L forecast, and because of the franchisor’s failure to assist the franchisee in the search for premises and negotiation of the terms of the lease, due to the unsuitability of the location, the excessive size of the premises and the excessive level of the rent.

The Court of Cassation began by recalling that “when the franchisor, who is not legally required to do so, provides the franchisee with a forecast, this document must be sincere and verifiable“. This is a classic solution (see, for example, Court of Cassation, Commercial Chamber, 31 January 2012, No. 11-10834).

The Court of Cassation thus approved the Court of appeal, which had held that the overly optimistic forecast submitted by the franchisor had triggered, in the mind of the franchisee – who had no previous experience in the economic sector concerned – an error on the profitability of his business. For the Court of cassation, such an error relates to the very substance of the franchise agreement, since the expected profit is decisive for the franchisee for its decision to enter into the franchise agreement.

To counter the franchisee’s claims, the franchisor argued that the forecast could not constitute a determining factor in the franchisee’s consent since, in the franchise agreement, the franchisee expressly declared, first, that it was aware that the data communicated only allowed it to draw up quantified assumptions without any guarantee of results and second, that a discrepancy, even a significant one, between its actual achievements and the forecast would not constitute a reason to question its commitment to fulfil its obligations under the agreement.

The Court of Cassation rejected the franchisor’s argument and held that the Court of Appeal was not required to analyse the scope of these contractual terms since they were annulled together with the entire franchise agreement and could therefore not be opposed to the franchisee.

Then, the Court of Appeal also held that the franchisor had breached its contractual obligations. In the case at stake, the franchise agreement expressly provided that the franchisor would assist and advise the franchisee in the search for premises and negotiation of the terms of the lease. The franchisor had therefore validated the location chosen by the franchisee and negotiated the terms of the lease. However, the premises proved to be unsuitable for the franchisee’s business because they were too wide and the rent was excessively high, making the franchisee’s business unviable.

The Court of Appeal inferred that while these contractual breaches did not in themselves induce a defect of consent, they gave credibility to the erroneous forecast and added to the consequences of the absence of a local market analysis, since the cost of the lease represented an important factor in consideration of which the franchisee had developed its project.

Here again, the Court of Cassation agreed with the Court of Appeal. It ruled that the Court of Appeal rightly held that the unsuitability of the location, the excessive size of the premises and the excessive rent, which was too high to guarantee the franchisee a minimum profitability, were also decisive for the franchisee’s consent and related to the very substance of the franchise agreement, for which the expectation of profit is decisive.

This ruling calls for two observations:

  • First, the error as to profitability, recognised by case law since 2011 (Court of Cassation. Commercial Chamber, 4 October 2011, No. 10-20956) in a now constant manner, is necessarily an error that was caused by the erroneous information submitted by the franchisor. The franchisor did not necessarily intend to mislead (otherwise it would be fraud/deceit). But absent the communication of erroneous figures leading to the error, the franchisee would not be able to claim an error as to profitability. The submission of figures, if it happens (and it is difficult to do otherwise in practice) must therefore always be done with seriousness and caution. The submission of forecasts by the franchisor constitutes a risk that must not be taken without proper consideration and is not recommended;
  • Second, this decision was rendered in light of the provisions of the French Civil Code preceding the 2016 contract law reform and it is questionable whether the solution would have been the same under the new provisions. Indeed, under the provisions of former Article 1110 of the French Civil Code, the cancellation of the contract was only possible in the event of an error as to the substance and the Court of Cassation had considered, as from 2011, that the expectation of profit was a determining factor related to the very substance of the franchise agreement (Court of Cassation, Commercial Chamber, 4 October 2011, No. 10-20956; Court of Cassation, Commercial Chamber, 12 June 2012, No. 11-19.047). Since the entry into force of decree No. 2016-131 of 10 February 2016, cancellation based on an error is governed by new Articles 1132 et seq. of the French Civil Code. The notion of substance is replaced by that of the “essential characteristics of the obligation“, which are defined as “those which have been expressly or tacitly agreed and in consideration of which the parties have contracted” (New rticle 1133 of the French Civil Code). However, new Article 1133 of the French Civil Code specifies that “the acceptance of a contingency on a characteristic of the obligation excludes the error relating to that characteristic”. One can wonder whether, under this new Article 1133 of the French Civil Code, the franchisor’s argument according to which the franchisee had accepted the risks of its business in a clause of the contract would be accepted as a valid ground for dismissing the application for annulment of the contract.

The Court of cassation confirms that the provisions of the French Commercial Code which prohibit the restrictive commercial practices are overriding mandatory provisions

Court of Cassation, Commercial Chamber, 8 July 2020, No. 17-31536

The French Commercial Code contains several provisions, which are prohibited as being restrictive commercial practices: (i) the fact of obtaining an advantage without anything or very little in return (Article L.442-1, I, 1° of the Commercial Code), (ii) the fact for a professional of imposing or attempting to impose significantly imbalanced obligations to another professional (Article L.442-1, I, 2°), (iii) the abrupt termination of an established commercial relationship (Article L.442-1, II), (iv) the participation to the violation of the prohibition to resell products to unauthorized resellers in selective distribution systems (Article L.442-2), (v) the fact of obtaining retroactive discounts or other advantages (Article L.442-3 a)) and (vi) the so called “most favoured nation” clause (Article L.442-3 b)).

The ruling rendered by the Court of Cassation on 8 July 2020 was eagerly awaited by the distribution law community. Over the past years, the Paris Court of Appeal has constantly decided that the provisions of Article L.442-1 of the French Commercial Code (formerly Article L.442-6 of the French Commercial Code) which prohibit the restrictive commercial practices as being overriding mandatory provisions (for example: Paris Court of Appeal, 21 June 2017, No. 15/18784). The position of the Court of Cassation was however long overdue.
Pursuant to Article 9 of the Rome I Regulation of 17 June 2008 on the law applicable to contractual obligations, “overriding mandatory provisions” are “provisions the respect for which is regarded as crucial by a country for safeguarding its public interests, such as its political, social or economic organisation, to such an extent that they are applicable to any situation falling within their scope, irrespective of the law otherwise applicable to the contract under this Regulation”.

It is case law that determines which French domestic mandatory provisions are, or not, overriding mandatory rules which must also apply in the international order when a law other than French law applies (either because it has been chosen by the parties or because is designated by the conflict of laws rules). The Court of Cassation is traditionally – and rightly so – rather strict in this respect. For instance, it recognised that the 31 December 1975 law on subcontracting was an overriding mandatory provision (Court of Cassation, Joint Chambers, 30 November 2007, No. 06-14006), but it denied this classification to the provisions on commercial agency, notwithstanding case law to the contrary from the Court of Justice of the European Union (Court of Cassation, Commercial Chamber, 5 January 2016, No. 14-10628).

A few years ago, in the context of a dispute between an American company, Monster Cable Products, Inc., and a French company, Société Audio Marketing Service, concerning an exclusive distribution contract that had been abruptly terminated (in breach of the provisions of Article L.442-6, I, 5° of the French Commercial Code (now Article L.442-1, II)) and which attributed exclusive jurisdiction to the courts of San Francisco (USA), the Court of cassation refused to recognise the jurisdiction of the French courts on the sole ground that French overriding mandatory rules were at stake. However, the Court used a wording that did not make it possible to conclude whether it considered these specific provisions to be overriding mandatory provisions: “the jurisdiction clause contained in this contract covers any dispute arising out from the contract, and consequently, has to be enforced, even if overriding mandatory provisions would be applicable to the merits of the dispute” (Court of Cassation, 1st Civil Chamber, 22 October 2008, No. 07-15823).

In the case which led to the ruling of 8 July 2020, Expedia was opposed to the Minister for Economic Affairs, who had brought an action on the basis of a significant imbalance of the respective rights and obligations of Expedia and its professional customers (on the ground of former Article L.442-6, I, 2° of the French Commercial Code, now Article L.442-1, I, 2° of the French Commercial Code) and challenged the application of French law to the contracts that were governed by English law.

For the first time, the Court of Cassation clearly confirmed that the prohibition of a restrictive commercial practice was an overriding mandatory rule:

The Court of Appeal rightly held that Article L. 442-6, I, 2° and II, d) of the French Commercial Code contains mandatory provisions, compliance with which is deemed crucial for the preservation of a certain equality of arms and loyalty between business partners and which are therefore essential for the economic and social organisation of France, from which it rightly deduced that they constitute overriding mandatory rules, the application of which is binding on the court hearing the case, without there being any need to seek the rule on conflict of laws leading to the determination of the applicable law, in accordance with both Article 9 of Regulation (EC) No 593/2008 of 17 June 2008 on the law applicable to contractual obligations and Article 16 of Regulation (EC) No 864/2007 of 11 July 2007 on the law applicable to non-contractual obligations”.

Although this decision was predictable, it has the merit of closing the debate: whatever the law designated by the parties or by the conflict of laws rule to govern the dispute, the French party, victim of a significant imbalance, will always be able to invoke the provisions of Article L.442-6, I, 2° (new Article L.442-1, I, 2°) of the French Commercial Code.

In this decision, the Court of Cassation only ruled on the provisions that prohibit the significant imbalance of the respective rights and obligations of the parties. However, it is very likely that the solution will be the same for the other restrictive commercial practices.

Unfair competition: the undue competitive advantage obtained by the unfair competitor can now be taken into account for the calculation of the victim’s damage

Court of Cassation, Commercial Chamber, 12 February 2020, No 17-31614

The principle of full compensation of the damage suffered is one of the fundamental principles of French civil liability law.

Following this principle, the compensation owed by the perpetrator of the damage to the victim must enable the victim to be restored to the state in which it would have been in if the damage had not occurred (Court of Cassation, 2nd Civil Chamber, 8 April 1970, No. 68-13.969, Bull. no. 111). In other words, the compensation granted to the victim of a fault must neither leave it with a loss nor allow it to make a profit (Court of Cassation, 2nd Civil Chamber, 23 January 2003, No. 01-00200, Bull. No. 20).

Implementing this principle generally requires analysing the victim’s situation before and after the damage has occurred and, in certain cases, requires establishing a counterfactual scenario which presents the situation in which the victim would have been if the damage had not occurred.

The analysis is therefore in principle performed exclusively in consideration of the situation of the victim, without examining the situation of the perpetrator of the fault that led to the damage.

However, a ruling rendered on 12 February 2020 by the Court of Cassation partially questioned the principle of full compensation in matters of unfair competition (Court of Cassation, Commercial Chamber, 12 February 2020, No. 1731614-).

The case which led to this ruling opposed two competing companies operating in the same street in a municipality of Moselle. On the one hand, the company Cristallerie de Montbronn, which specialises in the creation and manufacture of crystal tableware products. On the other hand, Cristal de Paris, which marketed crystal products manufactured, cut and polished in China and Europe as well as glass, crystalline and luxion products. The first of these companies accused the second of deceptive commercial practices consisting in presenting in its catalogues products made of glass, crystalline or luxion mixed with crystal products in order to give the impression that the whole would be made of crystal, presenting them as being “made in France” and presenting itself as a “high place for glass cut in Lorraine” and a “cutting specialist”. Cristallerie de Montbronn therefore brought a claim for unfair competition and sought compensation for the damage suffered as a result of these unfair practices.

The Paris Commercial Court and then the Paris Court of Appeal ruled that Cristal de Paris had misled the consumer as to the composition, origin and substantial characteristics of the products it sold and, subsequently, had secured an undue competitive advantage to the detriment of Cristallerie de Montbronn. In the ruling of the Paris Commercial Court of 29 February 2016, confirmed by the ruling of the Paris Court of Appeal of 19 September 2017, Cristal de Paris was sentenced to pay compensation of € 300,000 to Cristallerie de Montbronn.

In order to assess the loss suffered by Cristallerie de Montbronn and determine the correlative compensation, the judge took into consideration the undue competitive advantage that Cristal de Paris had granted itself and modulated it in proportion to the respective sales of each company and the share of those sales affected by the practice, even though the mathematical relationship between the loss suffered and the undue advantage is debatable.

The judges thus assessed the damage suffered by the victim of unfair competition, not according to the victim’s own situation (which is what the principle of full compensation would require), but according to the situation of the perpetrator of these wrongful acts.

Cristal de Paris appealed to the Court of Cassation, arguing that the principle of full compensation of damages should have been strictly applied.
In its ruling, the Court of Cassation recalled that there is indeed a principle of full compensation and also a presumption of damage in the event of acts of unfair competition.

However, the Court of cassation considered that the damage may be more or less difficult to assess, depending on the type of act of unfair competition at stake.

The Court of Cassation therefore decided to distinguish between two types of acts of unfair competition:

  • On the one hand, acts tending to divert or appropriate a clientele or to disorganise a competing business;
  • On the other hand, those consisting in free-riding on the efforts and investments, whether intellectual, material or promotional, of a competitor, or in avoiding compliance with a regulation.

The Court of Cassation explained that the harm resulting from the first type of acts can be easily assessed “in that they induce negative economic consequences for the victim, i.e. a loss of earnings and a loss suffered“, while the harm resulting from the second type of acts, “in that they enable the perpetrator of the practices to save on costs which are normally compulsory, induce an undue competitive advantage whose effects, in terms of economic disruption, are difficult to quantify with the available evidence, save disproportionate expenditure in relation to the interests at stake“.

The Court thus decided that for this second type of acts, “it must be accepted that compensation for damage may be assessed by taking into consideration the undue advantage granted to the perpetrator of the acts of unfair competition, to the detriment of its competitors, modulated in proportion to the respective sales of the parties affected by those acts“.

The Court of Cassation therefore confirmed the ruling of the Paris Court of appeal.

Finally, it should be noted that this innovative and pragmatic decision gives precedence to the proper administration of justice over the principle of full compensation by making it easier for the victim to assess its loss and obtain compensation.

The Paris Court of Appeal recognises that the Covid-19 pandemic is an event of force majeure

Paris Court of Appeal, 28 July 2020, No 20/06689 and No 20/06676

The Covid-19 pandemic and the lockdown measures taken by the Government have led many companies to claim force majeure in order to suspend the performance of their contractual obligations.

This was notably the case for Total Direct Energie and Gazel Energie Solutions towards Electricité de France (EDF).

Total Direct Energie and Gazel Energie Solutions, which are alternative energy suppliers, have each entered into a contract with EDF in which they have undertaken to purchase from it, at a price specified in a decree, a certain volume of energy determined on the basis of their customers’ consumption forecasts.

These contracts contained a provision providing for their suspension or termination “upon the occurrence of an event of force majeure” defined as “an external, irresistible and unforeseeable event making it impossible to perform the obligations of the parties under reasonable economic conditions“.

This was thus a very broad understanding of force majeure, which is defined by new Article 1218 of the French Civil Code as “an event beyond the debtor’s control, which could not be reasonably foreseen at the time of the conclusion of the contract and whose effects cannot be avoided by appropriate measures, which prevents the performance of his obligation by the debtor.”

In March 2020, following the lockdown measures which led to a reduction in electricity consumption in France (particularly in the industrial sector), Total Direct Energie and Gazel Energie Solutions notified EDF of the application of the force majeure clause and requested the suspension of their electricity purchase obligations at the price specified in the decree.

EDF refused, considering inter alia that the criteria of force majeure were not met.

The alternative energy suppliers then filed a petition before the interim relief judge of the Paris Commercial Court and asked for the confirmation of the suspension of the contracts due to the application of the force majeure clause.

Their request was welcomed, first by the President of the Paris Commercial Court, and then by the Paris Court of Appeal, in two rulings dated 26 July 2020.

The Court first noted that the force majeure clause stipulated that “the suspension takes effect as soon as the event of force majeure occurs and automatically leads to the interruption of the annual transfer of electricity“, that the party invoking force majeure must “inform the other party (…) by registered letter with acknowledgement of receipt, of the occurrence of this event” and that “the obligations of the parties are suspended for the duration of the event of force majeure“.

The Court concluded that the notification by one party of an event of force majeure had the effect of automatically suspending its obligations, the other party having to justify that the event did “manifestly not constitute such a case, with the evidence required in summary proceedings.”

With respect to the question as to whether or not the Covid-19 pandemic constituted a case of force majeure as defined in the contract, the Court reversed the burden of proof, holding that it was up to EDF to justify that the event invoked by Total Direct Energie and Gazel Energie Solutions did not manifestly constitute a case of force majeure. The Court noted that the contractual definition was broader than the legal definition “since it refers to the impossibility of performing under reasonable economic conditions, and in this case, the force majeure event invoked was the Covid-19 epidemic and the drastic health and legal measures taken to curb it, which had a very significant impact on electricity consumption and its price level“.

It concluded that the reality of an event of force majeure within the meaning of the contract could not be ruled out so that EDF’s refusal to interrupt the transfer of electricity constituted a manifestly unlawful disturbance. The Court therefore ordered the suspension of the performance of the contracts for a time-limited period.

The two decisions of the Paris Court of Appeal are questionable in several respects:

  • Firstly, it is surprising that the interim relief judge declared it had jurisdiction to rule on the case in the presence of a clause, which required interpretation. Indeed, case law is consistent on this subject (Court of Cassation, 1st Civil Chamber, 4 July 2006, No. 05-11591);
  • Secondly, the Court of Appeal reversed the burden of proof of the existence of a case of force majeure by placing the burden of proof not on the party invoking the clause but on the party challenging it, in disregard of the provisions of Article 1353 paragraph 1 of the French Civil Code;
  • Thirdly, in the case at stake, the request aimed at freeing the alternative energy suppliers from their purchase and payment obligations, whereas , according to case law, a force majeure event cannot release the debtor from an obligation to pay a sum of money (Court of Cassation, Commercial Chamber, 16 September 2014, No. 13-20306);
  • Finally, it is questionable whether the performance of the obligations of Total Direct Energie and Gazel Energie Solutions had become impossible “under reasonable economic conditions“, the Paris Court of Appeal merely identifying “a disruption of the previous economic conditions which results in the occurrence of significant losses arising from the performance of the contract.”

Publication of the European Commission’s conclusions on the evaluation of the Vertical Block Exemption Regulation

European Commission report of 8 September 2020, SWD (2020) 172 final

On 3 October 2018, the European Commission launched a review of EU Regulation No 330/2010 of 20 April 2010 on the application of Article 101(3) of the Treaty on the Functioning of the European Union to categories of vertical agreements and concerted practices (the “Block Exemption Regulation”) and the Guidelines on Vertical Restraints. It sought to verify how well they are enforced, ahead of the expiry of the current Block Exemption Regulation which will take place on 31 May 2022.

The European Commission has just published the findings of its evaluation on 8 September 2020. Below are the key points.
First, it states that the assessment showed that the Block Exemption Regulation and the Guidelines on Vertical Restraints are still relevant, as they are useful tools that facilitate self-assessment by businesses of the vertical agreements they enter into, thus contributing to reducing the cost of compliance.

The Commission however notes that the Block Exemption Regulation and the Guidelines are no longer fully aligned with the current business environment, in particular the increasing digitalisation of the economy (the online sales boom and the arrival of new players such as the marketplaces since 2010). Some of the current provisions are only adapted to traditional supply and distribution patterns.

The Commission observes that suppliers are increasingly resorting to new vertical contractual restrictions in order to better control the distribution of their products, as the rise of e-commerce has led to increased price transparency. It notes in particular the increase in:

  • restrictions on the use of price comparison sites and marketplaces;
  • retail price parity clauses;
  • restrictions on online advertising.

The Commission concludes that there is currently a lack of guidance on how to assess these new restrictions and that this needs to be remedied.
In addition, the Commission underlines dysfunctions in the regulation that are not necessarily linked to the evolution of the market, due to a lack of clarity and excessive complexity of applicable rules. This concerns in particular:

  • certain hardcore restrictions such as resale price maintenance and parity clauses,
  • or certain distribution patterns, mainly commercial agency and franchising.

Companies are therefore placed in a situation of legal uncertainty and face increased costs of compliance with competition law.

The Commission also highlights the risk of diverging interpretations of the rules applicable to vertical agreements by different national competition authorities and courts across the Union. Diverging interpretations would diminish the benefits of the rules (which are supposed to provide legal certainty to the stakeholders).

The Commission has therefore announced that it will launch an impact assessment in the coming weeks to examine the problems identified during the evaluation. A public consultation on the initial impact assessment is planned for the end of this year, before the publication of the draft revised exemption regulation, scheduled for next year.

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