Internationalisation of franchise networks - part 2
Article by Grégoire Toulouse
3. Pre-contract disclosure and registration requirements
In several countries of the world, the franchisor will face either pre-contract disclosure or registration requirements or both.
Before entering into franchise or master franchise agreements with local partners, it will therefore be necessary to check the existence of such set of rules and, as the case may be, to comply with local requirements which vary from a country to another and are usually considered as overriding mandatory rules by local laws.
3.1 Pre-contract disclosure requirements
With respect to pre-contract disclosure requirements, it is possible to distinguish three different types of countries:
- Countries where there is no pre-contract disclosure requirement. That is the case for example in the UK;
- Countries where there are statutory pre-contract disclosure obligations. That is the case, for example, in six European countries (France, Belgium, Italy, Romania, Spain and Sweden) and in different countries in the world (Australia, Brazil, China, the USA both at Federal level and in certain federated states…);
- Countries where there are no statutory requirements but where case law has imposed a minimum pre-contract disclosure. That is the case, for instance, of Germany, Austria and Portugal.
The aim of pre-contract disclosure is to protect the party considered as being the weaker party in the contractual relationship (the franchisee/master franchisee) and to reduce the information asymmetry.
The time period within which the information must be provided to the franchisee varies from a country to another (e.g. 10 days in Brazil, 14 days in Australia and the USA, 20 days in France, 30 days in China and Belgium).
The common information that must be provided almost everywhere relates to:
i) the franchisor (who he is, what is his history etc.),
ii) the Trademark,
iii) the franchisor’s business and its network,
iv) the main terms of the franchise agreement (restriction of franchisee, exclusivities, personal involvement, term, renewal, termination etc.),
v) the financial investment that is necessary to launch a franchise outlet and the fees to be paid.
That being said, there are variations and specificities in each country.
For instance, in France, under the so-called Doubin law of 1989 (articles L.330-3 and R.330-1 of the French Commercial Code) the franchisor must provide information on the general and local state of the market plus a market development outlook to the franchisee and master franchisee. This can be difficult for a foreign franchisor who is sometimes less aware of the market specificities than the local partner himself.
In practice, pre-contract disclosure requirements are often considered as overriding mandatory rules.
The sanction for non-disclosure or incomplete disclosure varies from state to state but is often the possibility for the franchisee to seek the termination of the franchise agreement or its annulment, and even damages if the franchisee can prove a loss.
It is therefore essential to request the assistance of a local franchise law specialist to ensure that the pre-contract information provided to the prospective franchisee or master franchisee complies entirely with local law.
3.2 Registration requirements
Registration requirements are meant to:
- control the entry of foreign companies into the market (usually in developing countries); and/or
- ensure the compliance by franchisors with a minimum level of ethics and quality (in more industrialised countries).
Within the European Union, there are generally no registration requirements with government agencies, with the noticeable exceptions of Romania and Spain.
In Spain, for example, the franchisor (and the master franchisee as the case may be) must register with the Registrar of Franchisors (before the second franchised outlet begins operating) and must notably provide information on the trademark, the concept as well as statistics on the franchised and directly operated outlets in Spain. The information must be updated on an annual basis.
Outside the European Union, one finds registration requirements in several countries such as Brazil, China, Russia and 15 states of the USA (California, Hawaï, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Oregon, Rhode Island, South Dakota, Virginia, Washington, Wisconsin).
The scope of registration varies from country to country.
For example, in Brazil, the agreement must be registered with the Brazilian patent and trademark office (the INPI) and with the Brazilian central bank.
In China, the franchisor must register with the Ministry of commerce (Mofcom) and within 15 days from the signing of the 1st franchise agreement the following documentation: 1) its business licence or registration certificate, 2) the draft franchise agreement, 3) the operation manual, 4) a market development plan, 5) evidence that the franchisor’s qualification requirements have been met. Then, an annual update of the number of franchisees in the Chinese network is necessary. The fact that the operation manual must be disclosed is considered as an issue by many franchisors.
Of course, registration requirements usually imply that the agreement must be translated into the local language. Bi-lingual agreements are therefore necessary in those countries.
4. Choice of applicable law and overriding mandatory rules
As a general rule, the parties to an international agreement can freely choose the law applicable to their relationship (4.1).
However, choosing the law of the franchisor or any other law will not prevent the application of the domestic overriding mandatory provisions of local laws (4.2).
4.1 Choice of the law
Most of the time, if the balance of power is in his favour, the franchisor will choose his domestic law. Sometimes, however, the master franchisee will be in a position to refuse the franchisor’s law.
In such a case, three options are possible:
- choosing the master franchisee’s law.
- choosing a neutral law. This is a complicated compromise because both, the franchisor and the franchisee, will reflect in light of their own laws while being compelled to refer to rules that generally neither of them will fully master.
- choosing not to refer to a state law but instead referring to international commercial rules such as the Unidroit Principles of International Commercial Contracts (updated in 2010), which are harmonised uniform rules of private law with the aim of finding the right balance between the rights and obligations of the parties. Although this option is rather balanced, it is rarely chosen by the parties.
4.2 Overriding mandatory rules
Once the franchisor and his business partner have agreed on the applicable law, it is still necessary to check whether the terms of the agreement are compliant with the overriding mandatory rules applying in the country where the franchised business will be run.
Such rules can be found in franchise specific legislations (in around 30 countries in the world) but also in competition laws and general commercial laws.
The following are a few examples of overriding mandatory rules that can impact the drafting of the agreement:
- whereas Anglo-Saxon agreements commonly provide for the possibility to terminate the franchise agreement unilaterally in case of insolvency of the co-contracting party, in France termination is possible only with the prior agreement of the administrator appointed by the Court;
- French law prohibits purchase exclusivities for periods longer than 10 years. That is sometimes an issue for long term master franchise agreements;
- Cooling-off periods” can be found in certain jurisdictions such as China, Malaysia, Mexico or Taïwan. Under such rules, the franchisee is entitled to withdraw from the contractual relationship without any penalty within a certain period of time after the signing of the agreement;
- some countries impose a minimum term for the franchise agreement, from 3 years in China for franchise agreements up to 10 years for master franchise agreements in Indonesia.
5. Choice of jurisdiction: national courts or arbitration?
The parties must also decide either to give jurisdiction to national courts or to an arbitral tribunal. Both systems have their advantages and disadvantages.
National courts proceedings are less expensive and the parties (as well as their lawyers) are more used to them. That is why franchisors usually prefer giving jurisdiction to their domestic courts, which is also coherent with the choice of the franchisor’s law in most cases.
Arbitration is a confidential, more flexible and quick mean of resolving disputes, but it is more expensive than a procedure before a national court.
As a matter of principle, in international agreements, the choice between national courts and arbitration should be determined (i) by the level of neutrality expected from national courts, should a dispute arise, but also (ii) by the enforceability of the decision that would be rendered.
There is indeed no point for a franchisor in getting a satisfactory decision before his domestic courts if the decision is not enforceable in the country where the franchisee is operating, i.e. where the monies are or where the court’s injunctions must be enforced.
For European franchisors, the choice of their domestic courts is an acceptable option since decisions rendered in a Member State are easily enforceable in the other member states thanks to EU Regulation n° 44/2001 of 22 December 2000 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters.
Outside Europe, enforcement of the decisions of national courts in foreign countries is sometimes difficult.
On the contrary, arbitration is a good – and neutral – way of having a dispute settled since arbitration awards are well recognised in most countries thanks to the New York Convention of 1958 on the recognition and enforcement of foreign arbitral awards. This convention has been ratified by 147 countries in the world as of today.
If arbitration has been retained, the franchisor must then choose either to refer to the rules of an arbitration institution (such as International Chamber of Commerce (ICC), the London Court of arbitration or the China International Economic and Trade Arbitration Commission (CIETAC) etc.) or to an ad hoc arbitral tribunal, which is not common in international agreements.
The parties must also decide how many arbitrators they will appoint.
A sole arbitrator usually costs less than half the price of 3 arbitrators and the sole arbitrator option should be chosen for the agreements (or disputes) of low financial value.
For more important agreements (or disputes), the parties may prefer having a panel of arbitrators to be certain to obtain a balanced decision.
To limit the costs of the proceedings, it is advisable to add an amicable dispute resolution (ADR) clause pursuant to which, before launching proceedings, the parties must try to find an amicable solution to their dispute, with the help of a mediator. The ICC provides such a service.
Last but not least, the questions of injunctive relief and emergency proceedings in order to prevent substantial harm should not be ignored and should be mentioned clearly in the agreement. The parties can either decide that they may seek injunctive relief with local courts, despite the choice of arbitration, or give such power to the arbitration tribunal. For example, in 2012, the ICC instituted such a mechanism whereby an emergency arbitrator can be appointed in the event that a party seeks an interim injunction.
6. Tax and foreign exchange issues
Finally, the franchisor must take two additional issues into consideration:
- the taxation system in the target country: royalties and other fees are often subject to withholding taxes and other business taxes, which vary from a country to another and also depend on the international bilateral treaties between states. The advice of tax specialists on a case by case basis is therefore highly advisable in order to minimise the amount of taxes that must be paid both by the franchisor and by his local partner;
- the existence of foreign exchange regulations. These regulations are usually found in developing countries and are sometimes extremely strict.
Both the tax system and foreign exchange regulations might have an impact on the choice of the legal structure and of the business model by the franchisor. These issues should therefore be addressed cautiously.
Growth through internationalisation implies an in-depth preparation in order to choose the right business model and the right business partner(s).
To maximise the franchisor’s chances of success, it is advisable to prepare the international expansion with the assistance of franchise specialists in various fields (franchise recruitment, development and strategy, legal, insurance, marketing…).
Last Updated: 19-September-2016