International Franchising versus National Legislation

Going international

Franchising has proven a great vehicle to expand your business internationally. Once you have shown your business to be successful in your local area, expansion to the national arena is not far away. At some stage even national market potential is fulfilled, and the only way to continue your expansion is outside your national borders. It is time to go global.

The first step is not a legal one, but a market assessment. Is it possible to conduct your business abroad? If so, in what markets? After a thorough market analysis you have to aim for certain target countries or regions. This is where the legal work starts.

As franchise systems are built mostly on intellectual property, you have to start by building a solid protection for your system in every region that you are targeting. The first and easiest protection is the trademark registration. There are some schemes for transnational protection (such the Community Trademark, through the European Union Intellectual Property Office), but also processes to seek protection in many countries at the same time (through the World Intellectual Property Office). Other than that, one has to apply for a trademark registration with each national trademark authority. A good advice is not to start any negotiations with potential counterparties before a solid protection for your system is in place.

National legislation

The second step is to assess the legal structure and the legislation covering franchising in the target country. As part of an ongoing research project at Stockholm University’s Department of Law, I am studying the franchise laws around the globe. In 36 countries we have found specific franchise laws, and in some of the big countries (USA, Canada and China) there are even specific franchise laws in separate states, provinces and territories. As these countries are sovereign states, the franchise legislation is also unique for each of them. There are some similarities but the franchise laws are not harmonised. There was, however, a big project within the International Institute for the Unification of Private Law (Unidroit) to harmonise the franchise disclosure laws around the world. The result was the Model Franchise Disclosure Law, published in September 2002. Some countries (Belgium, Italy and Sweden) have used the model law when creating their own national laws.

Disclosure and relationship laws

The national franchise laws may be divided in two main categories: disclosure laws and relationship laws. The disclosure laws address the phase before a potential franchisee becomes part of the franchise system and regulates when, what and how information shall be served to the potential franchisee. Relationship laws address the phase when there is a relation between a franchisor and a franchisee and regulates when, what and how they shall interact.

Both main categories of franchise laws can be broken down in sub-categories.

Registration

A main divider is the registration category by which some countries have a national, regional or local register. Even before starting any activity, the franchise company may be required to register as a franchisor in certain countries. Some jurisdictions require the franchise disclosure document to be registered; others require the franchise agreement to be registered. Amendments and annual updates are required in many of these registration countries or states. In the countries where registration is not a requirement, the interaction between franchisor and franchisee is deemed to be of private nature. To help sort out the burden of proof, some legislations that do not demand registration will, however, demand written form for the disclosure document or the franchise agreement.

Content

Another sub-category, applicable to both types of law, is content. If the franchise law requires a franchise disclosure document, the demand for content can take on a form ranging from “necessary information” to a full set of 23 prescribed specific items (the American Franchise Rule - 16 CFR Parts 436 and 437). The variation between types of content across national legislations can be best explained by the varying levels of transparency in different countries. One example would be the demand for past annual reports, which is uncalled for in countries where annual reports are official documents available to the general public from the relevant authority. The Unidroit Model law also used the American model and prescribed specific items (16 plus 12 items). Where the model law is used, for example, when creating the Swedish Franchise Disclosure Act, the legislators use their sovereignty and employ the model law for cherry-picking. The Swedish Act demands a minimum of eight specific items to be disclosed, but retains the purpose for the disclosure by stating “and other necessary information”. This is, in my opinion a coward or sloppy way of drafting legislation. Instead of giving clear guidance to the operating parties (ie, the franchisors), the legislators leave room for the parties to interpret the laws differently and hence create grounds for misinterpretation, which in many cases leads to conflicts that will end up in litigation or arbitration.

Regarding the quality of the content in a disclosure document, there are legal principles and laws to be considered. The principles of culpa in contrahendo and good faith demand that the provider of information acts decently and truthfully in both the disclosure of information and negotiations. But beware: some laws around the world do not stop at making the provider personally liable for the content in a disclosure document. The South Korean law states:

Any person who provides false or exaggerated information or omits a material fact [when providing a prospective franchisee with information] shall be punished by imprisonment with prison labour for not more than five years or by a fine not exceeding 150 million won.

The content issue is even broader in the relationship laws around the world. To start with, many of the countries that have implemented relationship laws require a franchise agreement to be in writing. Failure to comply with this requirement will usually render the agreement null and void. Some countries require a franchise agreement to contain certain information and not only one or two items but, in some cases, to an extent that you can use the requirement in the law as a checklist for the entire franchise agreement (eg, the laws of Malaysia and South Africa). In the laws where certain information is required, the content of the clauses are still open to freedom of contract – ie, the laws do not require specific wording and do not instruct the parties how to solve different issues.

Of course there are exceptions even in this case. In some countries the legislators have decided a minimum standard, most often to the benefit of the franchisee. Some laws also have a so-called “blacklist” of provisions that may not be included in the agreement, eg, in Taiwan you may not have differentiated treatment with various franchisees and you may not demand tie-in sales; under the European Block Exemption Regulation you may not have a post-contractual non-compete covenant lasting more than one year. Almost all franchise laws stress the importance of the trademark under which the franchise operations are conducted. Tunisian law demands that the franchisor shows that he or she has the “ownership” or is the “holder” of the trademark. It needs to be clarified if a trademark licence is sufficient to declare yourself a holder of the trademark. In Romanian law it is a requirement that the franchisor is the proprietor of the trademark rights. The rights must be exercised for a period of time at least equal to the length of the franchise agreement. This rule might create problems for a master franchisee during the latter part of each term of a master franchise agreement (MFA), until it is confirmed that the MFA will be renewed. On the same theme, Russian law requires that the time frame for a sub-franchise agreement may not be exceed that of the MFA.

The term of a franchise agreement has caught the interest of many legislators. A franchise agreement may not be less than four years in Argentina, or five years in Malaysia. In many countries the franchise law explicitly states that parties may conclude a franchise agreement for either a fixed term or indefinitely. Some countries (eg, Moldava and Mongolia) have a provision stating that a term of more than 10 years, or an indefinite term, will allow either party to terminate the agreement with one year’s notice. Regarding termination, some countries (eg, Mexico) demand just cause to terminate a franchise agreement. Finally, the post-contractual non-compete covenants are allowed in most franchise laws, but the provision that the franchisor has to compensate the franchisee for losses appears in some laws (eg, Malaysia and Moldava).

Franchise

Franchising has been a business model for 150 years, and an international vehicle for at least 50 years. There are many franchise systems present in many countries outside their own home country. These players have to comply with different cultures, different languages, different currencies and different regulations. One can lean back and conclude: that’s the way it is. Or, one can ask, why do we have different regulations on the same business model? For the franchise business, I hope that we can start a serious discussion on harmonisation of the different franchise laws around the world. Today, many franchise systems have to spend a lot of money to understand and comply with national legislation. With the same investment in harmonisation of the international legal framework for franchising, the franchise business might evolve even more.