Buying a Franchise: Check Contractual Penalties Before You Sign

A contractual penalty may become payable without the franchisor having to prove an actual loss of the same amount. Anyone joining a franchise network should therefore avoid treating these clauses as routine small print. What matters is which breaches they cover, how the penalty is calculated and whether several claims can arise together. These checks belong before you sign, not when the first dispute occurs.

1. Identify contractual penalties and understand the legal framework

A contractual penalty is intended to secure compliance with agreed obligations. Typical triggers may include unauthorised use of brand identifiers, breaches of confidentiality or failure to follow mandatory operating requirements. Terms such as “sanction payment” or “breach fee” may also conceal a contractual penalty. The substance matters, not the heading.

Germany has no dedicated franchise legislation and no specific government register of franchise agreements. Franchise agreements are governed primarily by general civil law and, depending on the circumstances, commercial law and other relevant provisions. Sections 339 onwards of the German Civil Code (Bürgerliches Gesetzbuch, or BGB) are important for contractual penalties. Pre-drafted contract terms are also subject to review under the rules on standard terms and conditions in sections 305 onwards of the BGB.

Section 307 BGB is particularly significant in business-to-business dealings: clauses must be transparent and must not place the other party at an unreasonable disadvantage. A signature alone does not make a problematic standard clause enforceable. Equally, a contractual penalty is not invalid simply because it is financially painful.

The European Code of Ethics for Franchising is a form of self-regulation within the franchise sector, not legislation. Membership of a trade association is therefore no substitute for reviewing the specific penalty provisions.

2. Define triggers and responsibility precisely

Gather all penalty provisions from the draft agreement and any appendices incorporated into it. Also check references to obligations described elsewhere. Such references can give a short penalty clause a very broad scope.

For each provision, you should be able to answer four questions:

• What conduct is prohibited or required? “Any breach of the interests of the franchise network” is much less precise than a specifically defined breach of duty.
• When is the obligation considered to have been breached? Deadlines, permitted exceptions and required approvals should be clear.
• Whose conduct are you responsible for? In particular, clarify how mistakes by employees or external service providers are treated.
• What role does fault play? Have an adviser check whether the clause is intended to cover events for which you are not legally responsible.

For less serious breaches that can be remedied, try to negotiate a requirement for written notice and a reasonable period to put things right. This is not a general statutory entitlement for every contractual penalty, but a useful contractual safeguard.

Not every breach can be corrected afterwards, however. Confidential information that has already been disclosed, for example, cannot simply be taken back. A provision that distinguishes between different types of breach is therefore more appropriate than a blanket remedy period for every situation.

3. Check amounts, repeated breaches and additional claims

Assess not just the individual penalty but your potential total exposure. Pay particular attention to wording such as “for each individual instance”, “per location” or “for each day of the breach”. This can allow several claims to arise from a single connected set of events.

Try this practical test: an employee accidentally uses an unauthorised advertising template across several channels. Does this count as one incident, several publications or, in addition, a continuing daily breach? You should not have to negotiate the answer only after receiving a demand for payment.

Also check:

• Are penalties scaled according to the seriousness and duration of the breach?
• Is there a clear limit for connected incidents?
• Who determines the amount if no fixed sum is specified?
• Can damages or further sanctions be sought as well?

Contractual penalties and damages are not the same thing. Under the statutory rules, additional damages may be recoverable; any contractual penalty incurred must generally be credited against them. Have an adviser check how the specific clauses interact. A contractual penalty also does not automatically rule out other contractual consequences.

4. Do not rely on having the penalty reduced later

Section 343 BGB allows a court to reduce a disproportionately high contractual penalty in certain circumstances. However, there is an important restriction for commercial obligations: under section 348 of the German Commercial Code (Handelsgesetzbuch, or HGB), a contractual penalty agreed by a merchant in the course of their commercial business cannot be reduced under section 343 BGB.

Whether this restriction applies to you depends on your legal status and the transaction concerned. Review of pre-drafted clauses under the rules on standard terms is a separate issue. An invalid standard clause is not simply reduced to an amount that would just be permissible.

Before seeking a solicitor’s review, prepare an overview of each trigger, calculation method, rule on repeated breaches and potential additional claim. Highlight any provisions whose financial consequences you cannot clearly establish. Any agreed changes should be clearly recorded in the final agreement; a verbal assurance that the penalty “will never be enforced anyway” is not sufficient protection.

Practical takeaway: Only sign once you understand what triggers each contractual penalty and how your total exposure is calculated. Clear limits and proportionate responses help protect both your business and a dependable working relationship within the franchise network.