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The Regulation of International Franchising

Mark Abell

Despite the best efforts of organisations such as Unidroit, there is no generally accepted way of regulating franchising internationally. Twenty-nine different nations have franchise-specific laws, and the lack of any common approach creates real challenges for companies seeking to franchise their businesses internationally, and for their legal advisors. In addition, general commercial law can have a substantial impact on franchising.

Mark Abell

Mark Abell

Franchise Specific Laws

There are three different types of franchise regulation in these other jurisdictions, each with a distinct purpose and characteristics. These are: anti-trust regulations; foreign trade and investment regulations; and pure franchise regulations.

National franchise laws can be placed into these categories by reference not only to their substantive content, but also their origins.

Anti-trust regulations are aimed at preventing restraint of trade and generally focus upon classical competition law issues such as tying, full line forcing, retail price maintenance, exclusivity and so on. These are found in Japan and Venezuela. The EU has this type of regulation in the form of article 101 of the Treaty on the Functioning of the European Union and the Vertical Restraints Block Exemption.

Foreign trade and investment regulations are typical of developing markets with either a protectionist economic policy, or distinct political aims, such as the distribution of wealth. These are found in China, Indonesia, Kazakhstan, Korea, Malaysia, Moldova, Russia, Ukraine, Belarus, Barbados and Vietnam. Typically, they seek to regulate the entry into their domestic market of foreign business systems that escape the restraints placed upon direct foreign investment. Clearly, the EU would not want to adopt this type of law, as it is contrary to its general approach to free trade.

Pure franchise regulations focus upon areas of potential abuse in franchising, namely pre-contractual disclosure and the in-term relationship between the franchisor and its franchisees. These are generally symptomatic of more developed markets, and are found in the US, Australia, Canada, Brazil, Taiwan, Georgia and Mexico. They have much in common with the franchise laws of France, Spain, Italy, Belgium and Sweden. The laws of the US and Australia are of particular relevance. Some of these pure franchise regulations have their roots in consumer protection law.

Some countries have adopted laws that are hybrid in form, in that they are best placed in one category but also show characteristics of another; two examples are Malaysia and China. Both have foreign trade and investment franchise laws with a strong element of pure franchise regulation in them. Croatia defines franchise agreements but does not regulate them. The South African Consumer Protection Act 2009, which will come into force in 2010, is a hybrid between anti-trust regulations (it prevents or limits full-line forcing) and pure franchise regulations (focusing on pre-contractual disclosure). All eight of the EU member state franchise laws are pure franchise regulations.

In addition to the 21 countries outside of the EU that have franchise specific laws, Tajikistan is also currently contemplating enacting one. The New Zealand government has recently rejected the need for a franchise specific law. The majority of these franchise regulations can be best categorised as foreign trade and investment regulations. They are more concerned with regulating foreign investment and trade than ensuring that potential franchise abuses are prevented or at least reduced. A number of themes can be identified:

Piloting concepts

This is an issue that was discussed at some length in the Italian parliament when it was considering its franchise law. China and Vietnam came to the same conclusion as the Italian legislature, prohibiting franchising by a franchisor that has not piloted the operation. In China, franchisors are required to establish and operate two company-owned units for more than one year before granting franchises to third parties. In the earlier regulation, the pilot had to be in China, but the current law removed this requirement, mirroring the debate in Italy as to where the pilot operation has to be.

In Vietnam, pursuant to article 2 of the Commercial Law of 2001, which came into force on 1 January 2006, a franchisor must be a lawfully established enterprise either in Vietnam or in a foreign country and a franchise can only be granted to a franchisee who has a Vietnamese business licence. In addition, the franchise system must have been in operation for at least a year before a franchise can be granted. In the case of a sub-franchise granted to a Vietnamese master franchisee, the Vietnamese master franchisee must have operated the franchise business for at least a year before it can grant sub-franchises to unit franchisees.

Disclosure

All of the countries that require pre-contractual disclosure take a similar approach to the issue, although the details tend to vary a little. The influence of the American Uniform Franchise Disclosure Document (UFDD) is generally evident.

Timing of disclosure

The time at which disclosure must be given tends to range from between 10 and 20 days before signing, although this does vary in some jurisdictions. In Brazil the offering circular must be delivered to a prospective franchisee at least 10 days prior to the execution of a franchise agreement. Malaysia and Taiwan opt for the same period, while Korea requires only five days and other countries require longer. The Canadian states all require 14 days, Vietnam requires 15 days, China, 20 days (South Africa is proposing the same time) and Mexico, a rather excessive 30 days. Japan and Indonesia lay down no minimum period of time. The trigger from which the due date for disclosure is calculated is generally the same. In Brazil, China, Mexico, Malaysia, Taiwan and Vietnam, it is the execution of the franchise agreement. In the Canadian states and Korea, it is the earlier of the execution of the franchise agreement and the payment of any consideration.

Cooling-off period

Some jurisdictions take the view that in addition to the period between service of the disclosure document and closing, a further period during which the franchisee can withdraw is appropriate. Malaysia, Mexico and Taiwan require a cooling-off period after the execution of the franchise agreement during which the franchisee can withdraw from the relationship without penalty. These range from a 30-day cooling-off period in Mexico to seven days in Malaysia, and five days in Taiwan.

Contents

All jurisdictions take a similar approach to the information that needs to be disclosed, namely, details of the franchisor and the commercial terms and details of the agreements. However, the details tend to vary in a number of aspects particularly with regards to the terms of the franchise agreement, the identity and experience of the franchisor and the franchise network. The information to be disclosed by the different jurisdictions is, in general terms, very similar:

• basic details of the franchisor;

• description of the franchise and of the market;

• financial information about the franchisor;

• details of the franchise network

• litigation details;

• initial fee, initial investment and continuing fees;

• earning claims;

• restriction on the franchisee;

• descriptions of the obligations that the parties owe towards one another;

• purchase ties and personal involvement of franchisee;

• term, termination, renewal;

• details about franchisors’ IP rights; and

• details of financing arrangements offered by the franchisor

Exclusivity

The consequences of failure to comply with the disclosure requirements vary somewhat. It generally entitles the franchisee to walk away from the agreement provided it acts within a reasonable period of entering into the agreement. Some jurisdictions also impose fines for failure to comply. Certain jurisdictions enable the government to take the initiative although most simply grant the right to the franchisee.

Minimum term

Only two jurisdictions impose a minimum term for the franchise agreement. Both take on a foreign trade investment approach to the regulation of franchising. In Malaysia the franchise agreement must be for a minimum period of five years. In Indonesia, in contrast to the provision in the former decree, which stated that a franchise agreement had be for a minimum period of five years, this period is now extended for Master Franchise Agreements to at least 10 years. Interestingly, the franchise business certificate which the registrant receives is the Surat Tanda Pendaftaran Usaha Waralaba (STPUW), which is only valid for five years, although it can be extended if the franchise agreement is still valid.

A general duty of good faith

The Canadian provinces, China, Korea and Malaysia impose a duty of good faith on both the franchisor and the franchisee, which impacts upon what the franchisor is permitted to do during the relationship. In Canada all franchise agreements impose upon the parties a duty of fair dealing in its performance and enforcement.

In Korea, both parties to a franchise transaction must exercise good faith in the performance of their duties and enumerates several specific franchisor and franchisee duties. In Malaysia both the franchisor and the franchisee are under a duty of good faith to each other and must act in an honest and lawful manner and endeavour to pursue the best franchise business practice of the time and place .

Registration requirements

Some jurisdictions require the franchisor to register relevant details and the documentation with a government agency. In developing markets this seems to be to enable the government to monitor franchisors doing business in the market while in more developed economies (such as the US and Spain) it is to ensure transparency and maintain a certain level of quality.

Compulsory contents of franchise agreements

A number of countries insist that a franchise agreement should contain certain standard clauses. There is a wide variety of approaches and no general trend or pattern can be identified other than a general desire for comprehensiveness.

Dispute resolution

Some jurisdictions, such as Italy, impose certain requirements concerning dispute resolution.

Non-Franchise Specific Legislation

Franchising is, of course, also regulated by general commercial law. The laws that are of most relevance tend to be good faith, anti-trust, misrepresentation, breach of contract, employment law, commercial agency law, consumer law and unfair competition law. In many jurisdictions franchisors find themselves hard done by under some of these laws, particularly employment, agency and consumer laws. They can impose heavy and inappropriate burdens on them with regards to disclosure obligations and termination rights. Lawyers therefore, need to be very careful when advising franchisors on entering new markets, even if they do not have franchise laws.

* * *

To advise clients appropriately on international franchising, lawyers need to have a good knowledge of both the various franchise regulations that exist and the way that general commercial law impacts upon them. It is a complex area of law, which requires expert advice.

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