Franchising may be an attractive proposition for many companies wishing to expand internationally. Knowing how to structure your franchise, and to identify the next steps for expansion into other countries, is crucial.
Take a look at this overview to discover the applicable franchise law in the Czech Republic, covering the essentials for franchisors, the relevant areas of law, selected aspects such as fees, and dispute resolution and applicable law.
about Czech Republic’s franchising law
- There is no legal definition of “franchise agreement“ in the Czech Republic. The franchise agreement, as an innominate contract, may include elements from various types of contracts. For example, the pro- visions of the purchase contract, commercial agency resp. commission contract or license agreement can be partially used.
- The provisions of the Czech Civil Code may apply.
- The franchisee acts as a separate business entity in its own name and on its own account and has complete legal and partial business autonomy.
RELEVANT AREAS OF LAW
Legal basis of Franchise Law
Since there is no legal definition of “franchise agreement“ in the Czech Republic, nor a definition of the word “franchise“ itself, the terms have been formed by court rulings and authority´s decisions, namely by the Czech Office for the Protection of Competition. When concluding contracts between a franchisor and franchisees, it is necessary to proceed only from the general legal regulation, covered particularly in the Civil Code. The Czech private law is generally based on the relatively wide contractual freedom of the parties, and therefore it is possible to adjust mutual rights and obligations to reflect individual needs (taking into account, in particular, the restrictions arising from the competition law). However, the general statutory regulation does not consider the specifics of franchising, and thus creates room for legal uncertainty.
According to the principle of private autonomy, there are no specific restrictions regarding the corporate form and, therefore, various types of legal entities are sustainable for both a franchisor and a franchisee. The most common corporate form to set up a business in the Czech Republic is the private limited liability company. A Private Limited Liability Company can be easily set up by one or more persons and requires a minimum capital of CZK 1. However, there are several other options. A sole trader represents the simplest business form available in the Czech Republic, which might be a suitable option for smaller businesses. Other than that, joint-stock company, general partnership, limited partnership or European joint-stock company present different possibilities, which can be chosen. Czech law also recognises other forms of legal entities, such as trust and associations, which can also perform business activity, but this should not be the main purpose of their existence.
The Czech Office for the Protection of Competition described a franchise agreement as an agreement, by which one entrepreneur - the franchisor - grants the other entrepreneur -the franchisee - the right to use the franchise - a body of knowledge, experience, know-how, and established trade name or trademark - for the purpose of sales of certain types of goods or services. A franchisee acts as a separate business entity in its own name and on its own account and has complete legal and partial business autonomy.
Specifics regarding foreign franchisors Czech law does not contain any differences regarding foreign franchisors. The same conditions as for domestic franchisors shall apply.
Consumer Protection Law
Under Czech law, franchisees are not qualified as consumers and, thus, consumer protection regulations should not apply. In order to be qualified as a consumer, one must fit into the definition obtained in the Civil Code, which describes a consumer as any person who, out- side the scope of their business activity or out- side the scope of independent performance of their profession, enters into a contract with an entrepreneur or otherwise deals with him. The relationship between a franchisor and a franchisee is rather business-oriented and, therefore, the franchisee cannot be seen as a consumer. However, the franchisee could be considered a weaker contracting party. This might have a significant impact on the franchise relationship. An example might be the inability to agree on a different from statutory limitation period to the detriment of a weaker party or to agree on a provision, which precludes or restricts the weaker party’s right to compensation for damage in advance.
The joint interest in the unification of the franchise network forces the franchisor and the franchisee to cooperate very closely, which may have the potential to distort competition. As a result, franchise agreements are highly affected by competition law. This area of law is fully harmonized with EU regulations. The core provisions of EU competition law on franchising can be found in art. 101 and art. 103 of Treaty on the Functioning of the EU (“TFUE”). The purpose is to avoid distortions of competition in the internal market. Exceptionally, franchise agreements may also be affected by art. 102 TFUE, which prohibits abuse of a dominant position. In the Czech Republic, therefore, the same rules, as in other EU countries, governing exclusivity, protection of contractual territory, resale price maintenance, and competitive re- strictions, apply.
The leading role of the franchisor in the franchise network may raise the question of whether franchising does not show elements of employment relations. In accordance with Czech employment law, franchisees are not generally qualified as employees of the franchisor. Under Czech law, an employee is a natural person who commits to perform dependent work in a basic employment relationship. Dependent work is work that is performed in a relation- ship between the employer’s superiority and the employee’s subordination, on behalf of the employer, according to the employer’s instructions, and the employee performs it for the employer in person. The only possibility the franchisees could be treated as employees would be if they were sole traders and the characteristics of an employment relationship were met. More likely, the franchisees are qualified as entrepreneurs since an entrepreneur is a person who independently carries out gainful activity on his own account and responsibility under a trade license or similar manner with the intention of doing so systematically in order to make a profit.
Law on commercial agents
A franchise agreement and a commercial agency contract have several identical features, namely the independence of the parties between which it is concluded, the long-term duration of the legal relationship, and the objective of ensuring the sale of goods or services of the represented person. However, the commercial agency contract differs from the franchise agreement in its basic feature - the agent under the commercial agency contract acts in the name and on behalf of the represented person. On the other hand, franchisees enter legal negotiations on their own behalf and on their account, although this may not always be apparent to the customer. For this reason, the franchisee is not paid commission and, conversely, the franchisee usually pays the franchisor a franchise fee.
An essential part of franchise agreements is the franchisor’s obligation to grant the franchisee a license to use the franchisor’s intellectual property. The franchise agreements thus contain a number of provisions typical for the license agreements. Franchisors should protect their intellectual property rights from third parties’ attacks, abuse, or imitation by registering their IPR as trademarks, designs, utility models or patents. Concerning the IPR’s protection, franchisors have several options. Apart from inter- national protection by WIPO or EUIPO, IPR also might be protected on a national level.
The regulation of the precontractual information/disclosure obligation, which in some countries is subject to detailed legislation even if the franchise agreement itself is not regulated as a special type of contract, remains neglected in the Czech Republic. However, the Czech Civil Code covers general precontractual obligations. It stipulates that when negotiating a contract, the parties shall communicate to each other the factual and legal circumstances, which they are aware of or must know, so that the parties are not affected by misleading information or by a failure to provide sufficient information.
Moreover, the Czech Franchise Association emphasizes the Code of Ethics, which stipulates that the prospective franchisor must provide truthful and honest information about his experience, financial possibilities, training, education and other communications regarding the franchise relationship. However, as a non-binding regulation, the non-compliance can be sanctioned only at the level of the association.
For the reasons of proof, it is highly recommended to carry out the precontractual information in writing. In the case of a breach, the franchisee has the right to claim damages, generally in the form of pecuniary damages.
Apart from the regulations governing IPR aspects of a franchise agreement and restrictions arising from competition law, it is also data protection law, which has to be taken into account.
There is no regulation affecting franchise fees specifically. However, the Act on the Restriction of Cash Payments prohibits making cash payments in excess of CZK 270,000. This amount is a daily limit that must not be exceeded by either a natural or a legal entity in a business transaction. Other than that, there are no laws regarding the nature, amount or payment of franchise fees, nor are there any restrictions on a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency in the Czech Republic.
Confidentiality clauses in franchise agreements are not only very common and enforce- able under Czech law, but they are also highly recommended. In the case of a breach, the franchisor may bring legal action against an infringing franchisee, claim damages occurred due to the breach, and possibly terminate the franchise agreement extraordinarily.
The Civil Code lays down that if a party violates the contract substantially, the other party may withdraw from the contract without undue de- lay. Since it may not always be easy to assess the damages caused by a breach of confidentiality clause, setting a contractual penalty for clearly defined breaches of confidentiality is highly recommended. The contractual penalty should however be proportionate. Besides, a confidentiality clause is recommendable as a way to protect existing trade secrets. According to the Civil Code, a trade secret is only protected if the owner of the secret has taken appropriate measures to maintain its secrecy.
The contracting parties are free to agree to change their rights and obligations. However, the commitment may also be changed unilaterally if certain requirements are met. If the franchise agreement contains a precise and reasonable change reservation clause, which considers the franchisee’s interest, the franchisor may be entitled to change a franchise agreement unilaterally in order to meet their obligation to continuously develop their franchise system according to changing marketing conditions. When such a reservation clause is missing, amendments of the franchise agreement may only be agreed unanimously between the franchisor and the franchisee. Therefore, it is advisable to at least consider the application of such change reservation clause in the franchise agreement.
Franchise agreements are either entered into for a certain period and terminate with the lapse of that time or are concluded for an indefinite period and can be terminated by the end of the calendar quarter with a three-month notice period. The duration of a franchise con- tract usually varies from 2 years to 20 years; the most common contracts are medium-term contracts of 5 years, generally concluded with the possibility of their renewal or option. It is highly recommended to expressly agree on the terminating reasons, conditions, and manner of terminating an agreement so that both par- ties are certain about the possible termination of their contractual relationship.
Renewal and transfer
Simply put, it is at the franchisor’s discretion whether they renew a franchise agreement or not. If they decide to do so, renewals should be done explicitly and in writing. The transfer may consist in the transfer of contractual rights and obligations or assignment of the entire franchise agreement. It is also possible to transfer a business shares to a new shareholder or to transfer a business enterprise or a part there- of to which the franchise agreement belongs. However, the franchisor may contractually re- strict the franchisee’s right to such transfers, typically by requiring an explicit prior written approval of the franchisor.
DISPUTE RESOLUTION AND APPLICABLE LAW
Dispute resolution, court system
If a conflict between a franchisor and a franchisee arises, there are various types of possible dispute resolutions in the Czech Republic, namely civil procedure, arbitration, or mediation. The judicial system in the Czech Republic consists of the Constitutional Court of the Czech Republic and the “ordinary” court system. The “ordinary” court system consists of district courts at the lowest level, regional courts, high courts, and the Supreme Court and the Supreme Administrative Court at the highest level. In the Czech Republic, there is a two-instance system, which is a determining factor in the hierarchical organization of the system of remedies.
Arbitration presents an alternative to civil procedure, which is often used in commercial matters. The parties trying to find a solution may choose either a permanent arbitration court or an ad hoc arbitrator or panel of arbitrators. An advantage of arbitration is that such procedures enable disputes to be settled promptly and cost-effectively. Moreover, arbitration proceedings are, un- like proceeding before ordinary courts, not held in public. Another option of dispute resolution is mediation. Mediation is a way of peacefully re- solving disputes and conflicts, the aim of which is an agreement. However, there is no enforceable judgement as a result of mediation.
Under Czech law, the parties to the contract are free to choose foreign law to govern the contract. Generally, it is recommended to choose the law closest to the contractual relationship. Making such a choice of applicable law is, however, advisable if, at the same time, the jurisdiction of the courts of the same foreign country or an arbitration court, arbitrator(s) or mediator(s) is agreed on.
Since COVID-19 entered the Czech Republic in early spring 2020, the impact on the franchise sector has been enormous, significantly due to the strict government measures in order to contain the pandemic. Public life has been shut down to the bare minimum and almost everything, except for groceries, pharmacies, and drugstores, had to be closed pretty much for almost an entire year – except for summer months and pre-Christmas shopping. Restaurants, bars, and stores could only have takeout.
The government has taken a number of measures to support particular sectors of the economy, entrepreneurs and business owners, as well as workers who have been affected by the consequences of COVID-19 in combination with the relevant anti-epidemic measures, and launched a number of subsidy schemes under the auspices of the relevant departments.
If a substantial change in circumstances resulting from the COVID-19 pandemic would create a gross disparity in the rights and obligations of the contractual parties, the affected party may request the resumption of negotiations on an already concluded agreement. In the event that the parties do not agree on new conditions, the contract may even be terminated by a court at the request of one of the parties. However, it will depend on the specific contractual relationship and its conditions, which may exclude respective provision of the Civil Code regarding a substantial change in circumstances.
The so-called Lex Covid newly introduced the institution of extraordinary moratorium into the Czech legal system implementing measures, including, for instance, the impossibility to declare insolvency, suspension of enforcement proceedings, or reversal of the sale of secured assets. The protection provided by virtue of the extraordinary moratorium should be effective until 30 June 2021 (if not prolonged).
By Ivan Telecký, Partner, and Matěj Konečný, Attorney-at-Law, Deloitte Legal