Who’s Who Legal brings together Martine de Koning at Kennedy Van der Laan, Olivia Gast at Gast Avocats, Peter Snell at Gowling WLG, Jonathan Solish at Bryan Cave Leighton Paisner and Chris Wormald at Chris Wormald Associates to discuss issues facing franchise lawyers and their clients in the industry today.
Martine de Koning: In February 2016, the Dutch Franchise Code has been published, which is a self-regulatory code. A draft bill was published to give the code a statutory basis in the form of “comply or explain”. This bill was heavily criticised by franchisors and academia. The Dutch coalition agreement – published on 10 October 2017 – states that there will be additional legislation to strengthen the position of franchisees in the pre-competitive phase. On 8 February 2018 the government confirmed that the Dutch Franchise Code will not be given a statutory basis but that it shall work on an Order in Council regarding rules for franchise in the “pre-competitive phase”. On 23 May 2018, the Dutch state secretary for economic affairs and climate policy, Mona Keijzer, announced in a letter to Parliament that a new draft bill on franchise would be published this autumn. This follows up on the promises of the new government made in the coalition agreement. She affirmed in her letter to Parliament that the Dutch Franchise Code will not be given a statutory basis. With this, Ms Keijzer buried the legislative proposal made by the former minister of economic affairs, Henk Kamp, and effectively rendered self-regulation toothless. Ms Keijzer now plans to launch a new legislative proposal which will provide a framework for four areas in the relation between franchisors and franchisees:
It is still unclear if an Order in Council will be part of this legislative proposal. The draft bill is expected to be published for consultation in autumn 2018.
There are a few other general civil, competition and consumer law legislative developments that will impact the franchise sector in Europe, and the Netherlands. These developments stemming from the EU’s digital single market initiative; the Geo-blocking Regulation that entered into force on 22 March 2018; the reform of various e-commerce and consumer (and SME) protection laws; the implementation, in all member states, of the Know-how Directive (the Netherlands has adopted a bill); the upcoming review and potential reform of the Vertical Block Exemption Regulation and Guidelines; the regulation on fairness and transparency in online platform trading and the impact of GDPR on franchise systems.
Olivia Gast: The most important regulatory development is the EU’s GDPR coming into effect, which nobody can have missed as there’s already been thousands of pages written about it. All companies know that they need to re-evaluate and rewrite all their data processes. For France only, the biggest legislative franchise news is a brand new law (29 March 2018, item 7) abrogating a previous labour-oriented, anti-franchise law (item 64), the El Khomri law (8 August 2016). This law made no legal sense, and confusingly classed franchisors and franchisees as one big employer when they combined over 300 employees, which made it possible for employees to come together in social dialogue as part of union. Thankfully it was in effect for less than a year (from 4 May 2017), and to our knowledge it never applied anyway.
Peter Snell: Franchising in Canada continues to evolve. Franchise laws in Canada are adopted province by province, with British Columbia being the most recent to adopt franchise disclosure laws (in February 2017). Franchisors continue to adapt to and apply the laws in the six disclosure provinces: Alberta, British Columbia, Manitoba, Ontario, New Brunswick and Prince Edward Island. There has been discussion at the Uniform Law Conference of Canada to develop a new model of Franchises Act and to adopt regulations that promote greater uniformity among the various provincial jurisdictions.
As for changes affecting the legislative framework in Canada, franchisors are still adjusting to changes made to franchise law in Ontario, which updated its franchise legislation, the Arthur Wishart (AWA) Act (Franchise Disclosure), in November 2017, under omnibus legislation called the Cutting Unnecessary Red Tape (CURT) Act, 2017. The amendments to the AWA bring Ontario more in line with the laws in the other provinces. Amendments included the following:
All of these are minor housekeeping changes, apart from the last – this change is important because it will likely increase the number of businesses that fall under the legislation.
The CURT Act also introduces two key changes to the circumstances under which a franchisor is required to deliver a disclosure document to a franchisee.
The first of these relates to the previous situation that, when a franchisor entered into discussions with a potential franchisee and signed a confidentiality agreement or non-disclosure agreement, they triggered disclosure obligations in Ontario. Now, franchisors and franchisees can use non-disclosure agreements to allow the franchisor to release proprietary information without concerns that the information will be unprotected. This allows more information to flow from franchisor to potential franchisee before the disclosure obligations are triggered.
The second change is that franchisors are now able to accept refundable deposits without requiring a disclosure document. It’s still unclear what the maximum amount for this deposit is for Ontario; however, British Columbia’s franchise legislation gives guidance that the prescribed amount for which the disclosure obligation doesn’t take effect, is any amount until the deposit exceeds 20 per cent of the initial franchise fee. The deposit must be refundable without any deductions, and be given under an agreement that in no way binds the prospective franchisee to enter into a franchise agreement.
There are also changes contemplated by the CURT Act that are not yet in force which relate to disclosure exemptions for officers and directors, and disclosure exemptions for de minimis investments and large investments.
Jonathan Solish: Historically, a trademark was the maker’s mark, ensuring the public that goods or services complied with the standard of the identified brand. Early attempts to license a trademark were seen as attempts to deceive the public by making it seem that a well-known brand was the actual source of the product, when, in fact, someone else had provided it. For many years, trademark licensing was illegal and could lead to abandonment of the mark and the loss of the right to claim licensing royalties.
The modern model of franchise relationships arose from a 1946 US trademark act, the Lanham Act, which allowed trademark owners to license others to use trademarks as long as the licensor exerted sufficient control over a licensee to preserve the uniform quality of the goods and services associated with its marks. Franchising – at its core a trademark licence – has grown exponentially since then.
For years, courts have generally concluded that licensors could safely impose brand standards on licensees without creating an agency or employment relationship. In recent years, however, the Department of Labor wage-and-hour division and the general counsel of the National Labor Relations Board have asserted that workers whose work is “controlled by” a licensors’ brand standard are the licensors’ employees. These initial assaults on the franchise model have foundered in the wake of the change in administrations in the US government.
Some courts, however, have not hesitated to pick up the charge. In 2018, the California Supreme Court chose to embrace a new standard to apply in identifying employment relationships. In the Dynamex decision, the court adopted the “ABC test,” which holds that a worker doing work that is in the “usual course” of the business of the “hiring entity” is an employee.
If the employee of a franchised pizza store filed a lawsuit claiming that he was the employee of the franchisor, he would apparently prevail if he could show that making pizzas was within the “usual course” of the franchisor’s business. Whether the franchisor was a “hiring entity” and whether the ABC test applies to a putative joint employer remain open questions, though an appellate decision later in 2018 has held that a licensor was not an employer and that the ABC test did not apply to joint employers. This ruling puts licensors in the surprising position of insisting that the less stringent test for joint employers must be applied to franchisors.
The Dynamex decision and the ABC test potentially pose a threat to the basic franchise business model. A trademark can only be licensed if the licensor imposes strict standards. Even though franchisors are usually contractually prohibited from hiring, supervising or compensating the employees of their franchisees, they still might be held liable for labour code violations.
It remains to be seen how these issues will be resolved. Recently, a proposed bill to amend the Lanham Act – the Trademark Licensing Protection Act – was introduced in the US Congress. The proposed Act would prohibit consideration of brand controls in determining employment status and put an end to claims that threaten the legal basis for franchising in the US.
Chris Wormald: Unless reversed in a new referendum vote or by Parliament, the UK will exit the EU on 29 March 2019. Essentially all then-existing EU laws to which the UK is then subject will become enshrined in domestic law. “Sovereign UK” then becomes free to choose over time to amend them, but this initial grandfathering is needed to ensure initial business and legal continuity and established standards in important areas of national life.
A major advantage of being freed from the evolving body of EU laws is that, after leaving, the UK will not be bound to incorporate into its legal system (which is already a good choice of law for so many international agreements) whatever pan-European disclosure and/or franchise relationship laws may finally emerge from the process, initiated in the EU Parliament, and under the next stage of which the EU Commission and member states have been asked to propose measures to combat unfair contract terms in franchise contracts by January 2019. Given the various interests involved, franchisors must remain vigilant in their lobbying to ensure that this process ultimately does not result in legislation that is damaging to franchising throughout the EU. The real barriers to more cross-border franchising are language and cultural barriers, and the differences in national commercial and consumer markets from country to country, and not, as some have suggested, the lack of harmonised regulation across the EU. Smaller franchisors particularly find it difficult to expand into new markets for this practical reason. The creation of more franchisee rights – likely to be elaborated further, in different ways, in the implementation processes in each EU member state, with corresponding risks and liabilities for franchisors, and the need for more lawyering – is potentially more likely to hinder, rather than facilitate, more cross-border franchising.
Martine de Koning: Yes, e-commerce and omnichannel have had a major impact on the retail landscape in general, and on franchise systems in Europe (as well as the wider EMEA region) and the Netherlands in particular. Internet platforms have shaken up the entire retail landscape. SMEs will be protected from unfair contract clauses by a draft regulation that aims to ensure transparency and adequate dispute resolution. We have seen conflicts between franchisors and franchisees regarding “e-commerce”. Most of these conflicts relate to the franchisor’s online shop, via which the franchisor directly competes with its franchisees. Franchisees often claim a share of the earnings made online by the franchisor. For example, franchisees of the bookshop Bruna protested because they had to promote the franchisor’s online shop without receiving earnings in return. Additionally, franchisees of the supermarkets Albert Heijn and Jumbo claimed a share of the profits that the franchisors earned via their online webshop. Recently, the court of Amsterdam ruled on Hema’s approach to e-commerce and the costs that its franchisees have to bear.
In order to regain control over brand image, reputation and pricing of products, some franchisors have implemented “genuine” agency or commissioner models to replace existing franchise networks in Europe. The supplier may then maintain the resale price, and determine the other commercial and legal terms applied by the retailer. The supplier may, in genuine agency or commissioner situations, prohibit or keep internet sales. The agent or commissioner bears no (or only insignificant) risks and earns a commission. Of course, the mandatory laws governing commercial agents may be applicable, depending on the precise qualification of the agreement.
In order to avoid conflicts, it is recommended that franchisors and franchisees make clear arrangements regarding e-commerce. In particular the revenue and profit (shared or otherwise) models for the online store need to be agreed and written down in detail as an appendix to the franchise agreement. For example, in specific circumstances it could be a good idea to negotiate that a franchisee gets a commission or service fee for services performed for the franchisor’s direct online sales to customers. Or in the case of an exclusive territory allocated to the franchisee, it could be negotiated that the franchisee will receive a part of franchisor’s earnings of online orders of consumers in the territory of the franchisee.
Olivia Gast: The growth of e-commerce and online shopping platforms is at the same time a wonderful opportunity for business development, making clients who are able to manage efficient solutions able to reach more customers, and at the same time a big threat. Indeed, the competition is biased by the already well-settled super giants. They are very close to gaining monopoly in such ways that make every other business either reliant or… replaced. Franchised businesses have the advantage to have more strength and last longer. But for how long? I would say only super innovative franchise business can succeed in accommodating the shifts in consumer purchasing habits. For many, it’s too late.
Peter Snell: The shift and impact caused by e-commerce in franchising in Canada is commensurate to the shift and impact caused by e-commerce in any other form or structure of doing business in Canada. The impact of online shopping effects the way that franchisors connect with prospective franchisees, as more opportunities are marketed over franchisor websites and other online platforms. The move to online platforms is a way for a franchise systems to remain competitive, but presents challenges in regards to keeping a system uniform, giving protected territories, and monitoring of franchisee activity. These changes have a more drastic effect on those systems that are still operating with a “brick and mortar” approach to franchising, as they may be squeezed in their market by competitors that are not restricted to stand-alone stores.
This shift in consumer purchasing habits is typically dealt with at the franchisor level, and is implemented consistently system-wide. Many franchisors are calling for their franchisees to implement new software and hardware upgrades, and as more systems ramp up their e-commerce and technology platforms we are seeing an increase in systems requiring their franchisees to pay a technology fee that is separate and apart from royalty payments.
Jonathan Solish: The emergence of e-commerce initially challenged franchise systems that had often been structured on the assumption that customers could be divided among franchisees based strictly upon geographical location. Franchise agreements written decades before either failed to address sales through later-developed technology, or have presciently carved out sales by “catalogue or other similar means”. By now, various systems have restructured their agreements to expressly allocate credits for online sales.
As new technological models develop, franchisors must have the freedom to quickly revise their business models to keep up with consumers. Companies that are out of step are not likely to stay in business. Sears filed for bankruptcy in October 2018. In 1896, Sears published its first catalogue, allowing customers to see all the goods Sears had available for sale without having to enter a store; order and pay for goods without leaving their homes; and have the goods delivered directly to their homes. This basic business model sounds a lot like Amazon’s model, but Sears was never able to present a new model that could compete with Amazon.
Unlike Amazon, franchise systems are comprised of several parties with potentially conflicting interests. Any changes in online business models may be acceptable to some franchisees but objected to by others.
When United Parcel acquired the Mail Boxes Etc brand and converted the system into UPS Stores, it appeared that franchisees were receiving a brand with much better customer recognition, but franchisees nonetheless vehemently challenged the change with class action lawsuits. As franchisors move to change with the times to avoid the fate of Sears, they must have the contractual freedom to quickly change their systems without becoming embroiled in lawsuits second-guessing their decisions.
Chris Wormald: In the services sectors e-commerce is less of an issue as local franchisees deliver the services in the field to the customers.
For most product sales networks, particularly in retail, the situation is different and in recent years many retail chains have either closed down or re-engineered after insolvency proceedings, largely due to online sales cannibalisation.
Internationally, the problem of sales from the franchisor’s own websites and those of others selling direct to customers in their franchisees’ markets and cannibalising their store sales, cannot be ignored, and currency movements can exacerbate online and overseas in-store pricing differences. Returns and exchanges in-store, click-and-collect, etc, do create additional “touch points” for franchisees when online customers visit their physical stores; but besides losing store sales franchisees must then incur the additional costs of providing these services to the franchisor’s online customers. To avoid potential damage to franchisor/franchisee relationships, not to mention the potential for legal claims, commercial arrangements must be struck – usually involving a combination of commission from the franchisor’s online sales and covering costs to incentivise franchisees to turn a potentially serious problem into a joined-up approach. Competition/antitrust law prohibitions with the risk of fines, claims and contractual nullity may make it difficult to implement market-partitioning and “price harmonisation” arrangements. Few franchisors positively encourage their local franchisees to operate their own online businesses alongside their physical stores which dovetail in with the franchisor’s own e-commerce/supply infrastructures.
Martine de Koning: The strict rules for personal data processing under the GDPR will impact franchise systems, not only within the EU, but potentially worldwide. The GDPR applies to processing in the context of the activities of an establishment of a controller or processor in the EU, regardless of whether the processing takes place in the Union or not. Moreover, the GDPR applies to the processing of personal data of data subjects who are in the Union by a controller or processor not established in the Union, where the processing activities are related to either: the offering of goods or services, irrespective of whether a payment of the data subject is required, to such data subjects in the Union; or the monitoring of their behaviour as far as their behaviour takes place within the Union. This means that only franchise networks without any business units nor (targeted advertising) activity, or individual (online) sales in the EU (and in the near future EEA), can safely say they do not need to check for compliance with the GDPR (and other EU privacy laws). If a franchise network has business units or advertising in the EU, or just makes individual targeted advertising there, even if it is only their (franchisee’s) website accessible from the EU, accepting reservations or making deliveries of products or services to data subjects in the EU, it is very likely that the GDPR is applicable to the franchisor or franchisee. Since violations of privacy laws by a franchisee can seriously harm the reputation of the brand and thus affect the franchisor and the entire franchise network, the franchisors also need to take account of a franchisee’s activities in the EU, even if the franchisee is only accepting reservations or orders online for products or services.
In order to be able to comply with the GDPR, franchisors and franchisees must map the data processing in franchise systems. The data processing may include client data (whether the client is a consumer, guest or patient) and employee data, as well as personal data relating to individuals visiting the premises and third-party service providers. Who will determine the purposes and means of data processing, and thus will act as the data controller? Where will data rest? Which data will flow between the parties? How long will data be kept and who exactly needs access to data?
Franchisors and franchisees are strongly recommended to clearly determine their respective positions: who will act as data controller? Will the franchisee act as data processor, processing data on behalf of the franchisor? In that case the franchising agreement must include processor clauses, meeting the requirements under the GDPR. If both parties act as joint controllers, they also must make an arrangement to determine their responsibilities for compliance under the GDPR. In our experience, most standard franchise agreements used internationally, require quite some adaptation to meet the requirements of the GDPR.
Contractual arrangements are of key importance in respect of claims by data subjects also: any data subject who has suffered damage (material or non-material) as a result of infringements of the GDPR has to the right to compensation from the data controller (or data processor if he defaulted in his specific role) or the damage suffered. Even if the franchisor and franchisees cannot be exempt from liability towards the data subjects involved, indemnification from the franchisor towards the franchisee (or vice versa, depending on what role each party has) may be included in franchising agreements. The same holds true for sanctions imposed by the competent supervisory authorities. Supervisory authorities may impose high fines of up to €20 million or 4 per cent of the total worldwide annual turnover of the company in the preceding financial year.
Finally, it is important to realise there is more to come: the strict rules under the GDPR are expected to be complemented soon by additional e-privacy rules, which will impact usual business operations in franchising, such as consumer profiling, e-marketing, behavioural advertising and geo-targeting. In July 2018, the Council of the European Union has published a draft of revisions to the e-Privacy Regulation. It is expected that the e-Privacy Regulation will come into force in 2019. For international franchising systems, thus, the final consequences for daily practice are unclear.
Olivia Gast: Franchise structures, like any other structures collecting data, face data security issues (breaches, hacks, internal mistakes or theft, public authorities’ controls, etc) and need to meet privacy requirements that keep developing. I won’t expand on EU’s GDPR again, which is the current biggest challenge for all companies. With franchising it becomes that much more complex because agreements need to mitigate between the need for uniformity and the need for franchisee independence.
Peter Snell: Ensuring that data security and privacy requirements are communicated to all franchisees in a franchise system, and are applied uniformly, is what poses the greatest issue for Canadian franchisees. Though cross-border issues do crop up, Canada has a relatively stringent privacy, data security and anti-spam regime; therefore when a franchisor is compliant in Canada, they will likely find it relatively painless to comply in a new country. Therefore, we often find that our Canadian clients are well versed and are trained in the areas of privacy, data security and anti-spam.
Franchisors coming to Canada should review their obligations under:
Jonathan Solish: The EU’s General Data Protection Regulation and the adoption of laws such as the California Consumer Privacy Act of 2018 bring increasing risks for franchisors. As Wyndham learned in the ill-conceived FTC data breach action filed against it in 2012, regulatory agencies may assume that franchisors are strictly liable for the acts of their franchisees. The Wyndham action arose from the practices of franchisees in Arizona but came to plague the franchisor for years. Franchisors must anticipate that they will be held accountable for mistakes made by their franchisees and act accordingly.
Chris Wormald: The creative opportunities, as well as the risks they present, seem to match the pace of evolution of the e-commerce and AI technologies. Swingeing fines, liabilities and brand damage now follow hacks and data failures as rapidly developing regulations the world over bulwark data security protection. Franchisors have had to re-engineer their data procedures, particularly those who have historically simply required their franchisees to take adequate precautions, and to “comply with applicable laws”.
Moving personal data across borders for central processing is fraught with danger, unless one is compliant with regulations at both ends designed to ensure data security and processing in accordance with required standards and consents.
Some seek to shift the burden to the country master franchisee/developer as far as possible: with a contractual requirement to use expert local advisers in the field, perhaps with an annual audit and “compliance certification requirement”, immediate incident reporting obligations, liability for breaches, and ultimately the risk of termination. But there are problems with this approach and all must review their risk management procedures regularly.
There are dangers in being over-prescriptive, and so almost inevitably getting it wrong in distant jurisdictions with a growing plethora of evolving regulations. Major multinationals with significant compliance budgets may behave differently than smaller franchisors.
What is crucial is to establish whether local compliance liability can fall on the overseas franchisor, with procedures and contractual provisions to protect the brand and the franchisor, and a reliable updating approach to ensure compliance as regulations evolve in future.
Martine de Koning: First, there is no uniform EU law on franchise, which makes expansion of a franchise into Europe a legally complex and expensive exercise. Harmonisation within the EU would have been great, but except for competition, data protection and other compliance aspects, all harmonisation projects have only rendered “soft law” – there is no concrete framework of law to reply on. And even on the compliance topics, variations occur in national laws, interpretation, and enforcement priorities of national authorities (the position of the German Federal Cartel Office on vertical restraints and underlying national competition law is noteworthy in this respect).
Second, Dutch law on franchise is merely contract law and interpretation by courts is relatively straightforward and predictable (and expansion in the Netherlands was thus low-cost and easy). As stated above, the final text of the Dutch Franchise Code (a self-regulatory code) was published in February 2016. Franchisors expressed disappointment with the final text and the minister stated that he would look into a way to give the Dutch Franchise Code a “statutory angle”. Franchisors were in particular concerned with this prospect. Hence, the biggest challenge for Dutch franchise lawyers in this regard was advising on how franchisors could respond to this legislative development and advise on the practical consequences if the draft bill would be adopted. Interesting questions in this regard included the following:
Interesting enough, the Supreme Court recently decided in an Ahold case, that the European Code of Ethics is not applicable, in the absence of an agreement between the parties that it should apply. Therefore, without enactment in a Bill, the Dutch Franchise Code does not stand a chance of applying if it is not declared applicable by the parties.
On 23 May 2018 it was announced that the Dutch Franchise Code would not be given a statutory basis. Everyone on the market is waiting for the new draft bill to be published in autumn. When the new draft bill is published, Dutch franchise lawyers will have the chance to express their opinion on it during the consultation round. In addition, private practitioners can, based on their knowledge and experience in the market, influence lawmakers and members of Parliament. This requires a more proactive approach and going beyond the traditional role as a private practitioner. By doing so, Dutch franchise lawyers can feed their ideas into the law making process early on, which failed to happen in the drafting process of the self regulation (which was drafted for the most part by non-lawyers) to safeguard the quality of lawmaking, and to protect the interest of their clients and influence the future of Dutch franchise legislation.
Olivia Gast: The greatest challenge facing franchise lawyers in the market at the moment would be, as with any other lawyers, to be able to evolve fast enough to stay relevant in terms of technology and services, and to take into account the changes that the new technologies are quickly imposing on all activities. Indeed, the rise of AI can be seen as a particul