Franchising and the Internet - A Never Ending Challenge for Franchisors

11 June 2015

Mark Abell

Since the beginning of the millennium, franchisors have struggled to come to terms with how they can best include the internet as part of their franchise strategy. This has not been without its legal and commercial challenges, as franchisors inevitably want to control or limit the extent or way in which their franchisees use the internet. However, EU and Member State competition rules impose strict limits on the extent to which a franchisor can prevent its franchisees from selling the franchisor's products online and franchise agreements which seek to restrict a franchisee's use of the internet in the EU may well be neither valid nor enforceable.

New Developments in the EU

Recent developments in the EU mean that the regulatory environment will continue to challenge franchisors for some time to come. Two enquiries have been launched which will no doubt create more challenges for franchisors and their franchisees. 

On 6th May 2015 the European Commission announced a sector enquiry into the e-commerce sector which will focus on the potential barriers caused by commercial operations to cross-border online selling in the EU for products for which e-commerce is most used, with electronics, clothing, shoes and digital content given as examples.

Also on 6th May 2015, the European Commission launched a Digital Single Market Strategy, under which a wide range of legislative measures will be proposed to deal with obstacles to cross-border e-commerce trading in the EU.  

The Fundamental Problem for Franchisors

The European Commission has always regarded the internet as a "passive" as opposed to an "active" form of sales. The problem for franchisors is that, whereas a ban on active sales is permitted under the exceptions criteria of Article 101(3), a ban on passive sales is almost always prohibited. Any sale by a franchisee through the internet is considered a passive sale and so is permitted. Restrictions on such sales are regarded as hardcore restrictions or restrictions by object as opposed to by effect. This means that they are treated as by their nature infringing the competition rules, without needing to demonstrate that it actually has anti-competitive effects. Restrictions on passive selling are black-listed in the European Commission's block exemption Regulation for Vertical Agreements so that their inclusion in a franchise agreement will mean that it cannot take advantage of the Block Exemption that many franchisors rely on.  

This rather harsh position was confirmed by the European Court of Justice in a case involving the selective distribution system of Pierre Fabre.  Pierre Fabre's selective distribution agreements concerned cosmetics and personal care products and required all sales to be made in a physical space in the presence of a qualified pharmacist. This was held to be a ban on internet selling and was a restriction by object within the meaning of Article 101(1) Treaty on the Functioning of the EU ("TFEU") and thus infringed the competition rules. The ECJ also stated that the aim of maintaining a prestigious product image was not a legitimate purpose and could not be relied upon to provide any objective justification for such a clause.  

The New Enquiries

The European Commission's current e-commerce sector enquiry will focus on contractual barriers to cross-border e-commerce sales of products and digital content, including franchise agreements. The Commission has also indicated that geo-blocking of access to websites will be an important aspect, so clauses requiring a reseller to geo-block certain data products or services are likely to come under scrutiny.  

Indirect restrictions on online sales contrary to EU law

The European Commission's Guidelines on Vertical Restraints indicate that any of the following obligations on a franchisee will be considered to be hardcore restrictions on passive selling:

  • obligations to prevent customers located outside a franchisee's allocated territory from viewing its website;
  • obligations automatically to reroute customers to the franchisor's website; 
  • obligations to terminate consumers' internet transactions where their credit card data reveal an address outside a franchisee's allocated territory; 
  • limits on the proportion of a franchisee's overall sales that may be made on the internet; and 
  • requirements to pay a higher price for products intended to be resold online than for products intended to be sold offline, (which means that it is virtually an automatic infringement to price-discriminate against a franchisee selling mainly on the internet as compared with a franchisee selling through a physical outlet).  

In addition, it is thought likely that restrictions on the purchase or use of search engine adwords are in many cases likely to infringe Article 101 TFEU as they constitute an impediment to franchisees selling products on the internet.  

However, franchisors can, according to the European Commission's Guidelines, take control of sales via the internet in a number of ways, such as:

  • Requiring its franchisees to sell at least a certain amount of products offline (measured in either value or volume) to ensure an efficient operation of a "bricks and mortar" shop. In this way, a franchisor can prevent a franchisee being an "internet only" reseller.  However, the franchisor cannot limit the proportion of sales to be made by the franchisee over the internet. 
  • Preventing its franchisees from using active sales techniques on the Internet. This includes advertising the products online in a manner specifically addressed to certain customers, for example using territory-based banners on third party websites, or paying a search engine or online advertisement provider to have advertisements displayed specifically to use in a particular territory. 
  • Requiring the franchisee's website offers links to the franchisor's website and/or other franchisees, although automatic rerouting to such websites is not permitted.
  • Imposing quality standards for the franchisee's website for the resale of the franchisor's branded products, in the same way that a franchisor may require quality standards to be observed in a physical outlet or for advertising and promotion in general, although any such quality controls must be proportionate taking into account the nature of the products. 
  • Limiting its franchisees use of third party platforms to distribute the products by requiring that they use third party platforms only in accordance with standards and conditions agreed between the franchisor and its franchisees for the franchisees' use of the internet. Where a franchisee's website is hosted by a third party platform, the franchisor may require that customers do not visit the franchisee's website through a site carrying the name or logo of the third party platform. This means that franchisors can prevent franchisees from making sales via an internet platform such as Amazon or eBay.  

Despite the EU competition rules, it is not uncommon in practice to find restrictions in franchise agreements on internet sales. However, it is clear that restrictions on internet selling, restrictions on advertising products and prices on the internet, and resale price maintenance obligations (for online as well as offline sales) are all incompatible with, and likely to infringe, competition law. 

Such restrictions will generally constitute restrictions by object meaning that there will be no need to demonstrate a restrictive effect to establish an infringement.  Where restrictive effects do need to be shown in order for restrictions on internet selling to be considered to infringe competition law (for example in relation to price parity or most favoured nation clauses), the price transparency enabled by the internet will in many cases be an important factor.

Some franchisors are more ready than others to accept that the internet is a fact of business life and to embrace the fact that it can result in an increased customer base and greater overall sales.  Some franchisors seek to control the quality of internet selling insofar as they can legitimately do so, rather than to exclude internet selling. The technology available for internet use has now developed to an extent that a virtual presentation of a product, including detailed close-ups, can be achieved almost as effectively as in a shop.

Such possibilities can provide a basis for the use of quality criteria that a franchisor might require its franchisees to follow when selling on the internet. This can be combined with obligations to safeguard the goodwill and reputation in the franchisor's brand name and products by ensuring that its name and products are presented on a website in a manner which meets equivalent requirements to those which are acceptable in relation to trade marks in the physical world.