New Brazilian Civil Code and its impact on Franchising

The new Brazilian Civil Code was enacted on January 10, published on January 11, 2002 and became effective one year after its publication date, on January 11, 2003, after more than 30 years in the House of Representatives. The former Civil Code had been enacted by Law no. 3.071 and was dated January 1, 1916.

In the meantime, Brazil has moved from an agrarian country into a prevailing industrial economy and the new Civil Code came to adapt our legal system into the new socio-economic context.

The entire Code emphasizes ethical and social principles and settled controversies already decided by our courts over the last 86 years. This new Code refuted formalisms and constantly refers to good faith, requiring a balance of rights and obligations in any and all agreement, including franchising. It privileged social interests in detriment of the individualism that prevailed in the previous Civil Code, which was enacted when 70% of the Brazilian population lived in the field.

Since Brazil adopts the Civil Law system, the Civil Code establishes important legal guidelines applicable to private rights, in general. For this reason, this important piece of legislation is usually called the "Constitution of the ordinary man".

Thus, although the new Civil Code does not expressly mentions franchising, which is subject to a specific law (Law no. 9.855, of December 15, 1994), it prescribes general rules and principles, which also have to be observed by franchising legal documents.

Consequently, franchising and all other private sectors were indirectly affected by the new Civil Code and will have to adapt their legal documents into the new concepts and spirit of the current Code.

The main changes adopted by the new Civil Code that will affect franchising are the following:

– Preliminary Agreements: article 462 of the new Code stipulates that preliminary agreements have to specify all essential aspects related to the definitive binding agreement to be executed between the parties.

In addition, article 463 establishes that, after expiration of the preliminary agreement, any of the parties may require the execution of the definitive binding agreement, granting a term to the other party for this purpose, provided that the preliminary agreement does not permit the regret.

Since pre-franchise agreements are considered preliminary documents, after the new Civil Code they should expressly include a disclaim underlining that the prospective franchisee will still go through a training process and that it may be approved by franchisor or not, depending on the development of the prospective franchisee’s obligations and performance under the pre-franchise agreement, at franchisor’s sole discretion.

It is now indispensable to have a specific provision in the pre-franchise agreement stipulating that franchisor has the right not to accept the prospective franchisee and not to execute the definitive binding agreement after expiration of the pre-franchise agreement. In the absence of this provision, the prospective franchisee may compel franchisor to execute the franchise agreement.

In addition, the most important aspects related to the franchise document, such as royalties and franchise fees, as well as any aspects that may limit franchisee’s rights, should be expressly included and highlighted in pre-franchise agreements. It is also advisable to attach the franchise agreement to the preliminary contract, in order to avoid redrafting all terms and conditions of the agreement and any possible arguments that the prospective franchisee was not aware of the essential aspects of the franchise agreement to be executed after the prospective franchisee’s approval by franchisor.

– Statute of Limitations: Brazilian Franchise Law, which was inspired by the existing laws in the United Sates and France, prescribes pre-sale disclosure requirements regarding franchisor’s business at least 10 days prior to any payment or execution of any agreement between the parties. This pre-sale disclosure intends to provide necessary information to prospective franchisees, in order to permit a conscious business decision and a thorough analysis of franchisors by the prospective franchisees.

If franchisor fails to comply with such requirement, franchisee may argue that the franchise agreement is null and request reimbursement of all amounts already paid to franchisor or to related third parties, such as franchise initial fee and royalties, plus damages.

The statute of limitations related to the possibility of claims filed by franchisee against franchisor for non-delivery of the franchise offering circular in accordance with the Franchise Law was reduced by the new Civil Code from 4 to 2 years, in view of article 179. According to this article, the law stipulates that if certain act is subject to annulment, the statute of limitations shall be of 2 years. Since this article does not mention damages, there are controversies regarding the applicable statute of limitation related to the possibility of claims filed by franchisee with such requirement. Some experts state that such term will also be of 2 years, while others believe it is of 10 years.

– Principle of Good Faith: this principle used to implicitly rule the relationship between contractual parties and is now expressly mentioned in articles 113 and 422 of our Civil Code.

This means that the parties should be able to demonstrate that they have always acted in good faith in relation to the other party, informing all aspects of the business and fully cooperating with such other party in all possible aspects.

The principle of good faith is basically divided into the obligation to inform and the obligation of loyalty, which each of the parties has to demonstrate in connection with the other.

In view of the principle of good faith, the obligation to inform the other party about provisions that limit its rights has increased. Although the franchise offering circular already includes disclosure requirements stipulated in law, including the main essential aspects of the business, the obligation to inform became even more important with the new Code, also contemplating an obligation of loyalty.

In light of that, recitals of franchise agreements should become more detailed and include express acknowledgements by franchisee that it has been fully informed by franchisor of all aspects related to the business and that it acknowledges that franchisor has always acted in good faith and cooperated with it.

It is also advisable to keep letters, fax, e-mails and other correspondence related to the initial negotiations of the parties in its files, in order to demonstrate in the future, if necessary, how the negotiations were dealt with between the parties.

– Principle of Social Purposes of Agreements: article 421 of the new Code established that the freedom of the parties to contract has to comply with the social purposes of the agreement.

The expression "social purposes of agreements" is not expressly defined in our legal system and this concept will be gradually defined by the Brazilian courts.

However, it is possible to infer that this principle will impose some limitations on the general understanding that "agreements are law between the parties" and on the Latin expression pacta sunt servanda.

Therefore, social aspects related to agreements became more important and will certainly be taken into consideration in case of a judicial action. Notwithstanding, this principle is not supposed to implement relevant changes in the franchise system, as in practice Brazilian courts already considered social impacts of agreements in judicial decisions.
In addition, article 2.035 of the new Code stipulated that no provision shall prevail if contrary to the public order, as established in this Code to guarantee the social purposes of property and agreements.

Thus, the franchise agreement shall comply with the referred principle even if it stipulates foreign law and jurisdiction to govern the agreement, as any decision to be enforced in Brazil shall go through a process of approval by the Federal Supreme Court, called "homologation of foreign decision", in which conformance with this principle will be required.

– Excessive Burden: this principle was also inserted in our Civil Code, on articles 478 to 480.

Under such articles, for example, if franchisee’s obligations become excessively burdensome, with extreme advantage to franchisor, in view or extraordinary and unpredictable facts, franchisee will be able to request the termination of the agreement in court and the judicial decision which determines the termination of the agreement will be effective as from the date on which franchisor has been served in the process.

Modification of contractual conditions can also happen in order to re-establish the balance of rights and obligations in the agreement, in order to avoid termination.

Thus, judges will examine these aspects on a case by case basis and franchise agreements cannot impose excessive burden on franchisee, which may impose absolute obstacles to its business.

The most important to emphasize is that franchise agreements, as any other contracts, shall balance rights and obligations to both parties and not impose all burdens to one of the parties only.

In this sense, franchisor shall render effective training and assistance to franchisee in compensation to receipt of royalties and other payments involved in each franchise system, so that both parties can have benefits derived from the agreement.

All such principles are valid for both franchisee and franchisor.

– Agreements valid for an unlimited term: under Brazilian law, agreements executed without a determined term could be terminated by any of the parties, at any moment, upon a reasonable written notice.

However, article 473 of the new Civil Code established a general rule for termination of agreements, stipulating that if one of the parties has made substantial investments to enter into the agreement, unilateral termination will only be effective after some time compatible with the nature and amount of such investments.

Therefore, termination of franchise agreements executed for an unlimited term may not be effective at any time, upon receipt of a simple notice from franchisor by franchisee and may require good cause, depending on the circumstances. The most important is to verify if franchisee has already yielded the return of its investments in the business to become a franchisee.

Consequently, termination without good cause has to be carefully examined by the parties, on a case by case basis, even if the franchise agreement was executed for an unlimited term. The general rule is not to terminate such agreement without good cause before the franchisee has had reasonable time to receive the return of its investments in the business.

Conclusion

Franchisors should review their standard legal franchise documents in light of the new Brazilian Civil Code, in order to avoid possible provisions contrary to law in the franchising offering circular, pre-franchise contract and also in the franchise agreement.

Analysis of such legal documents is also advisable in order to defend the rights of each party and its interests in the agreements.

Franchisee should also review any legal documents related to the franchise business according to the new Code, especially corporate aspects of its company, which were completely revised in said new Code. Limited liability companies, which are the most used by small and medium investors in Brazil, are now subject to several changes and the companies have a legal term until January 11, 2005 to adapt their Articles of Association.