Encroachment in franchising: the application of the good faith principle by Italian courts

Sunday 3 September 2023

Silvia Bortolotti
Buffa, Bortolotti & Mathis, Torino, Italy
Officer, IBA International Franchising Committee, Newsletter Editor


One of the most critical aspects in drafting and managing franchise agreements concerns encroachment. This article will explore the different approaches followed by Italian courts with respect to: (i) the competing activity of the franchisor, selling through parallel sales channels; and (ii) the indirect liability of the franchisor for competing activities enacted among its franchisees.

Legal framework

Pursuant to Article 3.4(c) of Law 129/2004 (the Italian law on franchising):

‘(…) The agreement must furthermore expressly indicate:

(c)    the scope of the territorial exclusivity, if any, with respect to other franchisees or to channels and sales units directly managed by the franchisor;’

The above provision (and particularly the indication ‘if any’) is interpreted in the sense that an exclusivity clause cannot even be provided; however, if the exclusivity right is granted to the franchisee, the relevant scope of application must be clearly specified.

Franchisor selling through parallel sales channels

In most cases decided by Italian courts, the contractual framework in which encroachment arises, includes an exclusivity right granted to the franchisee in a given area close to his/her point of sale, providing for:

  • the franchisor’s obligation not to open direct shops; and
  • the franchisor’s obligation not to enter into other franchise agreements for the purpose of opening shops;

in the area granted in exclusivity to the franchisee, for the duration of the agreement.

This ‘typical’ clause, in principle, should leave the franchisor free to sell its products to customers of the area through different distribution channels (eg, multi-brand stores, modern distribution, online sales, etc), considering that the prohibited conducts seem to be limited to the opening of direct and franchise shops in the area.

In certain cases examined by these courts, franchise agreements also include an express reservation of right in favour of the franchisor, allowing him or her, for instance, ‘to maintain commercial relations other than franchising in the exclusive area’; or to sell through alternative channels. Notwithstanding that, Italian courts, in some cases, envisaged an encroachment and a liability of the franchisor, because the franchisor was selling through alternative channels in competition with the franchisee, even though in the absence of an actual breach of exclusivity.

In most cases, the courts have grounded their decision on the evaluation of the franchisor’s actual conduct: the most typical case being the franchisor strongly competing with the franchisee on prices, for instance, selling through other channels at prices that the franchisee did not have sufficient margin to compete on (see Trib. Isernia 12/04/2006; Trib. Milano 28/01/2014; Trib. Milano 21/06/2018).

However, taking the aforementioned three examples, the final decision was grounded on a different legal basis: in Trib. Isernia 12/04/2006, where the exclusivity clause expressly allowed the franchisor to sell through alternative channels, the court envisaged an abuse of economic dependence and a violation of the principle of good faith; in Trib. Milano 28/01/2014, where there was the ‘typical’ exclusivity clause, the court stated that such clause could not be interpreted as allowing the franchisor to strongly compete with the franchisee on prices (ie, it applied the general rules on contract interpretation); in Trib. Milano 21/06/2018 the franchisor’s behaviour was regarded as contrary to good faith, that is, the decision was based on a factual evaluation.

By way of contrast, there are cases in which the courts have decided that the franchisor’s conduct, consisting in selling through alternative channels, was (implicitly) allowed by the contents of a ‘typical clause’, which only prevented the franchisor from opening new direct or franchise outlets, but not from selling through alternative channels. For instance, in Trib. Bologna 19/04/2011, the contract provided for a ‘typical’ exclusivity clause and expressly mentioned that the franchisor was also selling its products to multi-brand stores; the franchisee claimed the breach of contract by the franchisor, alleging that he was selling to a multi-brand shop near his outlet; the court evaluated the conducts of the parties and considered the franchisor’s behaviour as not in breach of contract since the contract allowed him to sell to the multi-brand store.

The different outcome of the courts’ decisions in most cases depends on the assessment made by the courts of the actual conduct of the parties, based on the evidence provided in the court proceedings: departing from the idea that the franchise relationship needs to be based on the principles of solidarity and collaboration between the two parties, when the courts deem that the franchisor’s conduct exceeds the limits of reasonableness (eg, in case of a strong competition on prices as in the cases mentioned above), in fact, they decide against the franchisor and then they find a legal basis on which they ground their decision (eg, breach of contract, violation of the good faith principle, abuse of economic dependence, re-interpretation of the exclusivity clause in consistence with good faith, etc).

Encroachment among franchisees

Another interesting aspect examined by Italian case law concerns the liability of franchisees in case of possible encroachments among each other, as well as the ‘indirect’ liability of the franchisor for encroachment between its franchisees.

For example, there is a debate on the effectiveness of clauses providing for the payment of liquidated damages between franchisees pertaining to the same network, in the event of encroachment: the Court of Brescia in a recent decision (Trib. Brescia 04/04/2020) denied the effectiveness of such a clause in relations between franchisees, expressly departing from a previous judgment of the Court of Cassation (Court of Cassation No 1992 of 08/04/1981), which had found the principle of the ‘contract in favour of third parties’ (Article 1411 of the Italian Civil Code) applicable to a similar clause contained in a distributorship contract. In the relevant case, the Court of Brescia held that the agreement between the franchisor and its franchisees providing for the prohibition of encroachment and for the obligation to pay liquidated damages in the event of violation, cannot be applied to relationships between parties that are not parties to the same contractual relationship and cannot be considered as an agreement between the franchisor and the franchisee (who invades) in favour of the third party (franchisee whose area is invaded).

On the contrary, the franchisor's liability has been recognised in some cases, in hypothesis of area invasions between franchisees, in application of the principle of good faith, especially in cases in which the franchisor was aware of the infringement and had not taken sufficient action to prevent it (see, for example, Trib. Milano 02/04/2019; Trib. Milano 06/12/2018).

Finally, in some cases, the franchisor's liability was even envisaged in the case of encroachment between franchisees of parallel networks of the same franchisor (Trib. Milano 17/01/2019, and Trib. Milano 01/10/2018, confirmed by App. Milano 04/11/2019). Namely, in the aforementioned cases, the courts of Milano extended the scope of application of the exclusivity clause provided for in a franchise agreement between a franchisor and a franchisee concerning a specific franchise network, in order to challenge a competing conduct engaged by franchisees pertaining to a different – parallel – franchise network of the same franchisor.

These decisions all referred to real estate franchise networks, where the same franchisor was operating parallel franchise networks using two different brands, but actually addressing the same customers, and having a common interest, sector, image, management, services, know-how, manual and customers’ database. It must also be said that in those cases the relevant exclusivity clause was quite ‘wide’ (eg, ‘The Franchisor warrants/grants the Franchisee exclusive exploitation of the franchise in the agreed territorial area’).

In the aforementioned three decisions, the Italian courts concluded that the franchisors were liable for violation of the good faith principle and for an indirect breach of the exclusivity clause, stating that the encroaching conduct was against the spirit of cooperation that must characterise the franchisor/franchisee’s relationship.

An opposite decision was taken by Trib. Milan 14/01/2019, in a case (also in the real estate sector) where a new outlet of a parallel network of the franchisor was opened in the area granted in exclusivity to a franchisee. However, in that case, the franchisee knew when he joined the network that there was a parallel network of the same franchisor in the same area; moreover, the franchisee was firstly asked to open the new outlet, but he refused and he accepted (in writing) the new opening by another franchisee. Therefore, the court decided that there was not sufficient evidence to justify the extension of the scope of the clause to the parallel network and that there was instead clear evidence that the franchisee accepted the new opening and concluded that the franchisor was not responsible.