The main legal issues in franchising
in association with Lloyds TSB
In the UK, the franchise industry is lightly regulated compared with the US. There, the Federal Trade Commission enforces disclosure rules for franchisors. The main legal issues for a franchise business operating in this country are:
Competition law
In general, both European and domestic competition law prohibits many of the restrictions common to franchise agreements. However, both European and domestic law include ‘block exemption’ regulations in relation to vertical agreements such as franchises. These effectively exempt franchising from the main controls of competition law on certain conditions.
It is reasonable for the franchise contract to include certain limited restrictions that cover geographical area and the goods sold. Any post-termination restrictions must be strictly limited to the geographical area and subject matter of the agreement and limited in time to no more than is reasonable and necessary to protect the business. However, franchisors with market shares in excess of 30 per cent or large turnovers should take specialist competition law advice before entering into their agreements.
Trading Schemes law
Franchises are trading schemes and therefore, in principle, subject to the Trading Schemes Act 1996. However, there is an exemption available to franchise systems provided they comply with specific conditions, for example, by ensuring that all franchisees are, and remain, registered for VAT, and operating only single tier (i.e. not multi-level) systems. A franchise scheme which does not qualify for this exemption will need to comply with the formal and substantive requirements of the Trading Schemes Regulations 1997.
Trade Mark law
Both EU and UK laws provide a framework under which a branded system can register to obtain trade mark protection. This gives a branded system copyright protection throughout the European Union.
The following summaries outline the other areas of law that will impact on UK franchisors.
Contract law
This covers the franchise contract, which should include:
- granting the licence
- obligations of both franchisor and franchisee
- provisions for the franchisee’s death or incapacity through illness or accident or insolvency
- sale of the business by the franchisee
- terminating the agreement
- restrictions following termination.
The franchise contract should have viable property to licence (the business system). You should also avoid including terms that may be deemed unfair.
Tax law
Income that you receive as initial licence fees should be a revenue item and liable to corporation tax. Other franchisor income for the services and materials you supply to franchisees is usually also treated as revenue. For the franchisees, their initial licence fee is likely to be a capital payment and therefore not tax-deductible.
Agency law
You will need to avoid inadvertently creating an agency relationship with your franchisees. This can happen, for example, where a franchisor acts as a trustee for the franchisee. Exercising too much control through the contract could lead to this. It may also require you to disclose more about the business than you planned to.
In addition, a franchise system is subject to the same employment and data protection laws as any other business.
Before you go further we’d always recommend taking legal advice from a specialist firm of solicitors with experience of franchising agreements.
