The pilotage contract in franchising: features, legal precautions and differences with the franchise contract

The article provides an overview of the pilotage contract, an atypical contract used in franchising to experiment with the business format.

What is a pilotage contract?

The pilotage contract is an atypical contract, used in the franchising industry, that governs the relationship between an aspiring franchisor and a third party (the “pilot”) who is granted the right to experiment with the franchisor’s business formula, using its distinctive signs within a given location for a period of time generally of one year.

The franchisor is obligated to train the pilot, providing it with the necessary know-how and assistance, while the pilot must follow the franchisor’s directions and comply with quality standards. The piloting contract must regulate the mutual obligations of the parties, including the confidentiality of the contents of the know-how acquired during the piloting.

Upon the expiration of the pilotage contract, the signing of the franchise agreement may follow if the trial is deemed valid and effective.

What if the franchisee claims failure to test the business format?

Failure to test prior to the launch of a franchise network can result in significant legal and financial consequences for the franchisor.

Doctrine holds that a franchisee could even invoke the nullity of the franchise agreement due to franchisor liability. In addition, the franchisee could claim substantial compensation for damages incurred.

Let’s be clear, the Franchise Act does not explicitly provide for penalties for failure to test, but its importance is crucial in ensuring the validity and effectiveness of the business format and, therefore, of the contract itself.

To carry out the experimentation, the would-be franchisor can open one or more pilot units, operated directly, or use a third party through a pilotage contract.

The pilotage contract has some specificities compared to the franchise contract, including the lack of prior testing of the business format (which is an inescapable prerequisite of the franchise contract).

The natural outcome of the pilotage contract is the signing of a franchise contract between the same parties, but it may happen that the experimentation is not successful and the parties decide not to continue the contractual relationship.

What precautions should be taken in testing the format through pilotage?

If a franchisor decides to entrust the testing of its business format to a third party through a pilotage contract, it is important to take legal precautions to protect intellectual property, distinctive signs and know-how during the testing phase.

The pilotage contract must regulate the mutual obligations of the parties, providing for obligations of confidentiality and non-disclosure of the contents of know-how acquired during experimentation by the pilot. In addition, the franchisor must grant the pilot the right to use its distinctive signs, regulating the manner and quality standards of use.

The pilotage contract is atypical and not governed by the Civil Code or special laws, but the parties may enter into non-statutory contracts as long as they pursue interests worthy of protection under the legal system. Eventually, the natural outcome of the pilotage contract is the signing of a franchise contract between the same parties, of a longer duration and with economic obligations in the hands of the franchisee, but it is possible that the piloting is unsuccessful and the parties decide not to continue the contractual relationship.

What are the legal consequences if the "pilot" violates the confidentiality of know-how?

Violation of the confidentiality obligation imposed on the “pilot” regarding the contents of the know-how acquired during the testing of the format in the pilot store may result in legal consequences for the franchisor.

The franchisor can legally protect itself by preventing such violations by entering into a pilotage contract that regulates the confidentiality obligations imposed on the “pilot” regarding the contents of the know-how acquired during the testing of the format in the pilot store.

In the event of a violation, the franchisor can claim compensation for any greater damage caused, where it has been contractually provided for.

However, the loss of know-how could represent such serious damage as to be almost irreversible. It is essential to prepare a policy for the protection of confidential know-how that is fit for purpose and effective.

What are the main differences between pilotage and franchising?

The differences between the franchise contract and the pilotage contract can be summarized in the following points:

• Experimentation: The pilotage contract is characterized by the absence of prior experimentation of the business format, while such experimentation is a prerequisite in the franchise contract. In pilotage, the would-be franchisor carries out the experimentation required by law before launching a franchise network.
• Entrepreneurial risk: The contractor in the pilotage contract assumes a greater entrepreneurial risk than the franchisee in a franchise network because the proposed format has not yet been field tested. The success of the format will be evaluated at the end of testing and any adjustments, based on financial data.
• Economic burdens: Due to the increased entrepreneurial risk in pilotage, economic burdens are usually lower than in franchising. In the franchise contract, the franchisor often requires an entry fee and periodic royalties from the franchisee.
• Contract term: The term of the franchise contract, by law, cannot be less than three years, while that of the pilotage contract is freely determined by the contracting parties, generally not less than one year.
• Outcome of the contract: The ultimate goal of the pilotage contract is to enter into a franchise contract between the same parties, with a longer duration and economic obligations borne by the franchisee. However, if the piloting is unsuccessful, the parties may decide not to continue the contractual relationship.
• Cessation of use of distinctive signs and confidentiality: In case of failure of the pilotage contract, the pilot is required to cease using the franchisor’s distinctive signs. However, maintaining confidentiality on the know-how after the termination of the contract must necessarily be provided for in the contract. Violation of these obligations could result in a penalty being imposed on the pilot, if any, in addition to compensation for any greater damages to the franchisor.
• Non-competition agreement: The regulation of any post-contractual non-competition agreement is subject to agreement between the contracting parties. It could prove very useful in preventing the pilot from becoming a fearsome competitor by exploiting what has been learned.