Distribution, franchise or simply sale of goods? The importance of classification

May 28, 2021 | Blog

Why the right denomination for your sales channels matters

It is not uncommon for an arrangement between parties to be classifiable as a distribution agreement or franchise agreement, while in actual fact - or in spite of the fact that - the parties themselves dubbed it an “ordinary” purchase agreement. Putting the correct name on an agreement or contract for the sale, purchase or retail sale of goods is important in that it will help determine within which legal parameters the document is to be subjected to review. Whether or not mandatory law applies, for example, depends on the classification of the agreement. Mandatory rules do not allow for derogation by the parties, one such rule being the obligation to pay goodwill compensation. This obligation is provided for by the Dutch Franchise Act, which entered into force on 1 January 2021. The presence, or absence, of a mandatory rule imposing a compensation for clientele [klantenvergoeding], also known as goodwill, tends to steer parties towards a particular sales channel, be it distribution, agency or franchise. Determining applicable law is another element that may be crucially affected by the classification of an agreement.

Actual title is not the deciding factor
The classification of an agreement is not solely decided by its title as given by the parties to that agreement. The ultimate deciding factor is the substantive relationship between the parties. If an agreement, however titled, ticks all the boxes of a franchise agreement, it may well be classified as one. In that event, the statutory provisions on franchise will apply to the agreement.

Sale of goods
The contract for the sale of goods [koopovereenkomst] is identified in Dutch statute, which defines it as follows: ‘Sale is an agreement whereby one person undertakes to make a thing available and the other to pay a price in money for it.’ (Section 7(1) of the Dutch Civil Code (DCC))

Distribution
There is no provision in Dutch law defining the distribution agreement. The distribution agreement differs from the contract for the sale of goods in that it not only incorporates terms subject to which goods can be sold but also terms relating to the resale of the goods or services supplied. As part of the transaction, some know-how may be disclosed to the customer for the benefit of the resale of the goods, with the customer also to observe specific instructions given by the supplier. Under the terms of the agreement, the distributor is likely to be allowed to use the trade name and the brand of the supplier for the distribution of the goods or services. However, the marketing and resale of the contract products is for the sole risk of the distributor.

Franchise
Dutch law does recognise the franchise agreement. The franchise agreement is defined as the agreement by which a franchisor grants a franchisee the right and the obligation to exploit a franchise formula with regard to the production or sale of goods or the provision of services in the manner specified by the franchisor (Article 7:911 DCC). The core element of a franchise relationship is that the franchisor owns a franchise formula and that the franchisor affords the franchisee the right and imposes upon the franchisee the obligation to exploit that formula in the manner specified by the franchisor. The franchise formula includes at the very least: 1. A trademark, design or trade name, visual identity or drawing; and 2. know-how.

The objective in both franchise and distribution is for the products involved to be sold to third parties. The distinction between franchise and distribution will tend to rely on the questions whether the relationship satisfies the franchise formula element and whether a franchise fee is paid in return for the right to use the formula. That franchise formula falls apart into marketing, logistical and business operational elements, and may include provisions for the management of the franchise. As for the franchise fee, the Explanatory Memorandum to the Act provides that the fee may be either a straightforward payment of money or any other consideration [tegenprestatie], or it may take a less direct form of financial compensation for the exploitation of the franchise formula.

Consequences of classification
The correct classification of an agreement is important. For example, it helps determine within which legal parameters the agreement is to be subjected to review, or whether a right to compensation for goodwill exists. Determining applicable law is another element affected by the correct classification of an agreement. If the agreement has an international dimension, classifying it correctly is all the more compelling.

Goodwill
The distribution agreement and the obligation to pay goodwill are governed by the terms agreed by the parties to the agreement and by the provisions of the general law of obligations. Under Dutch law, distributors are not by operation of law entitled to goodwill compensation on termination of the distribution agreement is not There are additional requirements for such entitlement to arise. What also plays a role is that a distributor does not enter into contracts in the name of and for and on behalf of the principal, unlike the agent in the legal construct of agency, which does provide for goodwill compensation (Article 7:442 DCC). The new Franchise Act also affords franchisees the right to compensation for goodwill, which mandatory provision has been laid down in Article 7:920 DCC. Under the new legislation, any contractual clauses contrary to this provision are null and void.

Applicable law
Dutch courts tend to determine the right applicable to international agreements in accordance with Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I).

The cornerstone of Rome I is the parties’ freedom to choose the applicable law.

In the absence of choice, the contract for the sale of goods should be governed by the law of the country where the seller has his habitual residence. If the parties to distribution and franchise agreements have failed to choose applicable law, as a rule the law of the country where the distributor or the franchisee has his habitual residence governs the agreement - not the law of the country where the supplier or franchisor, as the case may be, has his habitual residence.

So when it comes to determining applicable law in the absence of choice, it really does matter whether an agreement is classified as an “ordinary” contract for the sale of goods or as a franchise or distribution agreement.

Conclusion
Putting the correct name on an agreement or contract for the sale, purchase or retail sale of goods is important in that it will help determine within which legal parameters the document is to be subjected to review. Determining applicable law is another element that may be crucially affected by the classification of an agreement.

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