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Trends in the Franchise Legal Market: 2016

Despite economic uncertainty around the world the franchise market has continued to grow, remaining robust in developed markets and making inroads in the developing world. Furthermore, with increasing internationalisation of brands, markets that in the last decade might have seemed unlikely spots for franchisors to set up shop have since seen a flowering of brands. But the market is not without its problems, several of which bring into question the fundamentals of franchise law and the franchisor-franchisee relationship. Despite the industry’s strong response to a turbulent market, franchise law is currently facing something of a crucible.

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The Growth of the International Franchise

In 2016, the franchise sector in the US is expected to grow for the sixth consecutive year despite the broader economy contracting, according to the International Franchise Association (IFA). Output in US dollars is expected to reach $934.6 billion, an increase of 1.7 per cent on last year, with quick-service restaurants accounting for $248 billion of that – no surprise with the continued success of food franchises like Dunkin’ Donuts, Taco Bell and Popeyes in and outside the US. There are also plenty of brands that can attest to the increasingly international outlook of erstwhile national concerns. In 2015 Dunkin’ Donuts arrived in Austria, Brazil, Denmark, Georgia, Germany, Iceland, Mexico and Sweden, while Popeyes recently saw a rollout across Canada. US hotel chain franchises are also demonstrating a move into developing markets, with Marriott having entered into India and China since the beginning of the current decade, and Hampton by Hilton opening its first hotel in China earlier this year.

In the UK, the economic contribution of the franchise industry to the UK economy currently stands at £15.1 billion, a 10 per cent increase on the previous two years. While we cannot be sure what kind of effect Brexit and continued European economic uncertainty will have on the market, recent entries into the UK market from US and global brands suggest that things are not about to slow down. This is corroborated by the rising popularity of conversion franchises, allowing independent retailers to convert their business to a well-known franchise that can provide them with greater commercial opportunities and enhanced stability.

Private equity companies are increasingly opting to invest in franchises due to their reputation as a safer bet, thanks to the umbrella of a well-known brand and their ability to better defy the current economic malaise. Prominent private equity companies that have chosen to invest in franchises include Sentinel Capital, Levine Leichtman Capital Partners and Apollo Global Management; Roark Capital, meanwhile, owns 31 franchise brands. The franchise industry continues to expand: units are moving beyond their traditional status as a stand-alone part of a greater whole and emerging as a serious business prospect for companies looking to grow their reach to new and developing markets.

Australia has updated its franchising laws in order to keep up with the industry’s rapid expansion. It introduced a new Franchising Code of Conduct on 1 January 2015, which included the obligation of good faith in dealings and financial penalties for serious breaches of the code, including an emphasis on disclosure and transparency. This was partly to address allegations of underpayment of employees by franchise networks, an issue that has also been felt in the US and Canada via the “joint-employment” debate, and in other places where franchise law remains vague or less explicit. 

As always, the USA remains the exemplar when it comes to detailed and robust franchise law. This is no surprise when you consider that of Franchise 500’s “Top 10 Franchises of 2016”, nine are US-founded – including Subway, the world’s largest fast-food chain, and Anytime Fitness, the world’s fastest-growing fitness chain.

Franchisor-Franchisee Relationship and Good Faith

While the growth in franchising has been robust compared to that of the global economy, issues surrounding the nature of franchising and franchising law have continually been challenged over the past year. The “joint employer” debate rumbles on in the US in particular, as well as in Canada and Australia. Sparked in part by David Weil’s book The Fissured Workplace, which argues that franchising has led to wage depression, the debate has formed the backbone of a push by the National Labor Relations Board (NLRB) for greater rights for workers in franchises.

An atypically sluggish economy in the US has resulted in more bullish labour unions, which have only served to further escalate the issue, especially given that the McDonald’s joint-employer case is currently before the courts in New York. In California, a new federal ruling enacted by the California Legislature and championed by the NLRB has declared that joint employment can be held by both the franchisee and the franchisor, making the franchisor newly liable for bad working practices continued by the franchisee. This new standard was stated during the Browning-Ferris Industries (BFI) decision during which, according to a memorandum, “the Board relied on indirect and direct control that BFI possessed over essential terms and conditions of employment […] as well as BFI’s reserved authority to control such terms and conditions,” one of the central tenets of the Board’s new definition.
However, with 9,695 new franchises opening in North America between July 2014 and July 2015 (an increase of more than 30 per cent from the previous year), it is clear that new legal challenges are doing nothing to dent franchising’s reputation as a sturdy business model. Some practitioners argue that, rather, this is a dispute that has always existed, but has simply been less visible until now. The question of who legally employs franchise workers – the franchisee or the franchisor – has always been present, but an answer was never sought. But the growth of the franchise industry means it now encompasses some 9 million US employees – and with a struggling economy highlighting wealth inequality and poor labour rights, it seems that the “joint employer” debate will need to be resolved sooner or later.

Meanwhile in English contract law the principle of good faith, which has historically been nothing stronger than an implication and therefore has often meant franchising is tilted towards the franchisor in the UK, is now being challenged. After the Yam Seng case, where the claimant successfully argued that its contract for the distribution of aftershave to be sold at duty-free outlets in Asia contained an obligation – however implicit – to act in good faith, the debate as to when and where this obligation in English contract law must be acted upon has not gone away. Such a change of precedent would bring English contract law closer to that of the US, France and Germany, where civil law is clearer and codifies an obligation of fair dealing. With the Yam Seng case facing no appeal, English franchising may soon see a change in what Professor McKendrick called the "traditional English hostility" to the nature of good faith in English contract law.

Impact on the Legal Market

The number of lawyers in our Franchise guide has grown for the third consecutive year, with many firms in and outside the US looking to take advantage of franchising as a growth industry. Increasingly franchise lawyers need to have cross-jurisdictional expertise if they want to be top in their field, with additional languages highly sought-after. What is more, if franchising accounts for more of western economies’ GDP, and if the service sector is bigger than it has ever been before, some practitioners argue that margins have never been tighter – naturally making joint ventures a more appetising prospect. Lawyers know they have to be ever ready to provide detailed information on how franchisors facing litigation or the prospect of losing revenue can retain as much profit and wealth as possible, even for clients who are heading multimillion-dollar franchise projects.

Because of such tight margins, franchises have also been increasingly aware of the growth of the luxury retail franchise market, with lawyers quickly taking note of the legal hurdles involved in setting up a franchise there. With this market expected to double in size to £12.2 billion by 2017, franchises are making efforts to break into it and take advantage of its robust growth, which is less affected by economic sluggishness and does not depend on the purchasing power of the average shopper.

Another area in which law firms have been busy is the pursuit of a cohesive model for an increasingly international franchise industry. In 2014, Netherlands-based law firm Kennedy Van der Laan unveiled its Customized Alliance programme. A more localised, specialised, but fully integrated system, the project was conceived to allow companies to be able to use the best local law firms with an acute knowledge of their jurisdictions – perfect for franchisors looking for premier practitioners in multiple locations. As a demonstration of the confidence in which the industry holds such a scheme, their first client was multinational sports brand Nike. 

Fundamentally, globalisation is a fact of business in the modern world; but the franchise industry may be said to have embraced this reality with open arms, allowing franchises to reach new ground and generate ever greater sums of revenue. With such a situation, it is inevitable that franchise law will come under greater scrutiny across the world. Lawyers must be ready to advise their clients on the minutiae of international franchising in an era where it is no longer the preserve of the US, or even the western world.

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W11 1QQ, UK