The license of intellectual property rights, including the formula, and the transfer of know-how is an important element in a franchise agreement, besides uniformity, quality and control of these features by the franchisor. The franchisor usually provides operational, commercial and organizational information to the franchisee about the franchise formula.
This is the only way in which a franchisor can guarantee the uniform identity and appearance of their brand, and support and facilitate the franchisee in the day-to-day operations of his franchise company. The franchisor’s know-how is often communicated to the franchisee in the form of a franchise handbook or courses and trainings. But what exactly does ‘know-how’ include and why is it so important for franchisors to protect this information well in a contract? In 2018, the European legislator adopted a directive for the protection of trade secrets, know-how or commercially sensitive data. The Dutch Trade Secrets Protection Act implements this Directive, thus offering a basis for taking measures against infringements, which measures can be applied for to the courts (in preliminary relief proceedings).
This article answers the question why contractual protection of know-how is important nonetheless, taking into account the statutory framework in the Netherlands, which was recently altered by the Franchise Act that entered into effect on 1 January 2021. The Franchise Act poses restrictions on post-contractual non-competition clauses and establishes a link with the sharing of know-how by the franchisor with the franchisee. The section of this Act on the non-competition clause has a postponed entry into effect of two years for agreements that already existed on 1 January 2021.
Post-contractual non-competition clause; Why?
The purpose of a post-contractual non-competition clause is to protect the interests of franchisees and to ensure that their competitive position on the market is not eroded by ex-franchisees who compete with them (unfairly) using their experiences with the formula. Knowledge that is crucial to the franchise formula is usually not protected by an intellectual property right. The purpose of the non-competition clause is to restrict the activities of ex-franchisees who operate the franchise company (in a private capacity or for competing brands), but also of companies affiliated with the franchisees. Incidentally, non-competition clauses are also customary during the term of a franchise agreement, but they are not regulated in the Franchise Act and are hardly a topic of dispute in practice.
What to take into account?
The Franchise Act sets a number of conditions on the post-contractual non-competition clause a franchisor can include in a franchise agreement (Section 7:920 (2) DCC): -
- The non-competition clause is set out in writing.
- The restriction on the conduct of activities relates only to services which compete with the services to which the franchise agreement relates;
- The clause is indispensable to protect the know-how the franchisor transferred to the franchisee.
- The clause cannot exceed one (1) year after the end of the franchise agreement.
- The geographical scope of the clause does not extend beyond the area in which the franchisee exploited the franchise formula in accordance with the applicable franchise agreement.
Scope
The Franchise Act sets limits on the scope and duration of the non-competition clause. Firstly, and most importantly, this means that all arrangements made on non-competition after the end of a franchise agreement must always be recorded in writing; otherwise they will not be legally valid. The Act also sets the condition that a non-competition clause must be “indispensable” to protect the know-how. It is precisely this provision that is met with criticism in the market. After all, the post-contractual non-competition clause intends to protect more than just the franchisor’s know-how. It aims to prevent unfair competition by ex-franchisees who ‘latch on to’ the formula of the franchisor (and consequently to prevent confusion among the general public). This is a good thing, in the interest of the remaining franchisees in the network. A reliance made by the franchisor (or the franchisees if they have this right) on trademark law will often not suffice, because the ex-franchisee will often choose a slightly different company name. However, it is precisely if the enterprise is continued on the same location or in the same catchment area for the same products or services, without a franchise license that confusion is likely to arise among the general public.
We observe that the Franchise Act seems to have been inspired by competition law, since its wording almost literally follows that of the block exemption for vertical agreements, ignoring that the exemption is a ‘safe haven’ and that further-reaching non-competition clauses may still merit an individual exemption or be permitted as de minimis. In other words, things are not as bad as they look in competition law. As far as the Franchise Act is concerned, it seems important not use the term ‘indispensable’ too rigidly.
What is the definition of know-how?
Know-how is defined in the Franchise Act as “a collection of practical information not protected by any intellectual property right, originating from the franchisor's experience and from research carried out by him, which information is confidential, essential and identified” (Section 7:911 (2) under a 2°). This means that – according to the strict interpretation of the Franchise Act – know-how will in principle be less likely to exist if the information transferred is generally publicly available or easy to acquire, if the information is not relevant or useful for the exploitation of the franchise company, or if the know-how is not identified (which could be read as ‘recorded’). We advise against hasty judgment that certain information does not qualify as know-how and that the franchisor could therefore not rely on the non-competition clause. After all, a lot of the information in the handbook consists of pieces of information, business methods, a way of doing business or organizing business processes that is not so secret or essential in itself, but when compiled in this particular way does indeed constitute the essence of the formula. Compiling and selecting things that are not essential or special in themselves also has an essential, identified and secret aspect to it that deserves protection, especially in a franchise context. The necessity of identification should also be looked at from all sides, as it is the nature of know-how within franchise to be often disseminated to franchisees in trainings and frequent advice. It cannot be that the Franchise Act forces franchisors to share no more know-how with the franchisees verbally, and if they do share information, to do so in writing (with reference to or applicability of a confidentiality clause). This formalisation of the relationship does not appear to be in the best interest of franchisees.
Unfortunately, the above does not always go down well with the courts. On 24 February 2021, the Court of Overijssel held that the fact that a franchisor provides the franchisee with certain information personally does not mean that knowledge should therefore be qualified as unique and/or secret. This is correct in itself, but in the case at issue the franchisor had shared a handbook in which the working method and formula were described. According to the Court, the information in the handbook qualified as ‘general information’ because the individual elements in it were not secret, unique and formula specific. The Court also did not qualify knowledge as know-how, such as instructions on how to deal with relevant laws and regulations, trainings and standard answers to be used in communications with customers. We believe this approach of the concept of ‘know-how’ is too rigid and does not do justice to the strength of franchise. Franchise is precisely about ‘business methods’, often consisting of operational, commercial and practical information that serve the uniformity, quality and service orientation of the formula. It is hardly ever technical or industrial know-how in the sense that the court apparently advocates. The core of franchise is the handbook and that things are done in the same, uniform way across all franchised stores. If the handbook is not regarded as essential and secret, we throw the baby out with the bathwater. This is harmful for all franchised stores that must be able to count on not encountering unfair competition on the basis of the handbook, training or advice that was given to a former franchisee. In addition, it disadvantages consumers, who may become confused as to who is the offeror of products or services on the market.
Conclusion
It is in the best interest of franchise as a business model to include a post-contractual non-competition clause in the franchise agreement. This protects the entire network of franchised stores against unfair competition by ex-franchisees. The kind of know-how that is crucial in franchise may at first sight seem to consist of obvious elements, but is the whole of business processes and entrepreneurial tips described that makes the franchisee ‘hit the ground running’ when he starts his franchised store. That is the exact force of franchise: not having to reinvent the wheel (even through this could be done in theory using public information and by trial and error). Execution also requires great precision because uniformity and quality are paramount. We should take care not to interpret the definition of know-how or the requirement of ‘indispensable’ too ‘narrowly’ in a franchise context. Franchisors should therefore carefully consider the way, form and title under which they provide know-how, and the wording and form in which they record the non-competition clause. It is wise to dwell on the interest in the performance of the non-competition clause in advance, and on whether the shared knowledge meets the conditions, especially those regarding the definition of know-how. Know-how and advice should only be provided subject to obligations of confidentiality, and the entire handbook should not be shared with the prospective franchisee before the franchise agreement has been concluded. If there is fear that the ‘secret’ nature cannot be safeguarded, it may seem attractive to franchisors not to share certain information with franchisees, or to share it with restraint. That would be an undesirable outcome. Know-how gives franchisees a competitive edge on the market. In the long run, it is in the best interest of franchisees that the uniformity and quality, reputation and power of the franchise network are guarded. Do not judge too quickly that there is no know-how, since this may have major consequences for the competitive position of the franchise formula and of all franchisees who are part of it.
Should you have questions, please contact Martine de Koning (partner) and Tosca Bokhove (paralegal) of the Commercial & International Trade practice group.
