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Internationalisation of franchise networks - part 1

Article by Grégoire Toulouse

Taylor Wessing

Introduction to international franchise networks

After a successful development of his network on his domestic market, a franchisor can rightly be tempted by seeking new growth drivers through international expansion.

International expansion can prove to be very profitable for the franchisor provided that it is well and carefully prepared and planned in advance.

The following developments aim at giving franchisors a general overview of the most important legal issues to be taken into consideration once the choice of growth through internationalisation has been taken.

These issues are the following:

    • The choice of the right business model (direct setting up of operations, joint venture, master franchise, area developer, unit franchise, simple license) for the right country (1);
    • The protection of the trademark in the target country (2);
    • Compliance with the requirements of local law in terms of pre-contract disclosure and registration (3);
    • The choice of the law governing the agreement and compliance with local overriding mandatory rules (4);
    • The choice between national courts and arbitration or a mix of these two dispute resolution systems (5).
    • Last, the tax and foreign exchange regulations in the target country (6).

1. Choice of the model for international expansion

From a legal perspective, the starting point for a franchisor wishing to expand its franchise network abroad through franchising is to determine what model suits best to its expansion.

Depending on its financial resources, the originality and complexity of the concept, its development philosophy and the specificities of each country, the franchisor may choose between various options:

    • the direct setting up of a subsidiary in charge of running the local network (1.1);
    • a joint-venture with a local partner to run the local network (1.2);
    • a direct cross-border franchise (1.3);
    • a master franchise (1.4);
    • or less stringent systems such as licensing (1.5).

1.1 Setting up direct operations

Setting up a direct entity in the targeted foreign country to manage and develop the network allows the franchisor a direct and solid control over the network’s development.

This model is reserved to franchisors having sufficient financial and managerial resources in order to hire local employees in charge of the franchisees’ recruitment, training, and monitoring.

However, in some countries, the support of local partners can be advisable notably to get entries with local public administrations.

1.2 Establishing a joint-venture with a local partner

Joint-venture can be an interesting option for the franchisor because (i) the costs and profits are shared with the local business partner who – at least supposedly – has knowledge of the local market and (ii) the franchisor still has a direct eye on the operations in the country.

Once set up, the joint-venture can operate stores directly and/or become a master franchisee and develop a network of sub-franchisees in the country.

A good example of a successful mixed network of branches and franchisees is the case of Mc Donald’s in China. Mc Donald’s decided to enter the market by setting up a joint-venture with a strong local partner (Beijing Agricultural, Industrial and Commercial Federal Corporation) in charge of dealing with local officials. The joint-venture first opened hundreds of directly operated restaurants and from 2004 Mac Donald’s developed a franchise network, with the aim of having a total of 2,000 restaurants in 2013.

1.3 Direct cross-border franchising (through unit franchise or Area Development agreements)

Direct franchising from homeland can be an efficient way for developing in border countries which are close to the franchisor’s domestic market, where the consumption patterns are similar and where the language is sometimes the same.

Indeed, in these countries, providing direct support and training to the franchisees is not too complicated thanks to the geographic proximity.

As an example, French networks expanding abroad often choose to expand first into Belgium and Luxemburg through direct franchising.

The franchisor may choose between entering into Single Unit or Multi-Unit Franchise Agreements (called Area Development agreements), depending on the financial resources of the franchisee, the size of the territory and the franchisor’s strategy.

Under Area Development agreements, the same franchisee is authorised and requested to open several franchised units within a certain territory and over a certain period of time.

The main advantage of Area Development agreements is that they allow a continuous expansion of the network with selected partners and spare the time that would otherwise be necessary to find new franchisees.

Direct franchising is complicated in distant countries because it is not easy for the franchisor to provide support and training from a long distance.

In addition, direct franchising is not always permitted by local law. For example in China, following the entry into force of the last regulations on franchising in 2007 and 2012, it is still uncertain whether foreign franchisors are permitted to offer direct franchising from outside China to local Chinese franchisees without having to establish a presence in Mainland China – or at least in Hong Kong – first.

1.4 Master franchising

In this model, the franchisor appoints a local partner called Master franchisee who will act as the franchisor in the territory with the aim of developing the network through sub-franchising.

Master franchising offers a lower level of control on the franchise network to the franchisor but is an efficient way of developing in foreign countries for three main reasons:

    • it allows a quick expansion with limited financial resources since it is the Master franchisee who will bear most of the financial risk;
    • it requires limited human resources compared to direct franchising;
    • it provides the franchisor with a business partner having a local expertise.

Master franchise is therefore often the preferred choice for a franchisor expanding abroad.

Of course, the franchisor must carefully choose the master franchisee because in many ways, successful market entry will depend on the qualities of the latter and a bad choice could severely and durably damage the reputation of the brand.
The Master franchisee should be:

    • an experienced businessman / entity;
    • with a good knowledge of the local market; and
    • with sufficient resources to finance the development of the local network.

Master franchising being a complex tri-partite relationship (franchisor – master franchisee – sub-franchisees), it is all the more necessary for the franchisor to rely on a well structured master franchise agreement, which should notably provide for:

    • Clear targets for the master franchisee in terms of development of the network in the allotted territory, with sanctions in case of failure to achieve the targets. The sanctions may vary from financial penalties to a termination of the master franchise agreement or a reduction of the allotted territory;
    • Audit procedures to ascertain first that the master franchisee is faithful but also that he is correctly implementing the franchisor’s concept in the territory. To that end, it is useful to provide that the franchisor will be entitled to conduct direct controls in the sub-franchisees premises;
    • The process for adapting the concept to local habits, tastes and practices of the customers;
    • A standard sub-franchise agreement (as an appendix to the master franchise agreement) in line with the franchisor’s expectations, which will be used by the master franchisee with sub-franchisees (after the necessary amendments for compliance with local law have been made);
    • Clear transfer provisions, with pre-emption rights in favour of the franchisor, but also, to avoid bad surprises, provisions in the standard sub-franchise agreement on the prior consent given by the sub-franchisee to a transfer of the sub-franchise agreement from the master franchisee to the franchisor or any third party designated by the franchisor;
    • Clear and efficient termination provisions in case the business relationship with the master franchisee is not going well. These provisions must be easily and quickly enforceable under the law chosen by the parties but also under the laws of the country where the master franchisee is operating;
    • Clear and efficient post-term provisions, which must notably determine the conditions under which the master franchisee will transfer the network and all individual sub-franchise agreements to the franchisor or to the following master franchisee.

Needless to say, the master franchisee should be trained comprehensively by the franchisor in order to acquire his know-how with respect to the concept but also with regard to the way the network is monitored and managed (recruitment methods, communication, management of conflicts etc.).

1.5 Other models

Other models, which necessitate fewer human and financial resources such as licensing and master licensing can also be chosen for certain concepts, where the know-how does not require too much training and support.

This model can especially be chosen in certain countries, where there are excessively stringent regulations on franchising (pre-contract disclosure requirements, registration process, controls by local authorities, mandatory requirements on the content of the franchise agreement).

This is a matter of legal strategy, which should be dealt with cautiously as it may have important practical consequences on the ground.

2. The necessary protection of the Trademark

The question of the protection of the Trademark in the targeted country or countries must be dealt with at the early stages of the expansion preparation.

Indeed, there can be no franchise without a brand and the grant to the franchisee or the master franchisee of a license of use on the Trademark is the core of franchising.

Before filing the Trademark, an IP rights search is necessary in the targeted countries (2.1).

Once this has been done and registration is possible, the franchisor can either file the Trademark on a state by state basis or in several countries at the same time through international institutions such as the Office for Harmonisation in the Internal Market (OHIM) in the European Union (2.2) or the World International Property Organization (WIPO) at an international level (2.3).

2.1 The prior IP rights search

The first thing that the franchisor must do, with the help of Trademark specialists, is to invest in some research on the existence of a possible registration or use of the Trademark or of similar Trademarks by third parties in the target country.

Indeed, if the Trademark or a similar Trademark has already been registered or is already used (in common law countries) by a third party in the country, the franchisor will have to decide on a trademark strategy: trying to purchase the trademark; seeking a co-existence agreement; challenging the registration by the third party, choosing another brand…).

If the trademark is available in the target country, filing and registering the Trademark will be a pre-requisite to expansion in that territory in order to prevent third parties from using, without consent, the same or a similar trademark for identical or similar goods and/or services as those protected by the Trademark.

2.2 The Community trademark

In the European Union, the franchisor is offered the possibility to register his trademark for a renewable period of 10 years with the OHIM, which is based in Alicante (Spain).

A community trademark confers to its proprietor an exclusive right to use the trademark in the 27 Member States of the European Union. It is therefore a very cost-effective way of protecting the trademark on the whole territory of the European Union.

If the trademark is already registered as a Community Trademark or as a national trademark in at least one Member State, the former owner of the trademark may oppose the filing and prevent the registration of the Community Trademark within 3 months as from the filing date.

If the former proprietor is the owner of a Community Trademark, it will not be possible for the Franchisor to register the trademark on a case by case basis in each Member State.

On the contrary, if the opposing party has registered the Trademark in only one or several Member States, it will be possible to request the registration of the Trademark at a national level, in the Member States where the trademark has not yet been registered.

In any case, to avoid losing time and money, it is highly advisable to invest in some research on the existence of the registration of the trademark or of similar trademarks in the various Member States before launching the registration procedure with OHIM.

It is all the more so advisable that even if there is no opposition to the Community Trademark during the 3 months opposition period, the third party proprietor may still launch proceedings for IP rights infringement afterwards to obtain damages and the prohibition to use a similar trademark.

2.3 The International registration with the WIPO

In case of international expansion outside the European Union, it is possible to register the trademark at the same time in several countries through the WIPO in Geneva (Switzerland).

The pre-requisite is that the target country must be a member of the Madrid Protocol, which is the case of 88 countries (including most industrialised countries).

In the countries which are not members of the Protocol, it will be necessary to proceed to registration on a case by case basis. That is the case, for example, of Brazil and of most countries in the Middle East (such as UAE, Lebanon etc.).

Here again, it is highly advisable to proceed first to a prior rights search on the Trademark in all targeted countries.

Link to Part 2 of article

Last Updated: 19-September-2016

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