The Application of Good Faith in the Execution of Franchising and Distribution Agreements under Italian Law

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Introduction

Good faith is a fundamental principle of Italian contract law, enshrined in Articles 1175 and 1375 of the Civil Code. It requires that parties to a contract act with loyalty and fairness at all stages, from its formation to its execution. This principle is of particular relevance in the context of franchising and distribution contracts, where the relationships between the parties can be characterised by a significant imbalance of bargaining power. Furthermore, Article 9 of Law No. 192/1998 establishes a prohibition on the exploitation of economic dependence. This legislation offers specific protection for the weaker party in a contractual relationship, such as a franchisee or distributor.

The implementation of good faith in the performance of franchising and distribution contracts

• Franchising contracts: In the context of franchising contracts, the principle of good faith entails a mutual obligation on the part of the franchisor and the franchisee to collaborate in a fair and transparent manner, with a view to ensuring the success of the business. It is the responsibility of the franchisor to provide the franchisee with the necessary support, including training, assistance, and updates, in order to ensure the latter's ability to operate efficiently. Conversely, the franchisee is bound by the terms of the franchise agreement and is obliged to adhere to the franchisor's operational standards and directives. A breach of good faith may occur, for instance, if the franchisor imposes onerous contractual conditions or unilaterally modifies the economic terms of the contract without justification.
• In the context of distribution contracts, the principle of good faith is of particular significance. In the context of distribution contracts, the concept of good faith translates into a duty of cooperation between the supplier and the distributor. It is the responsibility of the supplier to ensure the uninterrupted provision of goods and services and to refrain from any actions that would impede the distributor's ability to conduct business operations. Conversely, the distributor is bound by contract to engage in the active and diligent promotion of the supplier's products. A breach of good faith may occur, for example, if the supplier unjustifiably interrupts supplies or imposes disadvantageous commercial terms on the distributor.

The prohibition of economic dependence abuse under Article 9 of Law No. 192/1998

Article 9 of Law No. 192/1998 introduces the prohibition of economic dependence abuse, which occurs when one party exploits its dominant position to impose unjustified or burdensome contractual conditions on the other party, who finds itself in a situation of economic dependence. Economic dependence arises when a party, despite maintaining formal autonomy, is unable to access viable commercial alternatives and is therefore compelled to accept unfavorable contractual terms.

Demonstrating Economic Dependence

To demonstrate a situation of economic dependence, it is necessary to prove that one party lacks valid commercial alternatives in the market. Indicators of economic dependence include:

• High initial investment costs: If the franchisee or distributor has made significant investments to start the business, they may find themselves in a situation of economic dependence on the franchisor or supplier.
• Exclusivity obligations: If the franchisee or distributor is required to terminate relationships with other suppliers or brands, this could limit their contractual freedom and create a situation of dependence.
• Inability to find satisfactory alternatives in the market: If the franchisee or distributor does not have access to alternative suppliers or brands that can offer similar conditions, they may be in a situation of economic dependence.

Economic Dependence Abuse

Economic dependence abuse occurs when one party exploits the other party's dependence to impose unjustified or burdensome contractual conditions. Some examples of abuse include:

• Imposition of excessively burdensome contractual conditions: For instance, a franchisor requiring the franchisee to purchase goods or services at prices higher than market rates, exploiting its dominant position.
• Unjustified refusal to renew the contract: If the franchisor or supplier refuses to renew the contract without valid reason, knowing that the franchisee or distributor has no commercial alternatives, this could constitute economic dependence abuse.
• Arbitrary interruption of supplies: In the case of distribution contracts, a supplier who unjustifiably interrupts supplies, leaving the distributor without products to sell, could be accused of economic dependence abuse.

The unilateral imposition of detrimental changes by one party to a contract may be considered an act of economic dependence abuse

The unilateral imposition of detrimental changes by the franchisor or supplier may be regarded as an act of economic dependence abuse, particularly if such changes are implemented without justification and in a context where the franchisee or distributor lacks viable commercial alternatives. For example, a franchisor who unilaterally modifies the economic terms of the contract, requiring the franchisee to assume additional costs or reduce profit margins, could be accused of economic dependence abuse if the franchisee is in a situation of economic dependence and unable to readily exit the contract or identify viable alternatives in the market.

The Legal Ramifications of Breaches of Good Faith and Economic Dependence Abuse

A breach of good faith in the execution of a contract can have significant legal consequences. In the event of a breach, the aggrieved party may seek the termination of the contract on the grounds of non-performance, provided that the breach is of a serious nature and undermines the contractual balance. Moreover, the aggrieved party may seek redress for damages incurred as a result of the other party's unfair conduct.

In the event of economic dependence abuse, the aggrieved party may petition for the nullification of the offending contractual clauses and seek damages. The case law has established that economic dependence abuse can also be regarded as a contravention of the principle of good faith when one party exploits its dominant position to impose unjustified or onerous contractual conditions.

Conclusion

Good faith is a fundamental principle that permeates the execution of franchising and distribution contracts, requiring the parties to act with loyalty and fairness. Article 9 of Law No. 192/1998, which introduces the prohibition of economic dependence abuse, provides additional protection for weaker parties, preventing one party from exploiting its dominant position to impose unjustified or burdensome contractual conditions. The unilateral imposition of detrimental changes can certainly constitute economic dependence abuse, especially if the franchisee or distributor is in a situation of economic dependence and lacks valid commercial alternatives.

Stefano Brustia - Lawyer at the Rome Bar

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The information contained in this article is general in nature and does not constitute legal advice.