Legalities of franchising in the UK: what international franchisors need to know
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This article considers some of key legal issues which international franchisors should bear in mind when expanding into the UK.
Introduction
Since the 1960s when the very first franchise networks, such as Dyno-Rod, were launched in the United Kingdom ("UK"), franchising has taken root and flourished as an effective technique for expanding businesses in the UK, across a variety of sectors.
The franchising industry continued to grow despite the global economic crisis in 2008 and the conditions for the rest of the UK economy are now looking positive.
For any successful international business, expansion into the UK is a logical next step, offering exciting new business opportunities and growth potential. For international businesses based outside of the European Union ("EU"), the UK is often chosen as a base from which to establish a "beach head" before further expansion across the EU.
There are a number of factors which explain why the UK is an attractive market for international businesses, including the UK's reputation as a lightly regulated place in which to do business, the emergence of the English language as a truly global language, London's status as one of the leading capital cities in the world and access to the City of London's capital markets.
The UK as a legal jurisdiction
A common misunderstanding about doing business in the UK is that it has a single legal system.
The UK was created by the political union of previously independent countries and there are three distinct legal systems; English law, which applies in England and Wales, Northern Irish law, which applies in Northern Ireland, and Scots law, which applies in Scotland.
While England and Wales, Northern Ireland, and Scotland diverge in the more detailed rules of common law and equity, and while there are certain fields of legislative competence devolved in Northern Ireland, Scotland, Wales and London, there are substantive fields of law which apply across the UK. This article will consider legal issues from the perspective of English law.
The UK's relationship with the EU
Another common misunderstanding is that the EU is a genuine single market with a close to fully harmonised legal system.
The EU is a union of 28 different member countries (called “Member States”), that share common political, economic and social objectives. The EU promotes the free movement of goods, services and workers and operates a ‘harmonized’ legal regime designed to ensure consistency between Member States’ laws.
However, significant differences remain between the national legal, regulatory and cultural regimes of individual Member States that prove challenging to businesses entering the EU market. In addition, some EMEA countries often considered “European” (like Switzerland and Russia) actually sit outside the EU and are subject to wholly independent national regimes.
Therefore, whilst a legally compliant English law franchise agreement will, by its very nature, incorporate a number of EU legal principles (see below for more information on Competition Law), if it is to be used in other Member States, it should still be reviewed for its compliance with the mandatory local laws of the relevant Member State, which may conflict with the position under English law.
The regulation of franchising in the UK and the EU
The disparity between the legal systems of Member States applies to franchising. Various Member States have franchise specific regulations requiring, for example, franchisors to register with the authorities and/or issue a pre-contractual disclosure document to prospective franchisees.
The courts in some Member States do not always recognise the difference between a commercial agent and a franchisee. By applying commercial agency laws by analogy, franchisees in certain Member States have been able to successfully claim compensation at the expiry of a franchise agreement.
Some Members States are civil law jurisdictions, such as Germany, and have a codified duty of good faith, which applies to all elements of the franchise relationship. This can impact on a franchisor's contractual discretion and its ability to take unilateral decisions on behalf of the network.
There is no analogous legislation in the UK requiring registration of franchise agreements or pre-contractual disclosure, nor do the English courts confuse franchisees for agents. There is no general duty of good faith under English law which applies to franchising, although some recent court judgments indicate that English law may be starting to move in the same direction as some of its European cousins. Nevertheless, English law remains an attractive choice of law for international franchisors wishing to do business in the UK and the wider EU.
The British Franchise Association ("BFA") is a trade association which promotes ethical franchising in the UK. The BFA's "Code of Ethics", which not legally binding but which its members must abide by, provides a benchmark for good industry practice in relation to issues such as advertising, recruitment, the exercise of fairness throughout the franchise relationship and dispute resolution.
Structuring the franchise business
At a very early stage, the franchisor will need to decide which entity or structure will best fit its needs and expansion plans. This will depend on factors such as the revenue model, tax profile, ease of raising debt and equity finance, and the commercial strategy at both a Member State and a European level.
In particular, businesses launching into the UK may intend to operate corporately owned outlets as well as franchised outlets and/or provide "on the ground" support to its franchise network, in which case a launch may or may not be best achieved through the creation of a new vehicle, acquisition of an already established local business or purely on an arm's length basis.
Foreign ownership and investment in the UK is subject to very few regulations. The UK Trade and Investment government agency exists to assist foreign businesses to invest in and move to the UK. There are no general restrictions on foreign ownership of UK assets or companies. All new companies must register with Companies House, the registrar for companies in the UK, and will be subject to official requirements, such as the filing of annual accounts.
UK employment contracts are subject to a number of statutory protections for employees. Many derive from EU-wide laws affecting the employment relationship which are designed to harmonize employment rights across the EU. Critical employee considerations include impact of local tax regimes on employee stock options, Works’ Council establishment, talent availability, and transferring employment rights for employees acquired in a business sale context (TUPE).
Protecting the brand
Each Member State has its own IP regime, as well as being subject to EU law and international treaties.
Trade marks and design rights can be registered through the UK Intellectual Property Office (IPO) or alternatively an application for a Community Trade Mark ("CTM") or design right could be filed with the Office for Harmonisation in the Internal Market ("OHIM") and which would provide protection in all 28 Member States. If the franchisor already has marks registered in other jurisdictions which are party to the Madrid Protocol, it may be possible to add the UK to the international registration by application to the World Intellectual Property Organization ("WIPO").
Other key IP issues include the protection of copyright (which is not a registrable right in the UK) in materials such as the franchise manual and the acquisition of employee, franchisee and consultant-generated IP (which is typically achieved by contract) and strategies to guard against counterfeiting.
Competition law
Franchise agreements can affect competition between either Member States (in which case the European Commission ("EC") may take enforcement action against an offending party) or at a national level (and in the case of the UK, the Office of Fair Trading), particularly if they contain location restrictions and pricing obligations.
This is a complex area of law and penalties for breaches can be severe (including unenforceability of agreements and/or fines expressed as a percentage of global turnover), which is why specialist competition lawyers who understand franchising should be consulted.
The key competition law issues in the context of franchising are:
Pricing controls – it is not possible to require franchisees to sell products and/or services at set or minimum prices. However, there is some scope for short term price promotions and restrictions on excessive prices.
Exclusivity – it is possible to grant exclusivity to a franchisee to operate a franchise in a Member State or within a defined territory within a Member State. However, the "exclusivity" granted can prevent a franchisee from "actively" selling into another reserved territory, but it must not prevent the franchisee from accepting "passive sales" which may originate from outside of its exclusive territory.
The Internet – the EC treats almost all business related online activity as "passive selling" and therefore it is not possible to prevent a franchisee from promoting and/or selling its products/services online. A franchisor can impose certain quality criteria but for multi-channel franchisors (particularly those in the retail sector), this poses a significant problem to franchisors who wish to reserve the internet to themselves.
Exclusive supply and other non-compete obligations – it is possible to both restrict a franchisee from being involved in a competing business during the term of the franchise relationship and oblige a franchisee to purchase a certain amount of the franchise related products from the franchisor, provided that the term of the franchise agreement is for no more than 5 years in duration.
A franchisor can impose stricter and longer obligations where it owns the premises from which the franchisee operates, which is why, in part, a number of franchisors, particularly in the quick service F&B sector, act as landlords to their franchisees. It is possible to impose enforceable non-compete obligations on a franchisee after the expiry of a franchisee agreement, provided that they are carefully drafted and are necessary to protect the franchisor's legitimate business interests and know how.
Other laws affecting franchising in the UK
Trading Schemes
The Fair Trading Act 1973 and the Trading Schemes Act 1996, regulate ‘pyramid selling’ schemes in the UK, and can apply to poorly drafted franchise arrangements, in particular those which involve sub-franchising, independent sub-contractors, or other multi-tier structures. It is important to ensure that the franchise comes within one of the exemption criteria; otherwise a franchisor may find that its agreements are unenforceable or worse, its directors and officers could face criminal liability.
Anti-Bribery
The Bribery Act 2010 has created one of the strictest anti-corruption regimes in the world (even in comparison to the US Foreign and Corrupt Practices Act), including a corporate offence of failure to prevent bribery. It is a strict liability offence for which companies face an unlimited fine if found guilty. Individuals found guilty of involvement in bribery face a maximum penalty of 10 years imprisonment. An offence would be committed by a commercial organisation when a person performing services on its behalf bribes another person and intends to obtain or retain business for it.
The Act has not yet been tested in relation to its applicability to the franchisor/franchisee relationship. Whether it does apply will turn on the degree of control that the franchisor has over the franchisee, and the degree of benefit that the franchisee's activities confer on the franchisor. It is important, therefore, that international franchisors protect themselves to the greatest extent possible and ensure that they have "adequate measures" in place to prevent bribery in their franchise networks.
Data Protection
The EU has the strictest data protection regime in the world. Complex rules govern every aspect of the data lifecycle, impacting when and how businesses can send marketing, use website cookies and collect, store and transfer personal data. This is particularly relevant for consumer facing franchise businesses, where a franchisee is often collecting customer data and processing it on behalf of its franchisor, who ultimately controls and owns that data. Setting up or operating in the wrong way can degrade the value of this vital business asset, cause serious damage to the brand and run the risk of incurring substantial fines from the regulators, both in the UK at an EU level.
Conclusion
It is extremely important that franchisors looking to do business in the UK invest properly in taking legal advice from a lawyer specialising in franchising to ensure that their business operations and franchisee agreements are legally compliant.
Understanding the risks and issues and managing those risks through effective structuring and enforceable legal contracts will enable international franchisors to reap the rewards of doing business in one of Europe's largest and most dynamic markets.
Author: Gordon Drakes is a commercial lawyer at the law firm, Fieldfisher and he specialises in franchising and multi-channel licensing. Fieldfisher's franchising practice is rated as the leading practice in the UK and globally by Chambers & Partners 2014 and Chambers Global 2014 respectively.
