It has now been over 40 years since the US Federal Trade Commission first considered requiring the disclosure of certain information to prospective franchises, with almost a decade of deliberation before the issuance of its pioneering Trade Regulation Rule on Franchising in 1979. Several US states took interest, and through the 1970s and 1980s 13 of them adopted pre-sale disclosure statutes.
With the exception of one Canadian province, no jurisdiction outside the United States adopted such a law until 1986, when France enacted its Doubin Law. Thereafter, at first slowly and then in a veritable deluge, other countries began adopting one form or another of the statute. Today there are approximately 46 jurisdictions imposing such obligations; new countries weigh in with proposals irregularly but frequently.
One consequence is that there are now several lawyers worldwide who understand what these laws require of a franchisor. (Most are listed in this publication.) Those who are engaged in this practice on either an occasional or regular basis have focused their attention almost exclusively on these statutes as the source of law dictating what their companies or clients must or must not, or may or may not, do to comply with applicable law when offering a franchise in a country with such a statute.
It is now apparent that the collection of legal requirements by no means represents the full panoply of the laws of which counsel must be cognisant. We do not refer to the few countries that impose requirements relating to the company’s business operations as a prerequisite of offering franchises. Nor do we refer to the statutes which impose requirements relating to the substantive content of the franchise agreements, or the conduct of the parties once the relationship has been established. Nor do we refer to the large and diverse body of law to which a franchisor, like any other business, will be subject: contract, commercial and agency laws; intellectual property laws; anti-competition laws; and the other disciplines in common or civil law of which a franchise lawyer must be aware.
We refer instead specifically to disclosure obligations which may be imposed, quite apart from any “franchise law”, when a franchisor is dealing with a prospective franchisee.
In jurisdictions where there is no specific franchise disclosure statute or code section, but where there is nevertheless some duty to disclose, the legal principles requiring such disclosure are usually expressed either in terms of the doctrine of culpa in contrahendo (fault in concluding a contract) or under a duty of good faith and fair dealing. The distinction between these two principles is somewhat blurred and there appears to be a certain amount of overlap between them. It is also the case that such a non-statutory duty to disclose is much more likely to exist in a civil law country than a common law country. A recent informal and high-level survey we conducted of lawyers practising in select countries around the world is illustrative of this.
The concept of culpa in contrahendo originated in German law. Although this doctrine, as applied in German law, requires some disclosure, the nature and scope of disclosure should be tailored to the prospective franchisee’s level of sophistication. Thus, when dealing with an unsophisticated, single-unit prospective franchisee, it would be prudent to provide more complete disclosure, probably in simple language. On the other hand, in a major international multi-unit transaction where the franchisee is a large and sophisticated company advised by legal counsel, a less expansive form of disclosure may be appropriate. In either case, if the prospect wishes to have a projected profit-and-loss statement for the business, the burden is on the prospect to create one; but the franchisor probably needs to give the prospect as much reliable information as it has to enable the prospect to develop its own projected profit-and-loss statement. A franchisee does have a remedy for non-disclosure in the form of damages, provided that the franchisee can prove the non-disclosure caused the damages and that the amount of damages can be proven.
Austria, which sometimes follows German law on individual topics, has also adopted the concept. It is the label for the clear duty to negotiate with care, and not to lead a negotiating partner to act to his or her detriment when negotiating a contract. It applies to contracts generally and in Austria local practitioners interpret it, in a franchise context, to require a franchisor to disclose relevant information concerning the franchised product or system in general. It is also believed to require accurate and complete information on the franchisee’s projected profitability. Austrian law allows for damages where faulty disclosure has been intentional or grossly negligent, but not where it has simply been negligent. Further, there is no obligation on the franchisee to conduct any investigation of the franchise opportunity itself.
By contrast, in Chile commentators appear to believe that culpa in contrahendo is not a living doctrine under their law. Rather, the question of a duty of franchise pre-sale disclosure is a question of the obligation of good faith and fair dealing under article 1546 of the Civil Code. Under that obligation, each party has a duty to negotiate with clarity and openness, while avoiding making inaccurate statements or maintaining silence regarding information that is necessary for the other party to make an informed assessment of the proposed contract. There is also a related obligation of fairness and “loyalty” in the context of pre-contractual negotiations.
In Colombia the doctrine of culpa in contrahendo is enshrined in article 863 of the Commercial Code and it establishes a duty to act in good faith in the negotiation stage. This is an example of the blurred distinction between culpa in contrahendo and a general obligation to act in good faith. Damages may be obtained in the case of the failure of a party to comply with this general duty during negotiations.
Lawmakers in the Czech Republic saw fit to adopt clearly and firmly the doctrine of culpa in contrahendo when they revised that nation’s civil code in 2014. It has no special application to franchise agreements in particular. Rather, the doctrine of culpa in contrahendo applies to all contracts under Czech law. Neither party is under any obligation to conclude and sign an agreement, unless one of the parties initiates or continues negotiations without having the actual intention to conclude the agreement at all. Similarly, and somewhat more troubling in its vagueness, one section of the civil code provides that a party shall be liable for damages if it decides not to conclude an agreement without any “rightful reason” where the negotiations have reached an advanced phase in which conclusion of the agreement seems to be very likely and the other party has the reasonable expectation that the agreement will be concluded. The code does not attempt to define what constitute “rightful reasons”. During negotiations the parties must disclose all relevant factual and legal circumstances which relate to the proposed agreement of which they are aware (or should be aware) in order to conclude a valid agreement. Also in geographic proximity to Germany, Hungary and Poland follow the doctrine of culpa in contrahendo, each with its own interpretive nuances. The Netherlands, on the other hand, does not, although the duty of good faith may require a certain degree of openness between the parties.
As mentioned above, however, there are jurisdictions, mostly rooted in common law, which do not recognise the doctrine of culpa in contrahendo or any other form of obligation to make pre-contractual disclosures. These include Hong Kong, Ireland, Singapore, India, the United Arab Emirates and Thailand.
In Egypt, the basic principles of culpa in contrahendo are applied under the general duty of good faith and fair dealing. However, this duty applies only to the performance and enforcement of contracts and not to negotiations. As such, it would appear to have no application to pre-contract disclosure in franchise transactions or other transactions.
When one surveys those countries where there is some general obligation to be forthcoming with prospective franchisees, but no franchise-specific regulation, one finds what would be logical to expect: little or no guidance on what should be disclosed, when and how. Thus, many of our survey participants admit that there is little or no concrete guidance in their legal systems as to specifics of the information that should be provided to prospects.
A case in point is Austria. There is no real guidance in the law, but it could be suggested that information be provided concerning the franchisor and its relevant authorities; the terms of the franchise agreement; expected profit and liquidity of the franchisee; relevant intellectual property assets; the franchisee’s present and future investment levels; the amount of equity the franchisee will need; and the franchisor’s prior experience with start-up locations. Having said that, these are merely suggestions with no firm foundation in the law.
Another category of responses we received from our short survey is from a group of respondents who concluded that the actual information to be provided must be determined on a case-by-case basis depending on all the facts and circumstances of each individual case. Chile and Poland fall into this category, although in Poland it seems that there is at least this guidance: There is a duty to disclose information which, in light of all the circumstances, could be relevant to the prospective franchisee’s decision making.
Colombia takes a slightly different approach. There, one encounters the same lack of concrete guidance, but we can offer an example. If, in a particular case, a franchisor has information that could be material to a prospective franchisee’s decision to go ahead or not, it is quite possible that a court would find a breach of the duty of good faith where the franchisor elected not to share that information with the prospect.
The Netherlands is an interesting case. As stated above, it has not adopted the doctrine of culpa in contrahendo and case law is clear that a franchisor has no obligation to provide statements or projections of the franchisee’s future revenue or profit. However, in perhaps a telling example of human nature at work, where franchisors have provided such statements or projections anyway, there have often been lawsuits that result. Thus, it seems a Dutch franchisor would question the prudence of providing revenue or profit information in the first place.
Thus, it is far from clear how a responsible, thoughtful franchisor and its counsel should approach the question of disclosure in these types of jurisdictions. A question that has been posed repeatedly over the years is: what about franchise association codes of conduct and the like? The question is logical enough; many countries have franchising codes of conduct promulgated by their national franchise associations stating what information a franchisor should provide to its candidates. However, it is in their nature that they are published by private organisations and no participants in our survey indicated any such code of conduct having the force of law. Thus, a franchisor cannot look to a code of conduct and assume it is the definitive word on pre-sale disclosure. Having said that, however, such codes may nevertheless be helpful guideposts in countries where there is a rather vague obligation to provide some kind of relevant information to prospects. At a minimum, they should represent the result of a careful thought process by the franchising cognoscenti in a particular country. As such, one could argue that the contents of a given code must be within the realm of reason even if they do not strictly or precisely represent what is or is not reasonable in any specific set of circumstances. Viewed this way, they would seem to be at a minimum a useful starting point for consideration, but not in a vacuum.
Franchisors continue to be well advised to consult local counsel for the latest local interpretation of the law concerning good faith, etc, in pre-sale negotiations of contracts, particularly franchise contracts. Further, it is practical wisdom to step back and look at the nature of the transaction and the characteristics of the prospective franchisee. There is still reason to think that a more experienced and commercially sophisticated prospective franchisee is less likely to feel the need for the protection of the law in negotiations. On the contrary, such a franchisee may well feel it knows better than any judge what information it should ferret out and analyse. The harder cases are those with less sophisticated prospective franchisees. There, franchisors would do well to consider seriously more detailed and formalised transmission of information that would be of any real relevance.
It seems clear that any franchisor who concludes from the absence of a “franchise statute” that a target country is free of disclosure requirements related to the sale of a franchise to one of that country’s residents is taking a very significant gamble. And it is a gamble a franchisor might lose. By the application of one or another legal doctrine, in many countries a franchisor is likely to be held to be obligated to provide some form of pre-contractual disclosure.
But what kind of disclosure? As Hamlet would say: there’s the rub. Too little disclosure provides the franchisee with the ammunition to argue that he would not have made the purchase if the missing information had been supplied. Too much information provides the franchisee or franchisee counsel with a target-rich document to search out negligent or intentional misrepresentations. As we have sought to demonstrate here, the key to the right balance is in identifying those factors which a reasonable prospective franchisee should need in order to make an informed investment decision – admittedly, a difficult process (the legal underpinnings of which are still evolving) but an essential one.
Finally, to what degree may a franchisor make use of a disclosure document prepared to comply with another country’s franchise law? Assume the best case: that country is the United States, which has the oldest, most comprehensive and most thoroughly litigated set of disclosure requirements. Any franchisor who does not “borrow” portions of that document (for example, those providing factual descriptions of the franchisor and its history) is squandering a valuable resource, which offers the potential of saving time and money... unless, of course, the franchisor has established a subsidiary or affiliated entity for the purpose of entering the target country. But if the franchisor selects information which is likely to be inapplicable (for example, projected income) it is almost certainly inviting a legal dispute. The lesson appears to be that an existing disclosure document can be invaluable, but one used indiscriminately or imprudently is likely to be a ticking time bomb. Learning how to draw that distinction may dictate whether the entry into a country goes smoothly, or becomes a legal trap.