INTERNATIONAL FRANCHISING – BUSINESS

AND LEGAL ISSUES

SOTIRIS YANAKAKISSOTIRIS YANAKAKISFranchise Attorney-at-Law LL.M. Harvard

General Director and Legal Counsel of the FRANCHISE ASSOCIATION OF GREECEMember of the Legal Committee of the EUROPEAN FRANCHISE FEDERATION

Vice Secretariat for the Legal matters of the MEDITERRANEAN FRANCHISE FEDERATION

Vice Secretariat for the Legal matters of the WORLD FRANCHISE COUNCIL

GENERAL Franchises are widespread in today’s society. Consumers do

business daily with a broad range of franchised brands - buying fast-food, coffee, gas and real estate, hiring cleaning services, booking vacations and having their taxes prepared. However, the popularity of franchising as a way of doing business is a relatively recent phenomenon.

 In its earliest sense, a franchise was understood as a “special

privilege to do certain things conferred by government on an individual or corporation, and which does not belong to citizens generally of common right”. This meaning is still relevant; the government grants franchises to companies such as telecommunications and utility service providers to encourage the development of a public good by the private sector.  

In the modern commercial environment, however, franchising now generally refers to a specific and prevalent method of doing business:

 

In its simplest terms, a franchise is a license from [the] owner of a trademark or trade name permitting another to sell a product under that name or mark. More broadly stated, a “franchise” has evolved into an elaborate agreement under which the franchisee undertakes to conduct a business or sell a product or service in accordance with methods and procedures prescribed by the franchisor, and the franchisor undertakes to assist the franchisee through advertising, promotion and other advisory services.

 

A franchise is a contract between two businesses, in which the franchisor grants the franchisee the right to operate its business system in return for payment of fees and royalties. The business system typically includes intellectual property (such as trademarks, trade names and logos), the right to sell products or services, access to business knowledge and methods, and other physical and intangible assets. Franchisors may operate some of their units directly and franchise others.

A key element of a franchise is the ongoing relationship between the parties. The franchisor often provides continuing support or direction regarding the operation of the business. The franchisee agrees to sell the franchisor’s product, often exclusively, and to comply with the franchisor’s standards. While the franchisee is an independent business, it will usually be required to operate in a way that is substantially similar to or indistinguishable from the operation of the franchisor and its other franchisees.

 

HISTORY

The franchising concept dates back to the English Middle Ages, when the Crown, wanting to avoid the costs and administrative burden of hiring, paying and supervising tax collectors, granted to officials the right to collect and keep the Crown’s taxes in return for a fee.

Franchises were also granted for purposes such as fairs and markets; a franchise gave an individual or group monopoly rights over a specific activity in a location for a period of time. Usually the individual or group that received the franchise was required to make a payment in return, generally a share of the product or profit, which was called a royalty.

Later, in North America, governments granted private individuals and corporations the right to carry out activities that would otherwise be restricted to the government, to facilitate the development of infrastructure and services such as railroads, utilities and banking.

Modern private sector franchising first appeared in the 1850s. The first franchise model is often attributed to the Singer Sewing Machine Company, which created an independent distributor network for its sewing machines. Over time, Singer developed mechanisms for greater control over the network, giving instructions for the operation of the offices and requiring detailed financial reporting. Although the business model ultimately failed for Singer, the private sector franchising concept began to take hold.

One of the first businesses to successfully employ the franchising concept was Coca- Cola. As the company expanded across the U.S., it licensed regional franchisee bottlers to produce and bottle soft drinks under its trademark. Coca-Cola’s rapid expansion was funded by the franchisees, who in return received exclusive distribution territories and support.

 General Motors began distributing automobile inventory across the

country through individual dealers in 1898. Dealers could purchase vehicles at a discounted price for resale and were granted regional franchise rights; in return they were required to sell only the products of a single manufacturer. This distribution method shifted to dealers some of the risks of market downturns, and proved to be successful for the automobile industry.

 

In the 1930s, oil refiners licensed franchisee gasoline stations to former employee managers to distribute their products. The refiners found that the owner-dealers had a more personal interest in the success of their locations, and the companies saw larger profits from higher gas sales and from the rent from the properties. In Canada, the Canadian Tire franchise was also successfully established in the 1930s.

 During the Depression, individual retail merchants grouped

together in order to cope more efficiently with the difficult economy and compete with large business chains. Following the Second World War, franchising expanded to a number of new industries, including fast food restaurants, hardware and drug retailing (including Shoppers’ Drug Mart in Canada) and motel and hotel services. There were high-profile failures associated with rapid expansion “as growth continued unprincipled and unregulated”, but by the 1970s, franchising had become a popular method of doing business and an enduring part of the U.S. and Canadian economies.

Franchising also permits a more rapid expansion through a selected market. This results from the combined effect of the more motivated owner managers, the use of the franchisee’s capital and the standardization of construction and business systems. 

Expansion into foreign jurisdictions is often easier, because the franchisee will take responsibility for dealing with local customs, tastes and regulations. The reduced amount of supervision required in a franchise system helps to overcome the problems of distance inherent in conducting business in other provinces or countries. Franchising is sometimes utilized, by a business which has expanded to its limit as a corporate owned network, to exploit markets which would otherwise be neglected. 

Franchising is the fastest and safest way to become a business owner. Rather than making all the mistakes and risking disaster at every turn of the road, a franchisee can buy the necessary experience and expertise. In many systems, franchisees get fantastic value in the knowledge they obtain for the dollars invested.  

When it is done properly and works well, franchising is a win/win situation for all concerned – not just for franchisors and franchisees, but also for consumers, landlords and suppliers. Consumers get superior products or services more efficiently and at better prices. Landlords can predictably increase their traffic flows and reduce the incidences of lease defaults. Suppliers can be assured of a steady volume of purchases with secure receivables.

THE FRANCHISE LEGAL RELATIONSHIP 1. Potential for Conflict The relationship between the parties to a franchise agreement is

often compared to a marriage: the parties depend on each other for their continued well being, the relationship is intended to continue for a lengthy period of time, and the arrangement is intended to be satisfactory to both parties. While franchisors and franchisees generally share a common desire to succeed, there is also considerable potential for conflict between them. The parties frequently have dramatically unequal bargaining power: the franchisor may have more extensive business and franchising experience and generally has control over the terms of the franchise agreement, while the franchisee may have little business experience and, in any event, often must “take or leave” the franchise agreement as offered.

 

The franchisee must rely to some extent on the franchisor’s representations with respect to the potential for business success, and some suggest that “all too often, the franchisor feels compelled to exaggerate the expected success of the franchise to make a sale”.

In some cases, disreputable franchisors use high-pressure sales

tactics and provide inaccurate or misleading financial information. When problems occur in the franchise, a franchisee suffering business difficulties will be less likely than the franchisor to have the financial resources available to fund litigation.

  

Various reviews of franchisor-franchisee disputes have identified a number of areas of conflict relating to the information and power imbalance in the relationship. The issues include: 

•lack of pre-contract disclosure;

•deceptive practices, including misrepresentation of the nature of the franchise, the range of supplies, equipment and training to be provided in the franchise package, the value and profitability of the franchise and the franchisor’s stability and prior experience;

•unfair contract terms arising from a refusal by franchisors to negotiate the terms and conditions of contracts (the “take it or leave it” contract);

•complexity of documentation;

•excessive prices charged for mandatory goods and equipment supplied by franchisors or other providers to franchisees, even when items are available more cheaply from alternative suppliers;

•hidden rebates and commissions received by franchisors from required suppliers;

•encroachment by the franchisor on the franchisee’s geographic trading area;

•franchisor-imposed system wide changes that bear significant cost;

•failure to provide adequate service and support to franchisees;

•substantial increases to renewal fees;

•use of advertising levies for non-advertising purposes;

•transfer and renewal restrictions and franchise renewals on different and more onerous terms; and

•unfair terminations.

FRANCHISING ETHICS

European Code of Ethics for Franchising, ‘Franchising is a system of marketing goods and/or services and/or technology, which is based upon a close and ongoing collaboration between legally and financially separate and independent undertakings, the Franchisor and its individual Franchisees, whereby the Franchisor grants its individual Franchisee the right, and imposes the obligation, to conduct a business in accordance with the Franchisor’s concept. The right entitles and compels the individual Franchisee, in exchange for a direct or indirect financial consideration, to use the Franchisor’s trade name, and/or trade mark and /or service mark, know-how, business and technical methods, procedural system, and other industrial and /or intellectual property rights, supported by continuing provision of commercial and technical assistance, within the framework and for the term of a written franchise agreement, concluded between parties for this purpose.’

  WFC Ethics , ‘Franchising is a commercial development strategy

based on an independent partnership between independent commercial entities, the franchisor and the franchisees’

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PREVIOUS BLOCK EXEMPTIONEUROPEAN REGULATION No 4087/88

‘franchise means a package of industrial or intellectual property rights relating to trade marks, trade names, shop signs, utility models, designs, copyrights, know-how or patents, to be exploited for the resale of goods or the provision of services to end users’

Further to the above, it is clear that franchising has two basic aspects: the legal (‘package of industrial or intellectual property rights) and the business aspect (‘a system of marketing goods and/or services and/or technology and a commercial development strategy’). Due to those aspects and the increase of transactions and collaborations in an international level, franchise agreements have become the preferable model of contract for many businesses around the world.

Certainly, that quick development was expected as franchising enables a business to expand and exploit its concept/franchise system both in national and international level quickly and with low cost while if this expansion proceeds carefully and according to laws and general policy of commercial transactions, results to the success .

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WHAT HAPPENS IN FRANCHISING WORLD

Notwithstanding the growth of franchising worldwide, only a few countries have elaborated a special legal frame concerning franchising. The rest of the countries that do not have such laws, apply general provisions of national laws in order to solve problems arisen from franchise agreements and franchise collaborations, with not always satisfying and fair results . Besides, even in those countries that have elaborated special laws about franchising, these laws do not cover all aspects of franchising but treat only some of them so as very few countries have adapted complete franchise regulations that cover all aspects of franchising.

The growth of franchising has also resulted to the appearance of several problems and disputes between the contracting parties that are solved worldwide either by mediation (where this is provided) or arbitration or Courts. However, the development of franchising around the world has indicated that problems between franchisor and franchisees do not differ much from one country to the other because they arise of course from the same source which is the franchising agreement. Furthermore, it is clear that the solutions given by Courts, arbitration or mediation are very often more or less the similar so as we could talk at least (even if we could not talk about a common legal framework of franchising) about a common appreciation of the significance of franchising around the world.

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FRANCHISE LAW ADAPTION MATTERS

Consequently and further to the above, the adaptation of specific franchise laws by the countries is today more than ever necessary because it could lead to :

◦ The achievement of security between the contracting parties .◦ The common appreciation of franchise rights and obligations

and the common settlement of disputes between the parties◦ The quicker development of franchising around the world as it

would be better founded and structured◦ The achievement of more benefits and profits for the parties

(franchisor and franchisees) and less risk as franchising would operate in a legally ‘well-framed way’

◦ The differentiation of franchising from any other kind of similar contracts existing around the world in different countries (that are regulated differently in each of them)

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WORLD LEGISLATION ENFORCEMENT

The usual legal framework met in countries that have applied special laws for franchising consists of mainly either disclosure laws or relationship restrictions or registration laws or all of them .

The countries that have applied such specific laws about franchising appear in the following presentation :

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COUNTRY DISCLOSURE

LAW

RELATIONSHIP

RESTRICTIONS

REGISTRATION

LAWS

ALBANIA YES YES NO

ALBERTA,

CANADA

YES YES NO

AUSTRALIA YES YES NO

BARBADOS NO NO YES

BELARUS NO YES NO

BELGIUM YES NO NO

BRAZIL YES NO YES

PEOPLE’S

REPUBLIC OF

CHINA

YES

YES

YES

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COUNTRY DISCLOSURE

LAW

RELATIONSHIP

RESTRICTIONS

REGISTRATION

LAWS

CROATIA NO NO NO

ESTONIA NO YES NO

FRANCE YES NO NO

GEORGIA YES YES NO

GREECE

INDONESIA YES YES YES

ITALY YES YES NO

JAPAN YES YES NO

KAZAKHSTAN NO YES NO

KYRGYZSTAN NO YES NO

LITHUANIA NO YES YES

MAKAU YES YES NO

MALAYSIA YES YES YES

MEXICO YES YES YES

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COUNTRY DISCLOSURE

LAW

RELATIONSHIP

RESTRICTIONS

REGISTRATION

LAWS

MOLDOVA YES YES YES

NEW ZEALAND NO NO NO

ONTARIO,

CANADA

YES YES NO

PRINCE

EDWARD

ISLAND,

CANADA

YES

YES

NO

ROMANIA YES YES NO

RUSSIAN

FEDERATION

NO YES YES

SAUDI ARABIA NO YES YES

REPUBLIC

OF KOREA

YES YES YES

SPAIN YES NO YES

SWEDEN YES NO NO

TAIWAN YES NO YES

TURKEY NO NO NO

UKRAINE NO YES YES

UNITED

STATES OF

AMERICA

YES YES YES (in 14 states)

VENEZUELA NO YES NO

VIETNAM YES YES YES

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DISCLOSURE LAW

financial information of the Franchisor and/or the master Franchisee (where applicable) publishable by law of last 2-3 years

business history of the Franchisor and/or the master Franchisee (where applicable)

a description of the franchised business. An estimate of the total costs associated with establishing a

franchised business. a general description of the principal characteristics of the

know -how the provision of technical support by the Franchisor and/or

the master Franchisee (where applicable) to the Franchisee.

names and addresses of the franchise network (with special reference to the existing franchised businesses in the case of a master Franchisee).

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the number of Franchisees whose franchise agreement have been terminated over the previous two (2) years and the reasons for such termination.

information relating to all licenses required by law for the establishment and operation of a franchised business whenever necessary and to all prerequisites for the issue thereof.

the essential elements of the franchise agreement such as rights and obligations of both parties, the duration of the agreement, conditions of renewal or termination, exclusivity clauses etc.

information on the master franchise agreement with the exception of the financial arrangements between Franchisor and master Franchisee.It is recognised that in discussing individual business projections with Franchisees, Franchisors are invariably involved in making assumptions which can only be tested by the passage of time.

SPECIAL FORMALITIES

Special definition of franchising Obligation for a written agreement for franchising duly

signed by the parties with the provision that all existing no written agreements should be adapted to a written form within a specific time period of 6 months-1 year otherwise they should be annulled .

Provision for a minimum duration of a franchise agreement of 5 years

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REGISTRATION LAWS

Obligation of registration of the franchise contract before the competent public authorities in each country or the Franchise Associations and provision of penalties in case of violation

Obligation of registration of interruption of a franchisor’s running of business and concept before the competent public authorities in each country or the Franchise Associations and provision of penalties in case of violation

Registration of franchisor’ s first franchise point and obligation of a previous proved operation of at least 1 year before developing each franchise system

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RELATIONSHIP LAWS

Provisions about the post contractual relations of the parties

Main obligations and rights of each party in a franchise agreement

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CONCLUSION

Further to the above, it is obvious that the adaptation of mainly a specific disclosure franchise law with few elements concerning relationship and registration, in different countries or even the adaptation of a common legal frame on franchising, for instance, through a Common Code of Ethics (ratified by a big number of countries) with compulsory effect, using the EUROPEAN FRANCHISE FEDERATON CODE OF ETHICS which IS AN EXCELLENT GUIDE ,could certainly result to the increase and development of ‘good standing’ franchise systems and the extinction of the eventual existing ‘fake’ ones that disadvantage franchising in order to gain the ‘win-win’ result and, consequently, the business success for both the parties (franchisor and franchisees).

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S.YANAKAKIS-A.KALOGEROPOULOU S.YANAKAKIS-A.KALOGEROPOULOU LAW OFFICESLAW OFFICES

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