The International Who’s Who of Franchise Lawyers has brought together five of the leading practitioners in the world to discuss the key issues facing franchise lawyers today.
DLA Piper LLP
Osler Hoskin & Harcourt LLP
Toronto MARK ABELL
Field Fisher Waterhouse LLP
London STEWART GERMANN
Stewart Germann Law Office
Auckland BENEDIKT SPIEGELFELD
CHSH Cerha Hempel Spiegelfeld Hlawati
CURRENT ECONOMIC CONDITIONS
Who’s Who Legal: How are franchisors and franchisees dealing with the effects of the global financial crisis?
Frank Zaid: Franchisors are suffering greatly as a result of the current economic crisis. The difficulty in financing their own operations has effectively thwarted positive growth and development of their systems, and with declining revenues from reduced franchisee gross sales, their diminished revenue streams have also negatively impacted development and operations.
Franchisees in many countries cannot obtain financing from previous conventional sources, and have to look to secondary, and often more expensive, means of financing.
Stewart Germann: Franchisors and franchisees in New Zealand are having to be smarter and more cost-conscious but really it is "business as usual" and money still has to be spent on marketing. The global financial crisis has caused the sale and purchase of franchises to slow down considerably so transactional dealing has diminished.
Philip Zeidman: There are some iron laws of economics at play here: consumers have dramatically slowed their spending, as unemployment has risen and the declining value of assets and perception of financial well being has eroded confidence (to the lowest level since tracking began, in 1967). That leads ineluctably to lower sales by franchisees (and more franchisee failures). It also leads to fewer franchises purchased, and both lead to lower income to franchisors. Taken together with the credit crunch and the need of consumers to deleverage after almost a generation of unsupportable borrowing, that presents a pretty unattractive picture for most franchisors.
Benedikt Spiegelfeld: As far as we can assess the current economical conditions seem to be a fairly good breeding ground for the franchise business in Austria. On the one hand, we are seeing more and more companies backing out of self-operated sales and after-sales departments reorganising their distribution channels to be completely franchisee-driven. The reasons are obvious: a franchise business does not need to maintain an expensive sales force, and further cost savings can be achieved by getting rid of other related fixed expenses. On the other hand, an increasing number of people are looking for alternatives to the classical employment relationships due to worsening prospects on the job market. In this respect, franchising businesses seem to be an adequate solution by reason of a more limited risk.
WWL: How has the crisis impacted on the role of the franchise lawyer? Which sectors of franchising have been most severely affected?
Frank Zaid: The franchisor lawyer’s role in these circumstances has been impacted negatively as stagnant development of franchise systems and slower growth obviously result in diminished retainers and, in some cases, increased pressures at the client level for fee concessions. However, a pro-active franchisor lawyer should focus on working with clients by suggesting creative approaches for assisting franchisees in troubled economic circumstances.
A well-connected franchise lawyer may be able to bring interested parties and investors to the table, and will be able to identify transactions that are proceeding without proper diligence or investigation. However, there is clearly an increased interest among foreign franchisors for entering into international transactions that would never have been considered before the current global economic crisis. In my view many of these deals will unravel - if the franchisors themselves do not disappear beforehand - in the future when there is a reasonable degree of global economic recovery.
Benedikt Spiegelfeld: From the business perspective of a lawyer, it is hard for me to complain about the current economic situation. As Frank Zaid mentions, clients are scrutinising fees, but this is not limited to the franchising sector and I guess we have to live with this and be more flexible and creative when it comes to fees.
Philip Zeidman: Franchising lawyers have of course been hit squarely by the crisis: fewer transactions, fewer financings, fewer new concepts being launched. There is some growth on the inevitable "other side of the coin" - workouts and disputes - but these are temporary palliatives for an undeniably reduced level of activity.
Stewart Germann: As to the sectors of franchising which have been severely affected by the recession, probably the most affected are real estate and automotive.
Benedikt Spiegelfeld: From my point of view it is too early to provide an indication on which particular franchise sector would be most severely affected by the recession but poor business decisions or a mediocre franchisee relationship management can be just as significant as the economics. Also, one cannot say that recession hits a specific franchise sector but rather specific industry sectors, regardless of whether those are operated through franchises or not.
Philip Zeidman: There are some encouraging and contrary forces at work. Among them: government stimulation, at least for a time; the drop in commodity prices; the relatively greater strength of multi-unit operators; the growing awareness by franchisors of the role they must play in enhancing their franchisees’ capacity to borrow; the continuing interest by private equity; the more insulated foreign franchisors and franchisees.
Historic data confirms that franchising outperforms non-franchised businesses, and perhaps especially in difficult times. "Outperform" can still be pretty lacklustre, but franchising may still lead the economy out of the recession. And no one should grieve for the lawyers. We will be at the side of our clients, helping them return to prosperity.
Who’s Who Legal: Which industries are currently seeing high levels of franchise activity? What are the reasons for these elevated levels?
Frank Zaid: The industry segments that do not require heavy capitalisation at the franchise level are showing positive growth, particularly when the end-consumer identifies cost savings in utilising franchise services or products. For example, many on-site service franchises that offer home repairs or renovations are experiencing reasonable growth as their services or products are needed, and the franchisee entrance cost is relatively low.
The ageing population coupled with diminished governmental health-care support have given significant impetus to the appearance and growth of a number of health-related franchises, especially for elder care. Healthy food concepts are being well received, as are automotive service franchises that cater to the fact that cash-stretched consumers are keeping their cars longer than they would in more robust economic times.
Franchises that cater to discretionary income spending, like family dining restaurants or leisure activities, are not growing. Travel-related franchise systems are experiencing significant downturns in new franchise sales and revenue growth.
It is difficult to predict with any degree of certainty which industry sectors will experience steady growth in the near future until and unless financing opportunities open up for franchise businesses in general.
Stewart Germann: Home services still have a high level of activity together with fast food franchises. Restaurant Brands Limited, a New Zealand public company that has the master franchise rights for Starbucks, KFC and Pizza Hut, recently reported record sales of pizzas, which makes sense as many people are going for low cost fast food options in these hard financial times.
Philip Zeidman: There are two ways to address this: how are well-established franchising companies doing? And in what sectors is there growth in new entries into franchising? As to the first, the answers appear in the quarterly earnings reports of publicly held companies, since consumer purchasing represents 70 per cent of the US economy. There is no reason to believe that franchising can be delinked from larger forces. There are, however, some interesting outliers: well known franchisors benefiting from skilful moves to lower price points, or reaping the benefits of efficiencies set in motion before the full impact of the recession was felt.
Perhaps of greater long-range significance is an examination of what sectors are entering franchising. Some are predictable (health care for the elderly); some more intriguing (personal wellness, child security). The recurring message - and one which resonates for franchising lawyers - is that the franchising method of doing business can be successfully applied to a multitude of industries, can adapt to changing demand and changing circumstances, and is a potent force in bad times as well as good.
Benedikt Spiegelfeld:The services sector is the predominant area for franchising in Austria, followed by the distribution sector; production franchising systems only play a minor role. In the services sector, unsurprisingly, financial services went into a downturn recently. The cosmetics and wellness sectors as well as the education sector have experienced steady growth in recent years. Also, the fast-food sector is still popular.
In the distribution sector the fashion industry is dominant, while under the current economic conditions building material retailers are expected to see difficult times.
LOCAL REGULATION AND ITS EFFECTS
Who’s Who Legal: What legislative conditions make a particular jurisdiction ‘franchisor-friendly’ or ‘franchisor-unfriendly’?
Frank Zaid: Legislative conditions - in the sense of franchise-specific legislation - are only one of many factors that determine whether a country is franchisor-friendly or unfriendly. Economic and cultural circumstances, and laws of general application, actually will have a much more profound effect. If a particular country has punitive laws regarding currency conversion, intellectual property protection, funds repatriation, withholding taxes, foreign investment review or approval, guarantees, indemnities, personal property security, and the like, a foreign franchisor will be much less attracted to the country even if the country has enacted franchise disclosure, registration or even franchise relationship laws. In these times of economic turbulence, the ability to finance franchise expansion, both at the franchisor and franchisee level, will significantly determine whether a country is franchise -friendly or unfriendly.
Stewart Germann: New Zealand is a very franchise-friendly jurisdiction and even more so since the government on 11 June 2009 announced that following the recent Discussion Paper looking at whether franchise-specific legislation should be introduced, it has determined that there is no need for such legislation at this time. There were 32 submissions, and my submission argued that there was no need for franchise-specific legislation as the current laws are robust and protect franchisors and franchisees.
Philip Zeidman: The existence of franchise-specific laws is only one factor in the characterisation of particular jurisdictions as friendly or unfriendly to franchisors. Far more important are the underlying systemic aspects of a country’s legal, economic and political culture: Is the sanctity of contract recognised? Are trademarks and other intellectual property protectable - practically, as well as legally? Is the judicial system cleanly, efficiently and reliably administered? What is the level of transparency? Of corruption? Is foreign investment welcomed? Those factors - together with the underlying economic and political soundness of the country, of course - are likeliest to explain fluctuations in franchise activity.
Benedikt Spiegelfeld: In my opinion the legal framework of a jurisdiction plays a subordinate role in relation to the economic reasons to enter a foreign market. Of course, the legal framework and its consequences have to be assessed with economics in mind, but this would only necessitate adapting the concept for particular jurisdictions. I do not think that a jurisdiction conceived to be unfriendly to franchising would create a burden to entering the market, though, you would need a minimum of legal security in terms of the ability to enforce a franchise contract, to be able to protect IP-rights and to have a good working judicial system. Once these conditions are satisfactorily fulfilled, a franchisor will most likely always find a way to adapt its legal framework to fit local needs.
Mark Abell: Franchise regulations obviously have a big impact upon how franchise-friendly a jurisdiction is. It is also important to bear in mind that it is not only franchise laws that need to be taken into consideration but also other laws, such as agency and distribution. These can apply directly or by analogy and can have a significant impact on franchising.
However, it does not stop there. The way in which the courts apply relevant laws also needs to be considered. Some jurisdictions, for example, impose very strong good-faith obligations that cannot only restrict and adapt contractual obligations but also establish new collateral obligations that can be very arduous on the franchisor. Germany, Austria and Portugal are good examples of such jurisdictions.
Benedikt Spiegelfeld: Naturally, I do not share Mark Abell’s opinion as to Austria being an "arduous" jurisdiction for franchisors in terms of good-faith obligations. It very much depends on a franchisor to provide a prospective franchisee with sufficient and correct information as to its franchise system in order for the franchisee to assess whether there would be a feasible chance for it to benefit from taking part in a particular system or not. I think openly providing a prospective franchisee with relevant information is only natural if you want to create a good business relationship with profits for both sides on the long run. I admit that the courts sometimes are in favour of franchisees, conceiving them as being at the mercy of the superior franchisor, but this often goes along with a reluctant information policy of a franchisor.
WWL: Have you noticed any difference in domestic and cross-border franchise activity?
Mark Abell: In my experience international franchising is still very active. Many companies that have not previously used franchising are now using it as a way in which to spread their domestic market exposure and take advantage of more robust economies overseas.
Domestically in the UK, the redundancy programmes that have been inflicted upon the workforce generally seem to be giving rise to an increase in those who are looking to buy a franchise, despite the rather grim economic times that we are experiencing in the UK. We are also seeing a steady stream of new franchise systems arrive on the market. Presumably because other access to capital is somewhat limited at the moment but many potential franchisees have redundancy cheques in their pockets and are looking to buy work and security for themselves.
Philip Zeidman: In recent months, I have - not surprisingly - detected more signs of economic distress in franchising, more widely spread across the globe, than I have ever seen in my career: a slowdown in growth in the franchising sector, fewer new transactions, failures or undeniable difficulties at both the franchisor and franchisee level. At the same time, however, I am seeing (even if only anecdotally) somewhat less impact of the worldwide recession on cross-border franchising than on purely domestic activity. I can only speculate on the reasons, but I think it may well flow from the fact that a typical prospective franchisee or area or master licensee in a cross-border transaction is almost certainly larger, more experienced, with greater resources - and, perhaps most importantly, less dependent on traditional sources of credit.
Frank Zaid: In Canada, which is one of the few countries to have a stable banking system which has weathered the current recession, foreign franchisors are showing heightened interest in doing master franchise or development deals, but are reluctant (perhaps unable?) to invest the resources necessary to do the groundwork to test their systems or even retain professional advisers to assist in developing their systems.
Philip Zeidman: Disclosure laws have existed in the United States for more than 30 years, at both the federal and state levels, and a substantial portion of the work of franchise lawyers in the US stems from those laws. Until a relatively short time ago, there was no significant body of non-US franchise law. That pattern has now shifted sharply; some 20 countries have franchise laws, and a significant number of those are disclosure laws. I don’t think it is yet possible to attribute these enactments to some widespread recognition of common concerns, demanding remedial legislation; the triggering events in most cases remain individualised.
Mark Abell: The US franchise laws have certainly had a substantial influence on many of the franchise laws that have been adopted elsewhere in the world. However, a good number of jurisdictions have taken a distinctly different approach to disclosure and registration. Australia, France, Italy, Sweden, Latvia, Romania and Belgium are good examples.
Jurisdictions adopt franchise laws for a variety of different reasons. In general terms though they fall into four distinct categories: (i) those that genuinely want a specific regulatory environment for franchising, eg, Australia; (ii) those that wish to control more general anti-competitive abuses such as full line forcing, price control and so on, eg, the EU; (iii) those that wish to control indirect foreign investment, eg, Indonesia; and (iv) hybrids of all three, eg, China.
There is no general trend of transparency, to my mind. Indeed, a number of countries such as Greece and - as Stewart Germann points out - New Zealand have recently decided against adopting franchise-specific legislation.
Frank Zaid: Increased international franchise legislation is an attempt - certainly necessary and overdue - by a number of countries to close the imbalance in the franchise relationship primarily at the initial stage by giving prospective franchisees useful and sometimes critical information regarding the investment they are pursuing. Governmental review and registration assist in this process, but often not to the degree that the governments perceive. While transparency may be a result, it is not always the intent, particularly in countries that use franchise legislation to regulate and limit foreign investment.
Stewart Germann: Because there is no franchise-specific legislation in New Zealand there are no legislative disclosure requirements. However, franchisors who belong to the Franchise Association of New Zealand (FANZ) must comply with the Franchising Code of Practice and must publish a disclosure document which is given to prospective franchisees at least 14 days before execution of the Franchise Agreement. This Disclosure Document sets out a seven day cooling off period and dispute resolution procedure.
Benedikt Spiegelfeld: In Austria, the concept of pre-contractual disclosure obligations is of a general nature, thus, not affecting franchising matters only, and has a long tradition. The idea is that at the time of commencement of contractual obligations a pre-contractual relationship is created by law, according to which the parties are obliged to be considerate of the other parties’ interests. Still, the amount and quality of information to be provided in advance with respect to franchising matters has to be assessed on a case-by-case basis; the information provided should be suitable for a franchisee to evaluate its risks and opportunities. Therefore, disclosure obligations as such do not play a major role in Austria as these principles are widely recognised and well observed by franchisors. Anyway, even if disclosure obligations would be infringed, this problem would only pop up if a franchisee fails to meet its expectations in connection with the system.
WWL: How will these or similar measures have an impact on the type of work franchise lawyers are seeing?
Frank Zaid: Increased franchise legislation will have some effect on the work that franchise lawyers do, both in the exporting and importing countries, but invariably the major work will be as a result of domestic laws on general import, and as a result of more informed franchise lawyers being able to assist their clients on complying with the sometimes obscure laws that are the most relevant.
Mark Abell: I agree with Frank Zaid’s comments - increased franchise legislation will inevitably have some impact upon the work that franchise attorneys do, but it will most probably be fairly marginal.
Benedikt Spiegelfeld: So far, even if there is no specific franchise law in Austria, the legal framework for franchising is pretty clear, not at least due to case law. Under such a legal environment, I think that more specific franchise legislation - to the contrary - would only lead to a short peak of higher demand for legal work in the beginning, but in the long run could even lead to less involvement of attorneys for the following reason: franchise specific legislation has to be quite "specific" to distinguish franchising from other commercial agent legislation already in place while maintaining the principles so far accepted and applied to franchising by the courts (this is not a must but any vital change of the generally applied principles in any case would neither be advisable nor to be expected); in such a case, franchise legislation would have to be detailed to a greater degree, resulting in an easier application by non-professionals. Admittedly, such an argument sounds odd, but in fact I have seen franchise systems built on self-made legal frameworks (without involvement of lawyers at all) based on templates found on the internet or contained in publications; in the event of more specific franchise legislation such templates will be more sophisticated leading to higher usage by franchisors, without involving an attorney.
Philip Zeidman: The real impact on the nature and volume of work of franchise lawyers will not come from the adoption of more laws in more countries, standing alone, but rather from the adoption of more comprehensive legislation, more vigorous enforcement by governments, or the development of a more robust culture of seeking private redress.
Who’s Who Legal: Have you noticed a fluctuation in the number of franchise-related disputes? What are the reasons for this?
Mark Abell: We have seen a steady flow of substantial franchise disputes over the past few years but there has not been a marked increase in these over the past nine months. There has, however, been an increase in smaller disputes. These often seem to stem from the commercial failure of franchisees who then want to try
and blame the franchisor for the failure. However, these rarely stick. This may be at least in part due to the fact that we try to school our franchisor clients into adopting operational procedures that enable them to disprove many of the unfounded allegations made.
The relatively new-found ability of attorneys to act on a contingency basis is probably the main reason for the increase in these largely spurious claims rather than the credit crunch.
Frank Zaid: Franchisee disputes and related court decisions, in Canada at least, have shown a marked increase in the past one or two years. The current economic crisis has resulted in some franchisors being unwilling or unable to provide operational or system support or development at past levels, while franchisee recruitment and same unit sales are diminishing. The net result is that some franchisees are looking for redress from their franchisors for failing units. Simlarly, some cash-stretched franchisors are unwilling to allow their franchisees to go into indefinite default in the payment of fees, and are pursuing remedies for payment or compliance from the courts or other dispute facilities.
Benedikt Spiegelfeld: Up to now everything seems to be pretty normal in Austria and recession has not yet been a trigger for a rush to the courts.
WWL: What are the preferred methods for resolving disputes?
Benedikt Spiegelfeld: Even though there is no specific franchise law in place in Austria, the Austrian Supreme Court in the past has defined how to deal with most of the crucial aspects of franchising, ie, compensation payment at the end of the term, forwarding of purchase of goods discounts to the franchisee, etc. This leads to a situation where franchisor and franchisee are well aware of their rights and duties, and disputes are usually resolved without the courts. However, even if most of the franchising law has been defined in case law, not all aspects are covered, and franchisors sometimes are keen to avoid creation of a prejudice and thus preferring to solve a dispute confidentially.
In addition particularly large and reputable franchise systems do not want to take the risk of damaging their image or creating concerns among their other franchisees, so to some extent are also willing to resolve disputes "undercover".
Mark Abell: Litigation remains the option of first choice for domestic franchisors although internationally arbitration is perhaps more popular. In both domestic UK and international disputes mediation is often used.
Stewart Germann: I have not noticed a huge jump in the number of disputes. The favoured method of resolving disputes in New Zealand is mediation, which is highly successful. Franchisors who belong to the FANZ must have a dispute resolution clause in their franchise agreements which follows the Code of Practice and lays out a process for mediation to resolve disputes.
Frank Zaid: Mediation is being used more frequently, and with positive results. Arbitration, in Canada, is not a preferred or effective method of dispute resolution. Franchisees are generally receiving sympathetic results from the courts when the franchisor is considered to have acted unfairly or in bad faith.
Settlements are more difficult to obtain, but at appropriate times in the process franchisors are more willing to settle than to incur prolonged expenses and to risk uncertain and unpredictable results. An increasing number of franchise litigation attorneys are taking class actions on a contingency basis. This results in earlier settlements and less interest on the part of franchisors to incur significant fees over a lengthy period.
LAW FIRM DEVELOPMENTS
Who’s Who Legal: To what extent is it to a law firm’s advantage, or disadvantage, to focus its resources on franchise law?
Mark Abell: Franchising is not a huge sector compared to other areas of law, such as securities and corporate finance. This is especially so outside of the USA. There is therefore an inevitable limit to the number of law firms that can specialise in franchising: an inbuilt barrier to entry.
Outside of the US, in markets where franchising is most developed, there seems to be increasing rationalisation and a focusing of high level technical legal expertise and commercial understanding of franchising in one or two firms that, as a result, dominate their local market.
Philip Zeidman: I think the answer may be different depending upon whether the country has a developed economy, or exports franchises; or is a developing society or one to which franchises are exported. In the latter case, a law firm which can set itself apart by virtue of its franchising expertise can attract the work of companies seeking to enter the country. In the former case, however, especially if the economy is mature, a franchise lawyer may face a good deal of a competition; those who are likeliest to succeed are those with a niche in which the competition may be less marked. As franchising becomes more "commodified", its principal attraction to law firms, especially large law firms, may be its potential for cross-selling, ie, the capacity to generate work for franchise clients in other areas of the law.
Frank Zaid: The most noticeable trend I have seen in the past 10-plus years is the disappearance or marginalisation of small boutique franchise law firms, and the growth of the practice in larger, national, full-service firms.
Of necessity, however, is the requirement for such firms to have well-known, business-oriented, proactive commercial lawyers who understand what the franchise relationship is, and what laws and practices affect the practicalities of advising both foreign and domestic franchisors on their general business operations. Such firms, to be successful in this limited field, need to have specialists who can readily apply their particular areas of expertise in advising franchisors without having to become educated on the relationship. Also, in the past 10-plus years, in Canada, a specialist bar is developing for franchise litigation work, particularly with the application of class action laws to franchise disputes. These lawyers are most often associated with firms that have a solid commercial franchise practice as the business issues that frequently arise in these disputes are often not understood by general litigation lawyers.
Benedikt Spiegelfeld: I agree with Mark Abell. Although Austria has a sound base of "home-grown" franchise concepts and still attracts foreign franchise concepts to enter the Austrian market, establishing a niche or boutique practice in franchising law in Austria would not pay off; even if you (and you should!) treat franchising only as a part of a more general distribution law practice. There are other types of distribution channels to consider like commercial agents, brokers, etc, and you sometimes are asked to assess - of course only on a legal basis - which type of distribution would be the best way for your client to achieve its goals in Austria.
Nevertheless, it makes perfect sense to establish a franchising competence centre in your firm since clients are explicitly asking for expertise and experience in franchise matters, giving you the opportunity to convince the client that your other areas of expertise would also be to its benefit.