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CAPÍTULO 1

Business Networks as a Legal Explanatory Framework¹

JUAN IGNACIO RUIZ PERIS

I. INTRODUCTION

Networks seem to be a natural element of organized trade.² Business networks as an economic and sociologic concept has been developed in last decades. The attention from the legal scholarship over this subject increased in the recent years in Europe.³ In fact recent works have tended to introduce that notion in the more recent pre-legislative works in European contracts Law⁴. The goal of this paper is to ask if Business networks are a different legal framework than contract and companies and if this legal framework is appropriate to solve problems that company law and contract law are unable to solve in an efficient way.

To do that I will proceed listing the main problems that may be explained and solved in a better way using the business network as a legal concept and in particular as a legal framework trying to propose some ways of solution following the network logic. I will discuss also some important concepts included in the business network legal problematic as interest or power relationship between members.

As a global study of the numerous relevant problems included in my delimitation would be impossible in these few pages I have selected some of them classifying them in conceptual problems as the role and meaning of interdependence, direction — members problems as ius variandi, horizontal members problems as encroachment, network — third problems as consumers actions against network, and network and public interest problems, as ancillary restraint doctrine.

II. CONCEPTUAL REGULATORY PROBLEMS

a. The need of a legal regulation of business networks as a tertium genus between contract and association.

As European and state members Law have not established a legal concept of business network the question of the delimitation of the object of our study remains in the constructive discussion of legal scholarship.

Business networks are organized from the legal perspective in a contractual or organizational form or in a mixed form. In all of them there is a direction — with own legal personality or not — but not a hierarchy and the relationships between members are not market relationships⁵. Contractual business networks are built over multilateral not associative contracts as the most part of strategic alliances or bilateral contracts as franchise⁶ or master franchise⁷, called in the most of the cases networks contracts. Only Italy among the European countries has introduced the concept of network contract in its law⁸ for contracts with the goal to increase the innovative capability and the competitiveness of the parties.

Networks can also be organized as an association or organization with or without own legal personality. In these cases joint ventures with corporate form, cooperatives and second degree cooperatives, groups of economic interest, consortiums, and horizontal groups are the more important cases.

Corporation is not a good framework for a network relationship. In the case of corporate joint ventures it certainly provides the parties with a veto right but the consequence is the increased risk of inoperability of the common business enterprise. The tendency of corporate joint ventures in face of internal difficulties is usually to be blocked and finally their dissolution. In consequence corporate joint ventures are not an efficient framework for the cooperation or the coordination of the parties’ entrepreneurial efforts.

Corporate model itself presents important difficulties to be a comfortable framework to improve the cooperation and solve easily some important problems of the business cooperation which are typical in network relationships.

Gains in business networks are determined ex post in response to the activity undertaken by its members but at corporate level a fixed allocation is predetermined in consideration of the owned share capital instead of the performance realized⁹.

The business decisions of network members — whose performance determines the network activity — are autonomous and may be coordinated but at corporate level decisions are take in collegial form by majority. Also in corporate joint ventures business decisions are taken by members in an autonomous form, the corporate board of directors being only a formal structure to execute the individual business decisions of the members or just a forum of discussion.

Company members do not have to operate a business and, if they do it, they do not need any connection between them. On the contrary the members of the network are all entrepreneurs and perform linked economic activities parallel or complementary.

The inadequacy of the corporate structure is yet more evident in the case of contractual networks — that shall not be conceived in our opinion as associations — and in particular in relationship with entry and exclusion of the networks members.

In the most of contractual networks as the distribution networks or in outsourcing networks, where the network has a direction personified in one of the members — for example a franchisor or the car company —, admission or exclusion of a network member depends, unlike what happens in the corporate field, only from the decision of the network’s head according to the principle of private autonomy typical of bilateral exchange agreements.

In fact, that principle allows the head of the network to accept or reject as a member of the network — with some limitations at the case of “open networks” as cooperatives or selective distribution systems — the other members or potential members.

At least the application of the company rules to business network involves the impossibility of giving adequate solutions to specific network problems.

Other organizational structures such as cooperatives, consortiums or EIG are more adequate. All of them are designed as coordination structures but they imply the existence of a common interest of the parties and, as discussed in the next section, in networks there is a dialectic relationship between a parallel interest of the parties and a divergent interest of them without a common interest.

b. The question of the network interest

The exchange bilateral contracts are characterized by the confrontation of the legitimate interests of the parties — not only in cases win/loss but also in cases win/win —. In these cases each party defends its own legitimate private interest and shall not pay attention to the other party interests —with some increasing exceptions in the case of long term, intuitu personae, trust or fiduciary contracts —. Only in the case of collaboration agreements — typical network contracts — we recognize the existence of a parallel interest shared by the parties and the existence of a shared interest with consequences both in the interpretation and integration of the contract and in the parties’ rights and duties. In the case of companies and associations there are always a common interest and private divergent interests of the members or stakeholders which are external, irrelevant in relation with the definition of common interest. In case of confrontation between common interest and shareholder divergent interest the board of directors of the company shall always follow the first.

In EIG, consortiums, and horizontal groups there are a crescent weakening of common interest and a progressive recognition of the legitimacy of parties’ private interest. In these cases the confrontation between the common interest and the members' divergent interest do not always imply that the second shall submit to the first.

Networks find themselves between contracts and companies — also when they are expressed in a contractual or organizational form — and we recognize in them the existence of a dialectical relationship between two types of interests held by their members. The interest to create value as shared interest is individual for each member or contractual party — each member or party has the same interest in parallel with the others — as individual is the divergent interest to the allocation or sharing of created value.

Both interests are expressed in the business activity of the organization and in the business activity of the members of the organization — network expressed in an organization — or in the business activity of contractual parties — contractual network— and both are legitimate in networks¹⁰. If it is easy to recognize the shared interest as a network interest we must also recognize that the divergent interest is also a network interest — just as our prior logic rejects the possibility of a particle being at the same time in two places following the quantum physics theory —.

As in networks the amount of value obtained for each member depends of the exercise of its own business activity — and is not fixed in relative terms as in companies — the marginal oscillation between the minimal and the maximum gain possible for each member is limited without the acquisition of new quotes of the market through the efficiency and competition or in the case through an arbitrary decision of network head.

That makes that nor company regulation nor exchange contracts regulation may be recognized as an adequate framework to deal with the relationship between the two kinds of network interest. In the case of company or organization regulation this is so because these regulations impose the prevalence of common interest in opposition to private divergent interest of parties. In the case of exchange contracts regulation because this imposes the prevalence of the parties' private interests.

The harmonization of interests is in consequence an important goal for a network regulation.

An efficient network regulation requires a legal framework that legitimizes both interests — the shared interest as well as the divergent — and shall explain with detail the parties’ or members’ relationships and the cases of prevalence of the first or the second interests when both are in conflict.

c. Hierarchy and market from the legal point of view

Only some words about this central question. Business networks imply cooperation, coordination and competition between members. There is no hierarchy but limited central direction — with different degrees of extension — and the position of the members in face of the direction may vary from the complete independent coordination to the dependence.

There is an inverse proportional relationship between market relationships between members or parties on the one hand, and the extension of central direction and the dependence of the members on the other hand.

A legal business network regulation must take account of this typical network miscegenation and of the dialectic relationship between dependence versus independence and coordination versus market.

d. Characteristics of business networks

Another key issue in the field of networks is the feature whose attendance allows us to recognize the existence of a business network.

Legal scholarship has identified the interdependence and stability — of the network, not the special relationship linking the members with her — as the characteristic of business networks. Complementary activities of the members or parties may be seen also as an essential element.

In the most of the cases these networks imply a division of the functions of production and distribution or others included in the value production chain such as research and development.

It is also characteristic that its members may sustain relations of cooperation and competition between them¹¹. This statement has important consequences in relation with regarding the question of networks and public interest and in particular in relation with competition issues.

Other relevant feature is the existence of a connection with the market shared by the members or parties — brand, technology, products —.

III. DIRECTION - MEMBERS' PROBLEMS AND HORIZONTAL MEMBERS PROBLEMS

In every network there is a direction centre — network directory — that may reside in the network’s head company, may be a manufacturer — outsourcing — or a provider of services — franchising or credit cards —.

The network’s direction also may reside in the entity that structure the network — Joint ventures, cooperatives, consortium or EIG —, or in a stable committee, personified or not, representative of all or some members of the network.

a. Direction power, control and authorisation

Network’s directory has the power to issue instructions and set the general framework for the development of the activity, to monitoring the implementation of these and in general the activity of the members and to allow the members' business decisions in the cases fixed by contract or by statute.

The foundation of directive power in contractual networks lies in bilateral contracts. These contracts generally parallel, adhesive and with a wide homogeneity, limit the commercial autonomy of the member.

On the one hand they involve the setting — usually via contractual appendices — of essential elements of the member company’s business policy such as the suppliers identity, composition and level of minimum stocks, methods of business organization, tradedress, distinctive signs that identify the products or services and even the store of the member — franchising —, marketing formulas and commercial know-how, among others.

In this way the freedom of network members is limited to the framework specified by the contract, and this transfers the decisions on such questions to the network head.

The contracts also provide supervisory powers, to define a greater or lesser degree the organization of the company’s network member, to allow the head to exercise the of ius variandi — to which we will refer in the over next section —, to instruct network members and to found the network head’s power of moderation among networks members by reference to internal organizational documents of the network.

In the case of organizational or associative networks the power of direction founds in company regulations — cooperatives — or results from consensus — second-degree cooperatives, horizontal groups, consortiums, or EIG, even when statutes establish majority decision, since the members possess extremely easy ways to exercise the right of separation.

The network directory provides the network’s business strategy and controls the performance of its members based on the power under contracts or statutes that govern the relationship that links each one with the others or with the head of network.

It also coordinates the activities of its members on achieving the targets — expression of shared interest — and mediates or arbitrates competitive struggles among its members — expression of divergent interest —.

In any case, the preservation of effective competition in the market stands as a limit to power steering, as we will discuss in the last section of this paper.

b. Network’s governance

The exercise of the directive power in networks requires that is shall be done for the benefit of the network, as in the case of corporations and corporate groups, in which it should be exercised for the benefit of society or group.

Unlike the case of corporate common interest, the interest of the network includes not only the parallel interest shared by its members but also their divergent interests. The attainment of the shared interest must respect their contradictory divergent interests.

In this sense the network resembles democratic states which are characterized not only by taking majority decisions but by respecting minorities taking into account their interests.

In this sense the exercise of network directive power by the directory shall take into account of the divergent interest of the members and shall not hurt them if there is not need. Just as in antitrust logic we postulate that a directive action that hurts the divergent interest of a member shall be covered by the shared interest and justified as inevitable to obtain a network goal. This implies that it must be clear that no other less harmful alternative for the member may be found.

An efficient exercise of directive power requires appropriate network governance.

This involves the recognition of the existence of special duties of care and loyalty that affect the network directory in the exercise of directive power and the establishment of a framework for dialogue within the network, enabling efficient pursuit and not conflictual power steering.

Appropriate definition of network governance requires the identification of the duties of network head, the definition of the framework for dialogue in the network and the establishment of an internal frame of moderation and internal resolution of disputes through mediation and arbitration.

The duties of head of network includes a special duty to act in good faith that is based on the stability and duration — real or potential-of the network connection and on the intuitus personae character of network contracts — intuitus personae that includes the intuitus instrumenti that is not an opposed alternative to the former, as it is generally accepted by the legal scholarship, but an evolution of it —.

The duty of good faith may involve a special set of duties: the duties of information, the duty of confidentiality, duties of care, duty of deliberation of important decisions for the network or a duty to give a preferential option to the network members.

The duties of loyalty that affect the network head — that is to act in accordance with the interests of the network to create value and no unnecessary damage to the divergent interests of its members — are based on the collaborative nature of contractual agreements or the associative relationship in the case of networks of this nature and in any case in the existing cooperation between the parties or members of the network.

The duty of loyalty means acting in the best interests shared by network members without unduly hurting the divergent interests of its members. The act that fulfils these conditions is often described as an act in “network interest”.

Some duties are deduced from this, such as the duty of transparency regarding the interests of the network head in the enterprises providing goods or services to the network, the duty to refrain from using the network resources for business purposes, not shared with the members of the network, the prohibition to replace an efficient network member in order to appropriate their business, or the prohibition of the encroachment and tortious interference which in some legal systems as the Spanish one may be also grounded in the duty to act in good faith and fairly.

A network regulation or auto-regulation shall provide rules that ensure the respect of these duties.

A network legal framework may rule in a more detailed way — as it is done in internal documents of some networks — the limits of the ius variandi and when the opinion of either the head of network or the member shall prevail.

An internal framework of the network for a non-confrontational and efficient exercise of directive power steering also requires the dialogue with associations of members, the creation of advisory or co-makers councils and the co-development of the internal network rules of operation.

Network governance also implies the organization of an internal dispute resolution system through mediation and arbitration. These mediators or arbitrators shall help to find solutions or give solutions to the problems between the members but also between the direction or network head and the members. In order to be efficient and in accordance with the good faith principle, a truly independence of internal mediators or arbitrators from the network direction is need. This independence may be obtained by creating a wide list of eligible mediators or arbitrators and by limiting the number of interventions of each one of them. If arbitrators or mediators are always the same and are paid by the head of network it is difficult to believe that they will act independently.

c. Ius variandi

The change of the activity conditions implies in general the conformity of all the members in organizational networks, with the exception of cooperatives and second degree cooperatives, companies, and consortiums or EIG’s where the statutes introduce the majority principle.

The decision to submit some or all decisions about the change of conditions to the majority — in company directory or assembly — concerns all members.

In the case of contractual networks the change of conditions may be attributed by contract to one of the parties — the network head for example in parallel contracts' networks as franchise —. In these cases the ius variandi concerns only one of the network members, limited by abuse of right doctrine — not global accepted — an objective novatio doctrine.

All these systems of control — consensus or majority, and unilateral attribution of the ius variandi with the limits of abuse of right or objective novatio doctrine are inadequate to regulate this question in networks, as the experience teach us.

d. Encroachment, virtual encroachment and tortius interference

The relationship of network members with customers is a typical source of tensions between them and, in some cases, with the network head. Network direction shall coordinate its members without infringing competition rules¹². Encroachment and tortius interference are sometimes used by the network head to convert shared customers in own exclusive ones. In the last years internet development has also created problems in networks regarding the internal relationships between members and between members and network head, if any, in relation with customers — virtual encroachment —.