Aside from the Brazilian Civil Code, there are also accounting rules that address the concept of goodwill, which solely take into consideration the intangible elements of an establishment, to determine the surplus value when acquiring a specific business.
For the purposes of this analysis, ‘goodwill’ will hereinafter mean the intangible elements of the establishment.
Brazilian doctrine and case law.
There is no statutory Brazilian Law stating that franchisees have an interest in the franchise’s goodwill.
In Brazil, the basic regulation applicable to franchise agreements is Law no. 8,955 of December 15, 1994 (‘Franchise Law’), the objective of which is solely to define the concept of ‘franchise’ and to introduce the franchisor’s obligation to provide a franchise disclosure document, called the ‘Franchise Offering Circular’ (‘COF’), to potential franchisees at least ten (10) days prior to the execution of any agreement or payment of any amount to the franchisor or other designated recipients. In addition, franchise agreements are broadly regulated by the general provisions regarding contracts in the Brazilian Civil Code.
In brief terms, current Brazilian legal analysis considers that the franchisor’s trademark is the most valuable intangible asset to attract clientele, along with the know-how, trade-dress and other particular elements of the franchise system, which belong to the franchisor and are intended to ensure the consistent level of quality of its goods and services.
In addition, franchisees benefit from the franchisor’s goodwill by receiving a license to use the franchisors’ trademark and other intangible elements of the franchise system through a written franchise agreement, usually for a determined term.
Taking into consideration Brazilian case law, it is commonly accepted that the tangible elements of the establishment belong to the franchisee, who is the owner and party responsible for the activities conducted in the franchise outlet. However, the controversy lies in one of the most important elements of the goodwill: the clientele.
Undoubtedly, the intellectual property related to the franchise system is owned by the franchisor, who licenses its use to the franchisee. Therefore, several Brazilian court decisions have ruled in favor of franchisors, recognizing that there were no grounds for payment of any compensation to franchisees upon termination and non-renewal of their franchise agreements, as the franchisors were the owners of the most valuable intangible asset – the trademark – with its definitive power to attract clientele.
However, a recent court decision, based upon fairness and allegations of unjust enrichment have recognized the existence of local goodwill, developed through the efforts and expenditures of the franchisee and, as a result, have granted such franchisees compensation in amounts corresponding to half of the value of the goodwill. In the case, the franchisee (who operated a service business) stated that the business was successful due to a significant personal investment of time and effort by the franchisee, which should be indemnified. According to his arguments, if his contribution to the goodwill of the franchise business was not indemnified, this absence of indemnification would result in an unjust enrichment to the franchisor.
Notwithstanding, it is still an isolated decision and, in general, the circumstances of each case must be assessed on a case-by-case basis, taking into consideration several aspects, such as, for instance:
- the terms of the franchise agreement;
- if the franchisor is the owner of a well – known trademark;
- if the case involves a service franchise or a product franchise system;
- if the franchise chain was started and developed in Brazil due to the particular efforts of a franchisee;
- if the franchisee has prior experience in the franchise business; and
- if the franchisee independently attracts clientele due to its own efforts and not due to the particular elements of the franchise system, among other aspects.
Terms and conditions of the franchise agreement.
As the Brazilian Franchise Law deals solely with the franchisor’s obligation to provide the disclosure document to potential franchisees and does not address particular aspects of the franchise agreement, the analysis of the terms and conditions of the franchise agreement will be extremely important to conclude whether the franchisee is entitled to receive any compensation for the local goodwill upon termination and non-renewal.
Moreover, general principles and provisions regarding contracts, as stipulated in the Brazilian Civil Code, will have an impact on this analysis, such as:
- pacta sunt servanda;
- the principle of good faith governing contractual relationships;
- unjust enrichment; and
- the principle of the social purpose of contracts, among others.
It is common practice to stipulate in franchise agreements that the goodwill, including the clientele, belongs solely to the franchisor, as the franchisor is the owner of all intellectual property rights connected with the franchise system. In case of a franchise related to a well-known trademark, such provisions usually contain an acknowledgement of the franchisee that the sale of products or performance of services contemplated in the franchise agreement is basically influenced by the famous brands owned by franchisor and that the role of the franchisee is not a determining factor in forming the clientele, notwithstanding the need to uphold the standards established by franchisor in order to maintain the consistency of the franchise chain.
However, this aspect must be analyzed together with other contractual terms, such as exclusivity, for instance. If the franchise agreement establishes an exclusive territory, franchisees have more arguments to state that part of the clientele was also attracted by the sole efforts of the franchisee, as the franchisor and other franchisees were not authorized to open other franchise outlets and conduct the same activities within the territory. Nevertheless, as mentioned above, several other aspects have to be considered in a particular case and the exclusivity of the agreement in connection with a certain territory for the franchisee is not the only determining factor to justify an indemnification for goodwill.
When no exclusive territory is granted by the franchisor and the agreement clearly states that the goodwill belongs solely to the franchisor, it is very unlikely that Brazilian courts will rule in favor of a franchisee by granting it compensation for loss of goodwill upon termination or non-renewal of the franchise agreement.
Another aspect to be considered is the degree of the franchisor’s oversight of the franchisee’s activities. If the franchisor exerts substantial control and provides consistent assistance regarding its franchised system, it is unlikely that any claim for goodwill compensation will be granted to franchisee, as any clientele resulting from this relationship clearly stems from the efforts of the know-how and operational methods stipulated by franchisor.
If the franchisee or master franchisee was the first to establish the brand in its trade area (or even within Brazilian territory) on an exclusive basis, such condition may lead to a different conclusion, and the franchisee may be partially granted the referred right to receive compensation.
Another aspect to be analyzed is whether the franchise agreement contains post-termination noncompetition covenants. Although Brazilian Competition Law (Law no. 8,884/94) establishes that any act that obstructs the establishment and operation of companies in the local market constitutes an infringement of the economic order, covenants that prohibit franchisees from competing directly or indirectly with the franchisor during or after the term of the franchise agreement should be deemed legally valid and enforceable due to special features of franchise business, provided that noncompetition covenants are reasonably limited in time and territory.
The courts have been enforcing post-term covenants not to compete when they specify a period of time, generally from 2 to 5 years, and a specific territory, which may be the same city, or even state, where the franchisee unit is located. A reasonable posttermination non-competition covenant stipulated in the franchise agreement will also be taken into consideration to avoid the payment of compensation for loss of goodwill to the franchisee.
Therefore, the analysis of the main terms and conditions of the franchise agreement, together with other circumstances and particularities of the case, are extremely important to determine whether the franchisee is entitled to receive any kind of compensation for the local goodwill upon termination or non-renewal.
Luciana Bassani (IDI franchising country expert for Brazil) and Cândida Caffè (Partner of Dannemann Siemsen Advogados).