September–October, 2015 Vol. 105 No. 5

Dedication: Gerald L. Ford

La peculiar función “ciudadela” de la marca renombrada en contratos con restricciones verticales. Estrategia competitiva, marca y distribución selectiva en redes físicas y virtuales. Luis Antonio Soler Pascual

The Peculiar “Citadel” Function of the Well-Known Trademark in Contracts With Vertical Restrictions: Competitive Strategy, Trademarks, and Selective Distribution in Physical and Virtual Networks Luis Antonio Soler Pascual

Delay in Filing Preliminary Injunction Motions: 2015 Edition Sandra Edelman and Fara S. Sunderji

Famous and Well-Known Marks in Mexico: Past, Present, and Future John M. Murphy

Parody as Brand Stacey L. Dogan and Mark A. Lemley

Questões Controversas Envolvendo Franquias no Brasil Paula Mena Barreto

Disputes Involving Franchising in Brazil Paula Mena Barreto

Commentary: Divert All Trademark Appeals to the Federal Circuit? We Think Not J. Thomas McCarthy and Dina Roumiantseva

Commentary: OEM

Commentary: The Nature of OEM Production in China Haoyu Feng and Jia Li

EDITORS’ NOTE

With this issue of The Trademark Reporter (TMR), INTA is pleased to introduce articles and commentaries in multiple languages. In alignment with INTA’s 2014–2017 strategic goal to bolster international expansion, the TMR will now publish multi-language pieces throughout the year to expose a broader TMR audience to important non-English writing on trademark law issues. Each article and commentary will be offered with an accompanying English translation. Inclusion of these pieces in the TMR will, it is hoped, have the salutary effect of encouraging authors whose native language is not English to share their writing with INTA’s members. Given the TMR’s long history of excellence and rigorous peer review, its editorial board is committed to ensuring that non-English pieces undergo as exacting an editorial process as that for English submissions but is aware that each submission (and corollary translation) may need to be handled differently from the norm. We have elected to approach English translations in a manner that champions fidelity to the author’s voice and favors substance over consistency with TMR style. We believe this is more respectful to authors and more useful for TMR readers. That said, we emphasize that only the native-language version of a multi-language piece should be considered authentic. TMR submission guidelines will be updated soon to reflect this exciting new feature and will include details about our translation process. We include three multi-language pieces in this inaugural issue, all of which have helped INTA to establish a framework for this practice going forward. In 2016, we anticipate having four to five multi-language articles spread throughout the year and expect this number to increase as more authors from around the world submit articles in their native languages. We would like to thank everyone who has helped to achieve this milestone, and hope that TMR readers will learn from and enjoy this new aspect of TMR scholarship.

DISPUTES INVOLVING

FRANCHISING IN BRAZIL

By Paula Mena Barreto

I. INTRODUCTION

In recent years, Brazil has shown steady, if not spectacular, economic growth based on macroeconomic stability. Moreover, its consumer market has shown particularly strong growth as a result of the rapid expansion of the middle class. This has produced a fertile climate for franchising. In 2012,1 the franchise sector produced revenue of R $107 billion,2 covering approximately 2,500 brands. The hospitality and tourism segments led the way in growth, followed by data processing and electronics.3 In 2013 and 2014,4 the sector produced revenue of R $118 billion and R $127 billion, respectively. Franchise segments that anticipate strong growth in the near future include food, tourism, and hospitality.5 Most of the large global franchisors already have a foothold in the Brazilian market, and more are arriving every year.

The strong growth of the franchise system in Brazil has been accompanied by legal disputes on a wide range of issues—primarily lawsuits arising from contractual obligations between franchisor and franchisee, but also disputes that address the obligations or liability of the franchisor to third parties. This article examines the main issues in dispute and the relevant

The author of this piece translated her work from English to Portuguese. INTA staff and members of The Trademark Reporter (TMR) Committee edited the English version, and the author then carried those edits to the Portuguese version of the piece. INTA staff and members of the TMR Committee have taken steps to ensure that the author’s intended meaning is preserved in both the English and Portuguese versions of the piece; however, because of language limitations, INTA has not undertaken its normal editorial process with regard to the Portuguese version of the article and does not vouch for the absolute congruity between the two versions. INTA’s goal is to expose important non-English writing on trademark law issues to the broader audience of its TMR readership.

Barbosa Müssnich Aragão Advogados, Brazil, Associate Member, International Trademark Association.

1. According to the Brazilian Franchise Association (http://www.portaldofranchising. com.br).

2. Brazil’s currency is the Real (R $). Over the period covered by this text, the exchange rate with the dollar fluctuated in an interval between approximately R $1.65 to R $3.10/US $, with a rough average of R $2.20/US $. The exchange rate for Euro is approximately R $3.41/EUR.

3. O Globo newspaper, October 28, 2013.

4. According to the Brazilian Franchise Association (http://www.portaldofranchising. com.br).

5. O Globo newspaper, February 3, 2014.

judicial treatment by the Brazilian courts. Although it is difficult to discover a unifying theme among cases that address such disparate issues as trademark protection, non-compete clauses, territoriality provisions, and liability to third parties (to name just a few), on many of these issues the decisions to date appear to favor the franchisors, confirming the business model’s potential appeal for brand owners wishing to enter the Brazilian market. The franchisees, on the other hand, tend to be protected in instances where their contracts are unclear or incomplete, or when their rights are contravened by a franchisor.

II. BRIEF OVERVIEW OF THE LEGAL FRAMEWORK

APPLICABLE TO FRANCHISING IN BRAZIL

Professor Borges Barbosa,6 one of Brazil’s leading franchising scholars, defines “franchising” as a system for multiplication of a business organization for sales of products or services under the responsibility of independent entrepreneurs, through the licensing of distinctive signs (brands, trade dress) or technology (patents), complemented by standardized administration. Under this arrangement, the franchisee bears the main business risk but has the expertise and resources of the franchisor at its disposal. However, this differentiation of roles is largely not evident to consumers, for whom the impression is basically that of a single organization with a chain of stores under the same brand.

Brazilian franchising law is primarily governed by Law 8,955 of 1994 (“Franchising Law”), which defines business franchising as:

The system by which a franchisor assigns to the franchisee the right to use a mark or patent, associated with the exclusive or semi-exclusive right to distribute products or services, and also possibly involving the use of technology for implementation and administration of the business or operational system developed or detained by the franchisor, against direct or indirect remuneration, but without characterization of an employment relationship.7 The Franchising Law applies to all franchising systems

established in Brazil, whether foreign or domestic. Franchising is also governed by the Civil Code (Law 10,406/2002), which contains rules on contractual relationships in general. The Franchising Law allows significant flexibility for the parties to define their contractual relationship and, in general, does not prescribe substantive rights and obligations. One notable exception concerns

6. BARBOSA, Denis Borges. Uma Introdução à Propriedade Intelectual. 2nd Ed.: Ed. Lumen Júris, p. 1059.

7. Franchising Law, Article 2.

the obligations of the franchisor regarding the information that must be contained in the “franchise offering circular,” which is described below. The franchise agreement itself is a complex instrument and involves many rights and duties of both parties, including transfer of technology, licensing of the brand, administrative and marketing assistance, supply of goods, and other aspects of the typical franchising arrangement. Both parties are typically contractually required to perform and satisfy numerous undertakings and obligations.

III. ISSUES IN DISPUTE IN

FRANCHISE RELATIONSHIPS

The numerous matters covered by a franchise agreement, as well as the complex relationship between the franchisor and franchisee, give rise to many opportunities for disputes. As with any such contractual relationship, one or both parties could become disenchanted and seek judicial or arbitral remedies to protect their rights. The disputes that arise range from obligations to register trademarks to provision of business assistance to responsibility for payment of certain taxes, among other things. Typical remedies include seeking termination of the contract together with monetary damages and enforcement of affirmative obligations or negative covenants.8

Many franchise-related disputes are resolved in arbitration; and because arbitration is a private procedure, there is little public information on the outcome of arbitrated franchise disputes. There is, however, significant jurisprudence from the courts, as discussed in this section, which attempts to present notable decisions from the full gamut of issues that arise in the franchise relationship.

A. Disputes Regarding the Franchise Offering Circular

The key document that must be prepared by the franchisor and carefully considered by the prospective franchisee is the “franchise offering circular.” The framers of the Franchising Law, in regulating franchising agreements, took pains to create this circular, which must contain clear and precise information on the

8. It should be noted that for many of the cases summarized herein, final decisions have not yet been rendered because they are subject to appeal to the Superior Tribunal of Justice (STJ), which is the highest court for non-constitutional matters, with responsibility for harmonizing the interpretation of federal laws and/or the Federal Supreme Court (STF), which is the highest court for constitutional matters, with responsibility for protecting and applying the Brazilian Federal Constitution. Furthermore, the general principle in Brazil (as is characteristic of code law systems) is that of jurisprudence constante, according to which a long series of previous decisions applying a particular rule of law is very important and may be determinative in subsequent cases, but is not binding on other courts, in contrast to stare decisis, according to which the decisions of the courts are binding precedent for future decisions (as is characteristic of common law jurisdictions).

business, to enable the interested party to have both an overview of the business and a clear idea of the specific rights and obligations of both parties.

In this respect, the Franchising Law enumerates all the requirements of the franchise offering circular, so as to protect the prospective franchisee from undisclosed risks. At the same time, these disclosures protect the franchisor, as since the inclusion of all relevant information fends off later allegations by the franchisee of ignorance of the conditions of the business. It is similar in nature to the required documents in other countries, such as the “basic disclosure document” required in the United States.

All the requirements for the contents of the franchise offering circular are found in Article 3 of the Law.9 The franchisor must

9. Article 3. Any time a franchisor is interested in setting up a business franchising system, the franchisor must supply a franchise offering circular to those interested in becoming franchisees, written in clear and accessible language, containing the following obligatory information:

I – a summarized history, corporate format and full name or company name of the franchisor and all companies directly related thereto, as well as the respective fictitious names and addresses;

II – balance sheets and financial statements of the franchisor company for the last two financial years;

III – a precise indication of all the pending lawsuits involving the franchisor, its controlling companies and owners of trademarks, patents and copyrights related to the operation, and its sub-franchisors, specifically questioning the franchising system or that can directly prevent the functioning of the franchise;

IV – a detailed description of the franchise, general description of the business and activities that will be performed by the franchisee;

V – a profile of the ideal franchisee regarding previous experience, level of schooling and other characteristics that are obligatory or preferable;

VI – requirements regarding direct involvement of the franchisor in the operation and management of the business;

VII – specifications regarding:

a) total estimated initial investment necessary to acquire, set up and start operation of the franchise; b) amount of the initial membership fee or franchise fee and security bond; and c) estimated cost of the installations, equipment and initial inventory and the respective payment conditions;

VIII – clear information on the periodic fees and other amounts to be paid by the franchisee to the franchisor or to third parties indicated by the latter, detailing the respective calculation bases and what they remunerate or their purpose, specifically indicating the following:

a) periodic remuneration for the use of the system, trademark or in exchange for services effectively rendered by the franchisor to the franchisee (royalties); b) rental of equipment or point of sale; c) advertising fee or similar; d) minimum insurance; and e) other amounts owed to the franchisor or third parties related thereto;

IX – complete list of all the franchisees, sub-franchisees and sub-franchisors of the network, as well as those that have left the system in the past twelve months, with name, address and telephone;

X – regarding the territory, the following must be specified:

deliver the circular at least ten days before execution of the contract or pre-contract, or payment of any fee by the franchisee (Article 4).10

According to Article 4, failure to comply with this advance disclosure can serve as grounds for the franchisee to annul the contract and obtain a refund of all the monies paid, plus interest and inflation adjustment as well as any losses and damages incurred. The same civil penalties also apply to franchisors that provide false or misleading information in the circular, plus any applicable criminal penalties.

There have been several cases regarding annulment of franchise agreements for violation of Articles 3 and 4 of the Franchising Law. In one such case, Farmacotécnica Seabra Nogueira Ltda. (franchisor) v. Viva Life Farmácia de Manipulação

a) whether the franchisee is guaranteed exclusivity or preference over a determined territory of operation, and if so, under what conditions; and

b) possibility for the franchisee to make sales or render services outside this territory or to engage in exportation;

XI – clear and detailed information regarding the obligation of the franchisee to acquire goods, services or inputs necessary to set up, operate or manage the franchise only from suppliers indicated and approved by the franchisor, offering the franchisee a full list of these suppliers;

XII – indication of what is effectively offered to the franchisee by the franchisor regarding:

a) supervision of the network; b) orientation and other services rendered by the franchisor; c) training for the franchisee, specifying the duration, content and costs; d) training for the employees of the franchisee; e) franchise manuals; f) assistance in analysis and choice of the site where the franchise will be established; and g) layout and architectural standards of the franchisee’s installations;

XIII – situation with the National Industrial Property Institute (INPI) of the marks or patents whose use is being authorized by the franchisor;

XIV – situation of the franchisee after expiration of the franchise, regarding:

a) know-how or industrial secrets to which the franchisee has had access because of the franchise; and b) establishment of an activity competing with that of the franchisor;

XV – standard model franchise contract, and as the case may be, also the model franchise pre-contract employed by the franchisor, with complete text, including the respective appendixes and validity periods.

10. Article 4. The franchise offering circular must be delivered to the franchisee candidate at least 10 (ten) days before execution of the franchise contract or pre-contract or also payment of any type of fee by the franchisee to the franchisor or a company or person related thereto.

In the event of failure to comply with the provision of the head of this article, the franchisee may move to annul the contract and demand refund of any amounts that have been paid to the franchisor or third parties indicated thereby as membership fee and royalties, duly adjusted for inflation by the variation of the basic interest rate on savings accounts plus losses and damages.

Ltda. ME (franchisee),11 the appellate panel12 held that the information contained in the circular is essential for the business and annulled the agreement because of the non-delivery of the offering circular, requiring a full refund of the amount paid by the franchisee.

In another case, between Dryclean USA do Brasil Lavanderias Ltda. and Next Challenge—Comércio, Serviços, Importação e Exportação de Equipamentos para Lavanderia e Cozinha Industrial Ltda. (franchisors) v. Maurício Lindolfo (franchisee)13—the appellate court upheld the lower court’s decision to annul the franchise agreement for failure to deliver the franchise offering circular. The reporting judge’s opinion cited the following passage from the scholar Claudio Vieira da Silveira:

It is evident that the franchising agreement is the legal instrument that binds and disciplines, both de facto and de jure, the relations between the franchisor and franchisee, establishing the rights, obligations and duties of the parties, but in the constitution of that agreement, the essential elements for the formation of the main and accessory clauses can under no circumstance be separated from the franchise offering circular, which must previously establish, clearly and objectively, all the rights and obligations that will be assumed by the franchisor and franchisee in the transaction.14 Disputes involving the circular do not relate only to the

amount of information or delivery of that instrument, but also to the accuracy of the information. This was the issue in Curso Mais Estudo Individualizado Ltda. ME (franchisor) v. Rosenilda Magnavita Lyro (franchisee),15 where the appellate court annulled the contract because of failure of the franchise offering circular to accurately describe the teaching method to be used in the courses to be given by the franchisee as well as failure to deliver the teaching material. The court ruled in favor of the franchisee, voided the contract, and ordered return of all monetary payments,

11. Rio de Janeiro State Court of Appeal, 4th Civil Chamber, Civil Appeal 0010224-87.2003.8.19.0001 (2007.001.59741), Reporting Judge Reinaldo P. Alberto Filho, decided on November 13, 2007.

12. In Brazil, the appellate courts (both state and federal) are divided into panels or chambers of judges, one of whose members is assigned to be the “reporting judge” (relator), with the job of examining the case in detail and summarizing it for the other judges of the chamber/panel and writing a leading opinion, which may or may not prevail in the final vote. The reporting judge, acting alone, can also issue various interim decisions and remedies, subject to review by the full chamber/panel.

13. São Paulo State Court of Appeal, 37th Private Law Chamber, Civil Appeal 0209114-24.2010.8.26.0100.

14. Claudio Vieira da Silveira, in Franchising Guia Prático, Ed. Juruá, 2nd edition, p. 275.

15. Rio de Janeiro State Court of Appeal 6th Civil Chamber Civil Appeal 0022091-41.2008.8.19.0021, Reporting Judge Pedro Freire Raguenet, decided on February 8, 2012.

based on the uncontested fact that the teaching method for the course did not correspond to the description included in the circular.

In De Plá e Agaphoto Ltd. (franchisor) v. Alvaro Dias Campelo Borges et al. (franchisee),16 the appellate chamber upheld the lower court’s verdict annulling the franchising agreement for failure of the offering circular to provide sufficient information about injury to good faith and the duty of loyalty. According to the decision, the circular failed to disclose the expenditures that would be necessary to get the business up and running. However, not all decisions regarding disclosure are favorable to the franchisee. There is a substantial body of case law holding that failure to present the franchise offering circular was not sufficient reason to annul the contract when other facts suggest the franchisee was fully aware of the inherent risks. In Ivan Lascaleia Pinheiro and Suellen Borges Pinheiro (franchisees) v. Emagrecentro Franchising Ltda. (franchisor),17 the franchisees argued that the franchisor had not presented the offering circular, preventing them from measuring the business risks due to their lack of experience in the health and beauty market. The appellate court held that the absence of the offering memorandum was not an obstacle to operationalize the business, where the franchisees did run the business for eight months, never asked for the offering memorandum, and had access to the relevant information in the franchise manual.18

A similar decision was rendered by the Reserved Business Law Chamber of the São Paulo State Court of Appeal. In Unicelli Comércio e Locação de Espaços Destinados a Serviços de Beleza Ltda (franchisee) v. Fazane Espaço Destinado a Serviços de Beleza S/S Ltda. (franchisor),19 the appellate chamber held that

16. Rio de Janeiro State Court of Appeal, 18th Civil Chamber, Civil Appeal 2008.001.48433, Reporting Judge Célia Meliga Pessoa, decided on September 30, 2008.

17. São Paulo State Court of Appeal, 2nd Business Law Chamber, Civil Appeal 0037482-94.2008.8.26.0068, decided on December 9, 2013.

18. According to the decision,

[t]here is no doubt that the offering circular is an important guarantee to the franchisee, and without a shadow of doubt it must be observed by the franchisor. However, the complaint regarding the alleged failure to present the circular should have been raised before the start of the activities, especially because in contracts of this nature, there is a presumption that the parties have equal acumen to formalize the deal, even considering the instruments are drafted with standard clauses. Despite the failure to present the offering circular, it is necessary to recognize that that fact was not an obstacle to implement the business, i.e., the plaintiffs were able to establish themselves as franchisees and integrally exercise their commerce (business), and the failure of the plaintiffs’ undertaking cannot be attributed to the alleged omission. Furthermore, the contract was maintained for approximately eight months, and at no time did the plaintiffs ask the defendant for the circular or complain of its absence. The plaintiffs also do not deny they had access to the franchisee manual, a document that contains the necessary orientation on the franchise.

19. São Paulo State Court of Appeal, Civil Appeal 0207083-65.2009.8.26.0100, Reporting Judge Pereira Calças, decided on October 11, 2011.

annulment of the franchise based on Article 4 of the Franchising Law depends on proving a causal connection between the franchisor’s omission and the loss alleged by the franchisee. According to the Chamber, the non-delivery of the offering circular, with no evidences of damages to franchisee, does not authorize the annulment of the contract, especially after its implementation.20

B. Trademark Questions in Franchise Agreements

The franchise contract includes, among other rights, the right to use the franchisor’s brand. The trademark obviously plays a key role in all franchises, by identifying the franchisee and binding it to follow uniform branding concepts to assure harmony of the network. Due to the importance of the brand, trademark-related disputes often arise between franchisees and franchisors. In circumstances involving the two most common issues that arise—(a) registration of the trademark, and (b) use of the mark after the contract ends—the decisions tend to favor the brand owner over the franchisee.

1. Application versus Registration of the Brand

Because of the typically long timeline for obtaining registration from the National Industrial Property Institute (INPI), it is common for franchisors to license their franchisees the use of their brand before a trademark registration is granted. Franchisees sometimes allege that the franchisor has breached the agreement by not obtaining a registration, but courts typically reject these claims.

For example, in Flavio Rezende Leite–Me VRF Comércio de Software, Treinamento e Capacitação de Recursos Humanos (franchisee) v. Compsul Brasil Livros e Consultoria Ltda. (franchisor),21 the franchisee sued to terminate the franchise agreement, alleging that the franchisor did not register the trademark. The appellate court denied the appeal, holding that the filing of a trademark application was sufficient to permit use of the mark by the franchisee:

(. . .) Despite, for example, the many (and well written) pages produced to differentiate application for a mark from registration of a mark, and trying to demonstrate the impossibility of recording transfer, the fact of the matter is that with the mere filing of the application it is possible to use

20. See also: Fernando dos Reis (franchisee) v. Vaz e Athena Gabriel Vaz–ME. (franchisor). São Paulo State Court of Appeal, 1st Business Law Chamber, Civil Appeal 0030252-34.2010.8.26.0196, Reporting Judge Teixeira Leite, decided on August 29, 2013.

21. São Paulo State Court of Appeal, 11th Private Law Chamber, Civil Appeal 9053158-07.2006.8.26.0000, Reporting Judge Soares Levada, decided on September 26, 2010, unanimous decision.

the mark, which is the fundamental aspect to be stressed. Regarding its use, Articles 13022 and 13923 of Law 9,279/96 (Industrial Property Law) clearly make this possibility legal. Hence, the alleged breach of contract is not present. Trademark registration was also discussed in Carinho do Pé

Podólogos Ltda. (franchisee) v. Spé o Spa do Pé Comercial Franchising Internacional Ltda. (franchisor). The franchisee sought nullification of the franchise agreement because the franchisor had not registered the trademark; at the time the agreement was executed, the application was still pending examination. The appellate chamber held, as in the above case, that Article 130, II, of the Industrial Property law allows the franchisor to license the use before obtaining registration.24

A related trademark issue that arises is the effect of subsequent denial of a trademark application by the INPI. This question was addressed in G 40 Educação e Treinamento Ltda. (franchisee) v. Projeta Cursos e Franquias Ltda. (franchisor),25 in which the franchisee sought a preliminary ruling to terminate the contract by summary judgment, because the franchisor’s application to register the mark PROJETA had been denied (a fact the franchisor had not reported to the franchisees). The appellate judges, following the opinion of the reporting judge, held that proof of the defects argued by the franchisee required examination of evidence from both sides, with proper rebuttal. The simple indication that the application had been denied, obtained from consulting INPI’s online database, did not make the franchise agreement unenforceable. Furthermore, despite the existence of a specific law governing such contracts, the rules of the Civil Code also apply, to the extent compatible, as does the principle of continuity of contracts. It was therefore premature to order summary termination of the contract before trying to find an alternative for continued validity. Hence, there was no unequivocal demonstration of the likelihood of the plaintiff’s allegations, one of the requirements for granting the interim relief sought.

22. Article 130—The owner of a mark or the applicant shall also be entitled to: I – assign his registration or application for registration II – license its use; III – take measures to ensure its material integrity or reputation.

23. Article 139—The owner of a registration or an applicant for registration may enter into a licensing contract for the use of the mark, without prejudice to his rights to exercise effective control over the specification, nature and quality of the respective products and services.

24. Rio de Janeiro State Court of Appeal, 15th Civil Chamber, Civil Appeal 2005.001.21114, Reporting Judge Ricardo Rodrigues Cardozo.

25. São Paulo State Court of Appeal, 2nd Business Law Chamber, Interlocutory Appeal 0016714-84.2013.8.26.0000, Reporting Judge José Reynaldo, unanimous decision, decided on July 1, 2013.

2. Abstention from Using Brands

After the End of the Contract

Another recurring trademark-related issue is the right of the franchisor owner to stop a former franchisee’s use of its trademark. Even after the end of the franchise agreement, some franchisees continue operating at the same location under the franchisor’s brand despite a contractual prohibition. Perhaps not surprisingly, the courts do not look favorably on post-termination use and generally issue orders prohibiting it. For example, in Mundo Verde Franquia Ltda. (franchisor) v. C&G Produtos Naturais Ltda. (franchisee),26 the appellate chamber concluded there was sufficient proof that the franchisee continued operating an establishment at the same address, selling products under the franchisor’s brand, even after the termination of the agreement for failure to pay royalties. The judges ruled that there was improper use of the brand and ordered the ex-franchisee to cease its activities. In another case, Maxcenter Distribuidora Comércio e Representações Ltda. (franchisor) v. Farmácia PH Ltda. (franchisee),27 the appellate chamber upheld a preliminary injunction issued by the lower court forbidding the defendant from continuing to use the PADRÃO brand until definitive resolution of the case on its merits, holding that, in addition to violating the franchisor’s trademark rights, the former franchisee was misleading consumers.

Similarly, in an interlocutory appeal filed by Original Brasil Comércio e Serviços de Telecomunicações Ltda. (franchisee) v. Telemar Norte Leste S.A. (franchisor),28 the appellate panel upheld the decision of the lower court ordering the franchisee to immediately cease using the franchisor’s trademark after termination of the contract by operation of law. In a dispute over a telephone system, franchise TNL PCS S.A (franchisor) sued Longitude Comércio e Serviços de Telecomunicações Ltda. (franchisee)29 to compel it to cease using the franchisor’s marks and other signs. Although the lower court refused to issue the injunction, the appellate court reversed, ruling that even though other issues were in dispute between the parties, the franchise agreement was previously terminated for default, so the franchisor

26. Rio de Janeiro State Court of Appeal, 5th Civil Chamber, Civil Appeal 2009.001.20666, Reporting Judge Cristina Tereza Gaulia, decided on June 16, 2009.

27. Rio de Janeiro State Court of Appeal, 5th Civil Chamber, Civil Appeal 0009439-48.2005.8.19.0004, Reporting Judge Zelia Maria Machado, decided on December 7, 2010.

28. Rio de Janeiro State Court of Appeal, 4th Civil Chamber, Interlocutory Appeal 2009.002.30229, Reporting Judge Sidney Hartung, decided on March 9, 2010.

29. Rio de Janeiro State Court of Appeal, 18th Civil Chamber, Interlocutory Appeal 2009.002.28363, Reporting Judge Leila Albuquerque, decided on 19.01.2010, unanimous decision, decided on March 31, 2010.

had a prima facie right to prevent the former franchisee from using its name, brand and other signs.

A final case relevant to this topic is McDonald’s Comércio de Alimentos Ltda. (franchisor) v. Food Land Comércio de Alimentos Ltda. (franchisee).30 The franchisor argued that the franchisee had breached the contract by failing to pay the service fees, so the contract should be terminated. The appellate panel upheld the preliminary injunction issued by the lower court ordering the franchisee to stop operating under the McDonald’s mark.

C. Absence of a Consumer Relationship Between

Franchisor and Franchisee

Another recurring issue in franchise disputes is whether the Consumer Defense Code (“CDC,” Law 8,078/1990) applies to transactions between the franchisor and franchisee. The CDC is applicable whenever the consumer—an individual or a legal entity—is considered the end-user of services or products.31 The Code establishes the legal principles and requirements applicable to consumer relations in Brazil, covering a broad range of issues such as product and service liability, contractual clauses, commercial practices, false advertising, civil procedures for individual and collective claims, including class actions, as well as administrative and criminal sanctions. Its main purpose is to establish a balance in the relationship with consumers, which is presumed to be naturally unbalanced. Thus, the CDC is quite consumer-oriented and provides much broader protection than the Civil Code.

Determination of whether or not an agreement between two companies is subject to the Consumer Defense Code is controversial in Brazil. However, with respect to franchise agreements, the majority view of the courts is that such agreements are not subject to the CDC. This is reflected in a decision by the Superior Tribunal of Justice (STJ) involving Oebax Vestuário Ltda. et al. (appellants) and Colcci Indústria e Comércio do Vestuário Ltda. (appellee), which held that “franchise agreements, by their nature, are not subject to the rules of Law 8,078/1990, since the franchisee is not a consumer of the products or services of the franchisor, but instead sells them to third parties, who are the end receivers.”32 The STJ took a similar

30. São Paulo State Court of Appeal, 23rd Private Law Chamber, Interlocutory Appeal 0023454-39.2005.8.26.0000, Reporting Judge José Marcos Marrone, decided on November 9, 2005.

31. Article 2.—Consumer is any individual or body corporate who acquires or uses any product or service as an end user.

32. STJ, Special Appeal 632958/AL, Reporting Judge Aldir Passarinho Junior, decided on March 4, 2010.

position in a case involving Banco Alfa de Investimentos S/A (appellant) and Cuiabá Produtos Automotivos Ltda. (appellee),33 holding that the Consumer Defense Code does not apply to franchise agreement between the parties, thus rejecting the allegation that the forum selection clause was abusive as part of an adhesion contract.34

A final emblematic decision on this issue was rendered by the Rio Grande do Sul State Court of Appeal, concerning a franchise agreement to sell petroleum derivatives. The court ruled that “the plaintiff cannot be construed as a consumer, because it uses the products supplied by the defendant in its business activity, and as such is not the final receiver.” The court further held that although franchise agreements are adhesive by nature, limiting the autonomy of will, this characteristic alone does not lead to their nullity because the vertical delimitation of the contractual provisions mainly aims to assure the success of the franchisee’s undertaking.35

D. Possibility of Joint and Several Liability

in Consumer Suits

Another significant franchise-related issue that arises is the possibility of joint and several liability of the franchisor for acts of the franchisee that are injurious to consumers. In Wizard Brasil Livros e Consultoria Ltda. (franchisor/appellant) v. Vanessa Cristina Oliva (appellee),36 the appellate chamber upheld the lower court’s preliminary injunction ordering the franchisor not to report the appellee’s name to credit bureaus. The franchisor had alleged that such report was made by its former franchisee, so that the franchisor was not the one subject to the injunction. The franchisor had further argued that it had no management powers over its franchisees, and in the specific situation, it had terminated the franchise agreement and did not know the whereabouts of the owner of such former franchisee.

According to the court, the standardization of the establishment, typical of franchising, makes it hard for consumers

33. STJ, Special Appeal 930.875, Reporting Judge Sidnei Beneti, decided on June 14, 2011.

34. Agreements that cover the relationship between consumers and suppliers are in general considered to be adhesion contracts. According to the Civil Code, adhesion contracts are those where the clauses have been approved by a competent public authority or are established unilaterally by the supplier of products or services, without the possibility of negotiation (GOMES, Orlando, Contratos. Ed. Forense, 2002, p. 109).

35. Rio Grande do Sul State Court of Appeal, 18th Civil Chamber, Civil Appeal 70031345077, Reporting Judge Pedro Celso Dal Pra, decided on September 10, 2009.

36. São Paulo State Court of Appeal, 18th Private Law Chamber, Interlocutory Appeal 0318830-92.2010.8.26.0000, Reporting Judge Rubens Cury, decided on October 13, 2010, unanimous decision.

to distinguish the division between the two companies. Therefore, the franchisor has the appearance of being the supplier because it places its brand and other distinctive signs on the services and advertises them to consumers, so the “theory of appearance”37 applies. Hence, the court held that the franchisor was the apparent supplier of the service under Articles 3,38 12,39 and 1440 of the Consumer Defense Code, and added that this is reasonable because of the presumed vulnerability of the consumer, according to the Code’s Article 4, item I.41 Therefore, the franchisor was held jointly and severally liable for the franchisee’s conduct.

In another case involving Wizard Brasil Livros e Consultoria Ltda., along with CWM Consultoria e Participações Ltda. (appellants) v. Vanessa Cristina Oliva (appellee),42 the appellate court applied the theory of appearance and also the doctrine of disregard,43 holding that the franchisor and franchisee appear to be a single enterprise to consumers, although from a legal standpoint they are different. Hence, there is joint and several liability between the franchisor and franchisee for damages caused to the consumer.

On the other hand, where the relationship between the franchisor and franchisee is disclosed to the injured party, at least one court has rejected joint and several liability. Thus, in a suit for moral damages (mental anguish or harm to reputation) filed by Vanildo Chuma (plaintiff) against Hoken International Company Ltda. (franchisor) and Paulo César Rondon (owner of a Hoken

37. The theory of appearance and the doctrine of disregard are applied in Brazil when two or more companies present themselves to the public and customers as a single company, although in the technical and legal point of view they are separate legal entities.

38. Article. 3: Supplier is any public or private, national or foreign individual or body corporate, as well as entities without a legal identity carrying on business in the field of production, assembly, creation, construction, transformation, import, export, distribution or commercialization of products, or rendering of services.

39. Article 12.: National or foreign manufacturers, producers, constructors, and importers are liable, regardless of the existence of culpability, for the redress of damages caused to consumers by defects from design, manufacture, construction, assembly, formula, handling, presentation or packaging of products, as well as for the improper or incomplete information about their use and risks.

40. Article 14: The supplier of services is responsible, regardless of culpability, for the redress of damages caused to consumers for defects related to the rendering of services as well as for incomplete or improper information about their use and risks.

41. Article 4: The purpose of the National Policy for Consumer Relations is to meet the consumer's needs, the respect to his dignity, health and safety, protection of his economic interests, improvement of the quality of his life, as well as transparency and harmony in the consumer relations, being considered the following principles:

I. – acknowledgment of consumers' vulnerability in the market relations;

42. Santa Catarina State Court of Appeal, Civil Appeal 2000.014832- 6, Reporting Judge Trindade dos Santos, decided on April 8, 2009.

43. The theory of appearance and the doctrine of disregard are applied in Brazil when two or more companies present themselves to the public and customers as a single company, although in the technical and legal point of view they are separate legal entities.

franchise store) for undue reporting of the plaintiff’s name to credit bureaus, the lower court held the pleading against Hoken to be unwarranted but to be partially warranted with respect to Paulo César, ordering payment of compensation for moral damages. The appellate chamber upheld the decision, ruling that Hoken could not be held liable. According to the reporting judge’s prevailing opinion, while that company was the manufacturer of the product (water filters) purchased by the plaintiff, and the sales receipt indicated the call center number of the manufacturer, it also carried the message that the seller (Água & Saúde Ltda., owned by the co-defendant), is “an independent Hoken franchise,” so there was no way to assign liability to the franchisor for the injury suffered by the plaintiff.44

E. Enforceability of Forum-Selection Clauses

Disputes as to the enforceability of forum selection clauses in franchise agreements arise with some regularity in Brazil, with forums selected by the franchisor usually enforced. According to Article 111 of the Civil Procedure Code, the competence of courts regarding subject matter and hierarchy cannot be derogated by arrangement between the parties, but the parties can modify the territory, thereby choosing the legal venue for suits involving rights and obligations. The choice of forum must be clearly stated in the contract. The Franchising Law does not contain any specific provision in this respect, so in principle there is nothing preventing the parties from stipulating the competent venue to resolve disputes over their rights and obligations. Nevertheless, it is very common for franchisees to allege that the contractual relationship is one of adhesion, in which they are the weaker party, so that the stipulation of a forum that is not convenient for them in effect denies their constitutional right to ample defense, and as such is invalid.

There have been various decisions on the question of forum selection. In most of these, the court’s position has been that the clause is valid, in service to the principle of pacta sunt servanda (as per Article 111 of the Civil Procedure Code),45 unless it is clearly demonstrated that the franchisee is the weaker party and the forum stipulated in the contract makes the full pursuit of its rights difficult.46

44. São Paulo State Court of Appeal, 16th Private Law Chamber, Civil Appeal 9152542-06.2007.8.26.0000, Reporting Judge Windor Santos, decided on August 3, 2010.

45. STJ, Special Appeal 765171/SE, Reporting Judge Jorge Scartezzini, decided on October 11, 2005.

46. STJ, Special Appeal 545575/RJ, Reporting Judge Cesar Asfor Rocha, published on September 9, 2003.

The economic value of the contract and level of knowledge are also factors that have been cited in some decisions on legal venue, such as Private Business Fashion Hair Franchising S/C Ltda. (appellant) v. Helio Ricardo Rodrigues (appellee).47 The court ruled that the forum-election clause was not abusive because it did not create any significant difficulty in access to the judiciary and the franchisee could not be considered the weaker party, given both the size of the deal and the respective sizes of the companies themselves. In another case, Mister S Comércio Empreendimentos e Administração Ltda. (appellant) v. Cabana Comida Árabe Ltda. (appellee), a different chamber of the same court held the clause to be valid on the same grounds.48

At the next level of appeal, a case decided by the STJ involving Lubrifiltros Representações Peças E Lubrificantes Ltda. et al. (appellees) and Shell Brasil S/A et al. (appellants)49 illustrates the need to verify the capacity of the litigants. In this case, the litigants were considered sufficiently capable from the financial, legal, and technical standpoints, of seeking justice in any court district they voluntarily contract.50 On the other hand, in Carlos Henrique Lagemann and Kinder Informática Ltda. (appellants) v. Futurekids do Brasil–Serviço e Comércio Ltda. (appellee), the STJ held that the franchise agreement was an adhesion contract, unilaterally drafted by the franchisor, which imposed all the clauses regarding the franchise, and held that this made the forum-selection clause abusive, since it was impossible for the franchisee to pursue its rights in the venue chosen. The court further stressed the disproportionate economic power of the franchisor in comparison to the franchisee.51

The decisions summarized above demonstrate that questions of legal venue should be analyzed on a case-by-case basis. Nevertheless, the majority view is that the forum-selection clause is valid unless one of the parties holds significantly less bargaining

47. São Paulo State Court of Appeal, 19th Private Law Chamber, Interlocutory Appeal 0005437-81.2007.8.26.0000, Reporting Judge João Camillo de Almeira Prado Costa, decided on March 27, 2007.

48. São Paulo State Court of Appeal, 23rd Private Law Chamber, Interlocutory Appeal 0412359-68.2010.8.26.0000, Reporting Judge José Marcos Marrone, published on December 1, 2012.

49. Special Appeal 813481/DF, Reporting Judge Massami Uyeda, decided on March 11, 2008.

50. The court held that “considering the large sums involved in the franchise agreement in dispute and the failure to demonstrate the inability to access the judiciary, since the isolated fact that the appellee company is now closed because of the contractual termination is not sufficient to consider the defense of its rights in the forum contracted to be unfeasible, the litigants are sufficiently capable, from the financial, legal and technical standpoints, of seeking justice in any court district they voluntarily contract.”

51. Special Appeal 32877/SP, Reporting Judge Carlos Alberto Menezes direito, published on February 26, 2003.

power than the other or there is some other obstacle preventing one of the parties from seeking judicial relief.52

F. No Guarantee of Profitability

A common claim made by franchisees is that the franchisor is to blame for the failure of the business. Many cases have held that a franchise faces the same risk as any other business, so there is no way to hold the franchisor liable for the franchisee’s losses, unless the franchisor affirmatively contributed in some way to the failure of the business. A decision from the Rio Grande do Sul State Court of Appeal illustrates this position, by stating that “[t]he franchise contract involves a business risk, by which there is an investment by the franchisee in the expectation of profit, based on market projections. The franchisee has the duty to manage the undertaking responsibly, so that the result will not be a loss.” The judges concluded that the failure of the venture was most likely caused by the plaintiff’s poor management, as indicated by the inspection report of the franchisor.53

In another case, this one involving a franchise store under the “DOM SABOR” brand, the franchisee sued to terminate the contract after only three months of operation, alleging that the franchisor breached its contractual obligations by not providing assistance to franchisee. The appellate chamber ruled that the refund of the franchise fee was not warranted because there was insufficient evidence of blame attributable to the franchisor and that three months of operation was not enough to build a customer base and reasonably expect a return on investment.54

The same position was taken in Marines Atolini de Oliveira (appellant) v. Hai Franchising Ltda. (appellee), where the judges

52. With respect to the choice of forum where the agreement is between a foreign party and a local franchisee, the Introductory Law of the Brazilian Civil Code, in its Article 12, establishes that a Brazilian court will be competent to rule in conflicts where the defendant has its domicile in Brazil and the obligations are performed in the country. It is not an absolute ground for competence like the one involving local real estate, but it does establish a relative competence for local courts which will decide, at their discretion, whether they are competent to hear the case. The Brazilian Civil Procedure Code further establishes that:

Article 88. The Brazilian judicial authority is competent when:

i – the defendant, independently of its nationality, is domiciled in brazil;

ii – if the obligation is to be executed in brazil; and

iii – the lawsuit arises from a fact occurred or an act practiced in Brazil.

Some Brazilian scholars and jurisprudence understand that, due to the provisions of 88 of the Brazilian Code of Civil Procedure, Brazilian jurisdiction cannot be summarily dismissed at the parties’ will. Therefore, if the parties have no interest in resolving disputes in Brazilian Courts, arbitration could be an alternative.

53. Rio Grande do Sul State Court of Appeal, 10th Civil Chamber, Civil Appeal 70037569613, Reporting Judge Túlio de Oliveira Martins, decided on August 26, 2010.

54. São Paulo State Court of Appeal, 37th Private Law Chamber, Civil Appeal 051430-12.2005.8.26.0100, Reporting Judge Irineu Fava, decided on June 14, 2012.

found there to be no guarantee of profitability.55 In a case involving the “Curves” franchise, the lower court ruled that J Assessoria Consultoria e Comércio de Artigos Desportivos Ltda. (franchisor) did not provide adequate assistance to the franchisee, Carla Walzertudes de Liama et al., and this failure was a relevant reason for the closing of the business. However, the appellate court reversed, ruling that the failure of the business could not be blamed exclusively on the franchisor, because both parties were in breach of contract.56

G. Enforceability of Non-Compete Clauses

Still another area of frequent dispute between franchisors and franchisees is the enforceability of post-relationship non-compete clauses. The principle of free competition is established in the Brazilian Constitution. However, this principle is not absolute, because it must be analyzed in light of other constitutional principles, such as those against unfair competition and abuse of power. According to well-known Brazilian author Fábio Ulhoa Coelho:57

The constitutional right to engage in economic activity, expressed in the principle of free initiative as the basis for organization of the economy, corresponds to a duty imposed on all. In relation to the state, this duty means the unconstitutionality of administrative requirements for opening and operating a business that are not based on law (Art. 170, sole paragraph). With respect to private parties, it translates into the unlawfulness of some competitive practices. Unlawful applies to all forms of competition prohibited by law, irrespective of the civil, criminal or administrative nature of the penalty. Sidnei Amendoeira Júnior, a law professor who specializes in

franchising, points out the need for non-compete clauses to protect the franchising system and to preserve the brand and clientele of the franchisor against unfair competition if a franchisee decides to end the relationship and compete independently with the franchisor and its other franchisees. He adds that franchise contracts commonly include non-compete clauses to deter this type

55. São Paulo State Court of Appeal, 13th Private Law Chamber, Civil Appeal 9140805-69.2008.8.26.0000, Reporting Judge Heraldo de Oliveira, decided on February 11, 2009.

56. Rio de Janeiro State Court of Appeal, 16th Civil Chamber, Civil Appeal 0002890-53.2009.8.19.0207, Reporting Judge Mauro Dickstein, decided on July 24, 2012.

57. Fábio Ulhoa Coelho, Curso de Direito Comercial, Ed. Saraiva, 4th ed., 2000, vol. 1, p. 183.

of behavior, which are justified on the ground that the franchisor provided its know-how to the franchisee.58

Professor Denis Borges Barbosa, one of Brazil’s leading franchising scholars, in commenting on the conditions for lawfulness of private contractual clauses, cites Rubens Requião, a renowned Brazilian commercial law specialist, according to whom the chief criterion for ascertaining the lawfulness of clauses is to determine the extent to which the exercise of competition can injure the party the clause is intended to protect. In other words, to what extent is it necessary to protect the interests of the beneficiary without injuring those of the other party (and in the sphere of antitrust law, the interests of defending competition in general)? It is the balance of interests that determines the legality. All these considerations enable configuring the requirements for validity of a clause or agreement restricting competition, from the legal perspective. Such restrictions must be limited in time, space, and subject matter, so that they subsist only to the extent needed to protect the legitimate interests of the beneficiary. Hence, such clauses have an accessory function of guaranteeing the main agreement, whose purpose is not to directly affect competition.59

The legitimacy of non-competition provisions is generally accepted by Brazilian courts. With respect to the acceptable time frame, there is no limit specified in law, so courts typically rely on Article 1147 of the Civil Code as a parameter, according to which “in the absence of express authorization, the seller of an establishment cannot compete with the acquirer in the five years after the transfer.” Despite this, most contracts that have been the subject of disputes stipulate non-compete clauses lasting no longer than three years. In CWM Consultoria e Participações Ltda. (franchisor) v. Omni Ensino de Idiomas e Representações Comerciais Ltda. (franchisee),60 the franchisee alleged that the non-compete clause was abusive, offending the rights of freedom to exercise a profession and free initiative. The appellate judges held that the prohibition of the former franchisee to engage in the same business in the same territory for 24 months after the end of the agreement was reasonable, because the right of the franchisor to be protected against unfair competition outweighed the right of free professional exercise and free initiative.61

58. Sidnei Amedoeira Júnior, “Principais Características dos Contratos de Franchising”, in Direito Processual Empresarial, org. Gilberto Gomes Bruschi et al. Ed. Campus Jurídico, 2012, pp. 948-949.

59. P. 1083.

60. São Paulo State Court of Appeal, Civil Appeal 0021636-35.2004.8.26.0114, Reporting Judge Ricardo Negrão. Published on August 19, 2013.

61. According to the decision,

(. . .) on signing the franchise contact, the co-plaintiffs obtained knowledge of the ‘business secret’ of the franchisor, which had made a financial investment in

In the case Databarao Edições Culturais Ltda. (franchisee) v. MC Edições Culturais (franchisor), the franchisee was ordered by the lower court to pay a penalty for breach of the non-compete clause.62 However, the appellate chamber reversed, holding that although the franchisee continued to engage in informatics (data processing) teaching after the termination of the contract, it did so without using the franchisor’s brand, products and methods. The judges also found that the franchisor had failed to demonstrate it suffered any damage, so there could be no holding of unfair competition.

Further on the question of unfair competition, the judges explained that although it was not present in the case, in principle non-compete clauses are valid, since they aim to deter unfair competition by former franchisees through unauthorized use of franchisor know-how. Therefore, if properly limited, such clauses do not violate Article 170 of the Federal Constitution. However, in this specific case, the evidence indicated that the contract had been breached by both parties, notably by the failure of the franchisor to control the territorial overlap of other franchisees, as well as its imposition of unreasonable requirements to acquire software licenses and excessive charges for advertising and marketing. Furthermore, the act of continuing to offer informatics training classes did not imply unfair competition with the franchisor, especially considering the proliferation of such schools and the fact that the equipment and knowledge to perform this activity can be acquired freely by anyone wanting to engage in this field of business, with or without a franchise. In short, there was no unfair competition justifying imposition of the contractual fine.

In a case involving fast food, the STJ upheld the decision of the São Paulo State Court of Appeal that ordered Jack Alimentos e Medicamentos Ltda. (franchisee) to pay moral damages (harm to reputation) to Bob’s Indústria e Comércio Ltda. (franchisor)63 for breach of the contractual obligation not to engage in similar activity in the same territory for 18 months after the end of the contract. While the indemnification for moral damages was upheld, the pleading for material damages (actual damages and

obtaining the know-how. The knowledge was transmitted to the franchisees, through the training and guidance provided for application of the teaching method. This knowledge is naturally aggregated to the human being. Hence, it is evident that to continue operating in the same area, the franchisee will not undo that knowledge and the interdiction exclusively applied to the area covered by the franchise is legally permitted, as occurs in succession of business establishments. It is a period of separation of the entrepreneur from the business activity, seeking to protect the party that invested in the consolidation of the brand and the franchise.

62. São Paulo State Court of Appeal, 14th Private Law Chamber, Civil Appeal 9107862-38.2004.8.26.0000, Reporting Judge Thiago de Siqueira, decided on December 9, 2009.

63. Special Appeal 18.799–SP (2006/0010714-6), Reporting Judge Castro Filho.

lost profits) was denied, because the former franchisee did not continue to operate under the same brand. On the contrary, it had removed all the signs and replaced the menus and other indicia so that consumers would not be misled to believe there was any connection with Bob’s by the simple fact of operating a fast food restaurant selling similar food items.

Because of the lengthy period generally required for court cases to be resolved in Brazil, plaintiffs seeking to enforce non-compete clauses almost always request preliminary injunctive relief from the lower court, generally on an ex parte basis. The decision to grant or deny such relief is then often the subject matter of interlocutory appeals by either side. For the most part, the decisions in these appeals have been to deny the preliminary injunction sought by the franchisor regarding the non-compete clause. This is based on the position that such prohibition requires careful examination of the facts and guarantee of the principle of rebuttal, due to the irreparable harm that can be caused to the former franchisee from a wrongful injunction, and also the possibility of abuse of right by the franchisor.

In an interlocutory appeal of a lower court decision that ordered the appellant, Incisivo Odontologia Ltda. EPP, to abstain from activity in the dental clinic field for a period of two years after termination, the appellate court held that although non-compete clauses are constitutional, there is a need to examine the facts of the case to decide on their efficacy and validity, from the standpoint of the theory of abusive exercise of rights.64 In this case, the appellate judges decided it was prudent to wait for the conclusion of the evidentiary phase before making any ruling on enjoining the former franchisee from engaging in its activity, due to the losses this could cause.

In an internal appeal65 filed by Tim Celular S.A (franchisor) against a decision favorable to Soares & Soares Comércio de Telefonia Móvel Ltda. Me. (franchisee),66 the appellate panel ruled against the franchisor, holding there was insufficient evidence to justify the need for interim relief; and an obligation not to compete imposed too drastic a measure on the ex-franchisee. According to the decision, “strictly speaking, the non-compete undertaking is compatible with the law. The validity of the clause, however, must be judged from both a standpoint of time and deprivation of the right to work. The effects of a preliminary order, in the specific

64. São Paulo State Court of Appeal, Interlocutory Appeal 0054513-64.2013.8.26.0000, Reporting Judge Alexandre Marcondes, decided on May 21, 2013.

65. An “internal appeal” (agravo interno), also known as a regimental appeal (agravo regimental), is a motion for en banc reconsideration by the full panel/chamber of a decision by the reporting judge alone.

66. Rio Grande do Sul State Court of Appeal, Interlocutory Appeal 7005501383, Reporting Judge José Aquino Flores de Camargo, decided on July 18, 2013.

case, could be deleterious to the franchisee.” Finally, another decision addressed the question of the territorial extent of the non-compete clause. In this case, the owner of the former franchisee, Alfredo Capozzi Filho, argued for the nullity of the non-compete clause in the contract with 5 À Sec do Brasil Franchising Ltda. (franchisor),67 due to the absence of a territorial limit. The appellate chamber refused to recognize any abusiveness in the clause, despite the lack of territorial limitation.

H. Exclusiveness and Territorial Scope

The indication of exclusivity or preference in a particular territory is an obligation established in Article 3(X)(a) of the Franchising Law, according to which the franchise offering circular must stipulate whether or not the franchisee is guaranteed of exclusivity or preference in a determined territory and, if so, under what conditions. Franchise contracts usually include a territorial limit on the franchisee, by requiring it to sell the franchisor’s products or services within a given area. The franchisor, in turn, is prevented from allowing other franchisees to operate in the territory. Disputes frequently arise over the enforcement of these territorial limits.

In an appeal involving a franchise related to car rental under the UNIDAS REND A CAR brand,68 the court held that the franchisor committed a contractual infraction by directly and through a third party exercising the same activity in the exclusive territory of the franchisee and in those where it has preference rights. In Maciel Braga Ltda. (franchisee) v. Sofcon Sociedade Franchising e Consultoria Ltda. (franchisor),69 the franchisee alleged that it held the rights to sell products under the L´ACQUA DI FIORI brand, but was surprised by the opening of a new franchise in the city, within its exclusive territory. The lower court denied the claim, on the grounds that the new store was located outside the area where the plaintiff could reasonably expect to draw customers, a decision that was upheld on appeal.

In Concessionária San Marino (franchisee) v. San Marino (franchisor), the franchisee alleged, among other arguments, that the franchisor violated the exclusivity clause and the duty of loyalty by selling vehicles within the plaintiff’s territory (city of

67. São Paulo State Court of Appeal, 14th Private Law Chamber, Civil Appeal 9108453-92.2007.8.26.0000, Reporting Judge Des. José Tarciso Beraldo, decided on March 26, 2008.

68. Santa Catarina State Court of Appeal, 3rd Commercial Law Chamber, Civil Appeal 2005.018153-2, Reporting Judge Fernando Carioni, unanimous decision, decided on September 15, 2005.

69. Minas Gerais State Court of Appeal, 11th Civil Chamber, Civil Appeal 1.0024.09.510797-5/001 (5107975-72.2009.8.13.0024 (1)), Reporting Judge Duarte de Paula, decided on May 5, 2010.

Gravatái).70 The appellate chamber upheld the lower court’s decision holding that the contract between the parties expressly allowed the defendant to continue selling vehicles to customers residing in the franchisee’s territory, so that the franchisor did not violate any contractual duty, but rather only relied on a prerogative stipulated in the instrument. In Sonia Carlotti–Comércio de Colchões Ltda. (plaintiff/appellant) v. Centro de Produção Rio Grandense de Espumas Industriais Ltda. (defendant/appellee), the appellate chamber reversed the lower court verdict, accepting the plaintiff’s arguments that the defendant (a mattress and bedding franchisor) acted in bad faith by authorizing other franchisees to set up installations at a traditional street market to sell the products in a small city where the plaintiff had a franchise store. Even though the contract did not stipulate territorial exclusivity in that city, the judges held that the plaintiff had a legitimate expectation, created by the defendant, of exclusivity in the small city, and that the competing marketing effort constituted an affront to the duties of good faith and loyalty.71

Some decisions have addressed the definition of territoriality, as in Multi Treinamento Ltda. (franchisor) v. Biel Treinamento Ltda. (franchisee).72 In this case, the court held that the territorial exclusivity clause was vague, accepting the arguments of the franchisee and denying the franchisor’s pleadings. The contractual clause in question read as follows: “The Franchisee is authorized to establish itself in the city of Brasília at an address that must be approved in writing by ALPS [franchisor], and the change of that address without the prior authorization of ALPS [franchisor] is not permitted under any circumstance.” The court further held that “these provisions do not contain any express stipulation regarding the territorial limits of exclusivity. In reality, the contract is obscure on this point and must be interpreted according to the expression of the will of the parties stipulating exclusivity in the area of operation, especially including teaching establishments.” The judges considered this to be the urban perimeter measured from the address approved for functioning of the franchise.

70. Rio Grande do Sul State Court of Appeal, 20th Civil Chamber, Civil Appeal 70030664981, Reporting Judge José Aquino Flôres de Camargo, decided on October 14, 2009.

71. Rio Grande do Sul State Court of Appeal, 9th Civil Chamber, Civil Appeal 70061266201. Reporting: Judge Miguel Angelo da Silva, decided on September 24, 2014.

72. São Paulo State Court of Appeal, 2nd Business Law Chamber, Civil Appeal 0069172-32.2010.8.26.0114, Reporting Judge Ricardo Negrão, split decision, decided on August 7, 2012.

I. Obligations of the Franchisor to Assist Franchisee

Article 3 of the Franchising Law defines the obligations of the franchisor and franchisee that must be stated in the offering circular. Besides these obligations, the contract can freely establish others. Questions involving default of the various contractual obligations of the franchisor are very case-specific, and can only be resolved by examining the franchise agreement and evidence presented in the specific case. Nevertheless, the decisions below, involving claimed failures to live up to various obligations under franchise agreements, illustrate the types of issues that can arise.

In Roberto Leonel Dubet da Silva Mouga, Denise Monique Dubet da Silva Mouga and Quick Clean Lavanderia Ltda. (franchisees) v. 5 À Sec do Brasil Franchising Ltda. (franchisor),73 the appellate chamber overturned the lower court’s decision and held that the franchisor was in default for failing to deliver the necessary equipment for the franchise. The franchisees were required to purchase the equipment and other items necessary to operate the store from Dry Brasil Importação e Logística Ltda., a company belonging to the franchisor’s business group, and had done so, paying in advance. Therefore, the failure to deliver the equipment by the seller constituted default by the franchisor.

In Flavio Rezende Leite–ME Vrf Comércio de Software, Treinamento e Capacitação de Recursos Humanos (franchisee) v. Compsul Brasil Livros e Consultoria Ltda. (franchisor),74 the franchisee appealed a verdict by the lower court that rejected its suit based on the allegation, among other questions, that the franchisor had failed to provide the support for the development of the business. According to the appellate chamber, there was no breach by the franchisor, and the appeal against the franchisor was rejected.75

In a typical case, the franchisor Sports Marketing Agency S/c Ltda. Sma sued the franchisee Rav & Valente s Agencia de Atividades Desportivas Ltda.,76 seeking return of the materials

73. São Paulo State Court of Appeal, 14th Private Law Chamber, Civil Appeal 0016564-45.2009.8.26.0000, Reporting Judge Pedro Ablas, decided on September 15, 2010.

74. São Paulo State Court of Appeal, 11th Private Law Chamber, Civil Appeal 9053158-07.2006.8.26.0000, Reporting Judge Soares Levada, decided on September 26, 2010.

75. The court confirmed the verdict, holding that “the fact is, unfortunately, that while the circumstances all indicate the appellant entered into a bad deal, it cannot be concluded that the losses suffered can be debited to the alleged misconduct of the appellee, even though it did show a certain amateurishness in its assistance. Once again, however, this is incidental to rather than of the essence of the contracted franchise, insufficient to establish a causal connection between this failing and the alleged losses.”

76. São Paulo State Court of Appeal, 19th Private Law Chamber, Civil Appeal 9089315-08.2008.8.26.0000, Reporting Judge Sebastião Junqueira, decided on November 3, 2008.

delivered, cessation of use of the franchising system and brands, alteration of the store façade and layout and payment of liquidated damages. The franchisee appealed the verdict in favor of the plaintiff, insisting on application of the theory of exceptio non adimpleti contractus,77 because the plaintiff had also defaulted on its obligations. The appellate chamber upheld the verdict, ruling there was proof of delivery of the offering circular and, regarding the other arguments, that the obligations allegedly breached by the plaintiff (i.e., marketing activities and trademark advertising) were not obligations, but rather facultative considerations, and could not be used as a reason to terminate the contract. According to the decision, “there is no way to speak of application of the exception non adimpleti contractus, since the contract in dispute does not stipulate reciprocal dependence of considerations to be performed simultaneously. Moreover, the plaintiff did not refuse to comply with any obligation established in the contract.” In another case, Caipira Label Rouge Ltda. (franchisor) v. Devones de Carvalho (franchisee), the appellate chamber upheld the lower court’s decision ordering the franchisor to indemnify the franchisee for the losses suffered for failing to provide the proper assistance and oversight.78

Another obligation over which disputes can arise is that of the franchisor to provide marketing and advertising support. It is very common for franchise agreements to stipulate payment of a percentage of the franchisee’s revenue, allocated to a marketing fund managed by the franchisor. This can lead to disputes over the way the money is spent, or the effectiveness of the marketing campaigns paid for by the franchisees. In one marquee case, the franchisee sued the franchisor to force it to properly account for the money spent on advertising, based on the contractual provision requiring delivery of an annual report upon request. The appellate chamber ruled that “the contract at issue assures the defendant, here the appellee, of free administration of the funds received from the franchisees’ payments, as well as free choice of the programs to be conducted, without interference of the franchisee. However, there was an express request for rendering of accounts regarding the royalties, as well as clarification of possible favoritism of the franchisor’s own store in detriment to the franchisee.” The allegation of the franchisee was accepted and the franchisor was

77. This principle is reflected in Article 476 of the Civil Code, which establishes that “[i]n bilateral contracts, neither of the parties may demand performance of the other party’s obligation before performing his own.”

78. São Paulo State Court of Appeal, 11th Chamber, Civil Appeal 9139971-81.1999.8.26.0000, Reporting Judge Antonio Marson, decided on October 4, 2001.

ordered to render accounts of the management of the marketing fund.79

J. Obligations of the Franchisee to Pay Royalties

With respect to payment of royalties, the decisions generally are favorable to the franchisors in cases of default by the franchisee, as reflected in those summarized below. In an appeal filed by Ademar Hiunes Junior (franchisee) v. Microlins Brasil Ltda. (franchisor), the lower court’s decision was upheld regarding termination of the contract and payment of liquidated damages, based on the existence of a confession of debt signed by the franchisee regarding nonpayment of royalties and advertising fund fees. The court held that the alleged failure of the franchisor to render technical marketing assistance was not proved.80

In Silvia Mendes Moreira (franchisee) v. Kumon Instituto de Educação Ltda.,81 the franchisee appealed the lower court’s verdict allowing termination of the contract by the franchisor. According to the franchisee, the termination was unilateral and unjustified. The appellate chamber, however, ruled that the termination was justified because of the franchisee’s repeated failure to pay royalties, without any indemnification owed to the franchisee, who had benefited from the teaching method and had attracted sufficient students to pay the amounts owed. Finally, in an interlocutory appeal filed by ALESER–Participações e Negócios Ltda. (franchisor) v. Fast Caxias Comércio de Alimentos Ltda. (franchisee),82 the appellate chamber overturned the lower court’s decision and granted a preliminary injunction ordering the franchisor to cease using any brand element of the franchisor due to failure to pay royalties.

K. Tax questions—Municipal Services Tax (ISS) on

Franchise Agreements

Brazil has a complex tax system, with a wide range of taxes and contributions83 at federal, state, and municipal levels. The

79. Rio de Janeiro State Court of Appeal, 13th Civil Chamber, Civil Appeal 2007.001.42265, Reporting Judge Azevedo Pinto, decided on September 12, 2007.

80. São Paulo State Court of Appeal, 15th Private Law Chamber, Civil Appeal 0020890-03.2008.8.26.0576, Reporting Judge Adherbal Acquati, decided on September 21, 2010.

81. São Paulo State Court of Appeal, 20th Private Law Chamber, Civil Appeal 9199066-95.2006.8.26.0000, Reporting Judge Francisco Giaquinto, decided on August 23, 2010.

82. Rio Grande do Sul State Court of Appeal, 18th Civil Chamber, Interlocutory Appeal 70024534737, Reporting Judge Cláudio Augusto Rosa Lopes Nunes, decided on June 6, 2008.

83. Contributions, which may only be established by the federal government, are taxes whose revenues are allocated for specific uses instead of going into the general fund.

taxing powers of the three levels of government are established primarily by the Federal Constitution and also by other federal legislation. Brazilian taxation is subject to the principle of legality, under which no tax may be established, or tax rate increased, without a law. Because of the complexity of the system, disputes can arise between companies and the tax administration, at all three government levels. Disputes can also occur between franchisors and franchisees regarding which party shall be responsible for payment of the taxes.

Whether payments under franchise agreements are subject to Municipal Services Tax (ISS) is an unsettled question. Supplementary Law 116/200384 contains a list of the services that are subject to ISS, and mentions franchising agreements. However, opponents argue that services are only a small part of a typical franchise agreement. In Extraordinary Appeal 603.136/RJ, the Supreme Court (STF) assigned general repercussion (repercussão geral) to the issue, signaling the importance attached to it.85

According to Supreme Court Justice Gilmar Mendes, in his favorable vote on assigning general repercussion to the case, “the list attached to Complementary Law 116, in item 10.04, establishes the application of ISS on franchise agreements. Therefore, the ruling out of the incidence of ISS on these contracts presupposes declaration of unconstitutionality of this provision.”86 The main argument in the current extraordinary appeal is that assessing ISS on franchise agreements violates the constitutional framework, according to which service tax applies only on service provision agreements, solely involving an obligation by the service provider to do something (obrigação de fazer), rather than an obligation to give something (obrigação de dar).

According to this position, franchise agreements are complex hybrid contracts, covering both obligations to deliver and perform, and their main objective is not to render a service, as defined in

Because the revenue in the general fund is constitutionally subject to certain set-asides (e.g., education, health, revenue sharing with state and municipal governments), the establishment of contributions gives the federal government greater discretionary spending power.

84. A supplementary law (lei complementar) is an enabling law of constitutional provisions.

85. General Repercussion (repercussão geral) is a procedural mechanism that allows Brazil’s constitutional court, the Supreme Federal Court (STF – Supremo Tribunal Federal) to select which appeals it will hear, based on the criteria of legal, political, social and economic significance. The primary purpose of the mechanism is to reduce the number of appeals to the STF. Once the STF declares that a case has “general repercussion,” it will examine the merits of the question at issue in the case and its decision will be binding on all lower courts in cases presenting the same question.

86. Favorable vote issued by Supreme Court Justice Gilmar Mendes when assigning general repercussion to Extraordinary Appeal 603.136/RJ on 09/02/2010.

Article 2 of Franchising Law. Justice Marco Aurélio also voted for assigning general repercussion to the case, because of its economic and social relevance: “[W]hether or not charging ISS on these contracts satisfies the constitutional definition of the tax requires the final word of the STF.”87 As this is a controversial issue, which was submitted to the institute of general repercussion (repercussão geral), only following the STF’s decision will it be settled whether the ISS is indeed due under franchise agreements.

L. Labor Relations

Two significant questions can arise regarding labor relations under franchising agreements: (i) the existence of liability of the franchisor (either joint and several or residual liability) for unsatisfied labor obligations of the franchisee; and (ii) the existence of an employment relationship between the owner of the franchisee company and the franchisor. According to Article 2 of the Franchising Law, a franchising relationship is one “without characterization of an employment relationship.” However, the Consolidated Labor Law (“CLT”, the basic Labor Code) establishes a series of characteristics of employment relationships, among them subordination, which can be detected when the employer has the employee under his command and control, and when an employee must be subject to employer’s instructions. In short, the subordination implies in employee’s submission of an employer’s guidelines, such as place, manner and time for implementing a certain activity.

The labor courts typically apply the principle that the de facto situation prevails over any formal document, and find the existence of an employment relationship even if there is a service provision or other agreement between an individual and company that disclaims such a relationship. The connection between the franchisor and franchisee is, as a rule, purely contractual, without subordination. Nevertheless, it is possible to recognize an employment relationship, depending on the specific case and the elements that denote a relationship of subordination between a franchisor and a franchisee.

Another tenet of labor law jurisprudence is joint and several liability for labor obligations of all companies of a business group, as well as the residual liability of the contractor for the labor obligations of outsourced staffing firms. As seen, the franchising relationship allows the franchisee to exploit the brand, image and products or services of the franchisor, under standardized procedures, to conform visual identity and other aspects of their businesses, so that to the public, the franchisee and franchisor are

87. Favorable vote issued by Supreme Court Justice Marco Aurélio when assigning general repercussion to Extraordinary Appeal 603.136/RJ on 09/02/2010

basically one and the same. Although the franchisee is a distinct entity from the franchisor and has independence in management, there is rigorous control by the franchisor to harmonize the system for coherence of the franchise network.

This reality is widely recognized in the doctrine, such as that of tax attorney Tiziane Machado, who specializes in franchising, according to whom “the franchisor exercises external power of management and control over the franchisee,88 but without any legal subordination.” She continues:

Unlike the concept of subordination existing between companies of a single business group, in the franchising contract there is merely a cooperative relationship and external control to guarantee the quality of the brand or patent that the franchisee has the right to use. This control of the franchisor is done without interference in the internal power of management and administration of the franchisee, which continues to have broad powers to make decisions, so that such interference is insufficient to characterize the existence of a business group. (emphasis added) Many cases have been decided by the labor courts involving

claims of an employment relationship between the owner of a franchise and the franchisor, or of joint and several or residual liability of the franchisor for the labor debts of the franchisee. In most cases, these claims have been denied, as reflected in the decisions cited below.

An appellate decision addressing a franchisor’s liability for its franchisee’s labor debts held the following:

The fact that the franchisor company establishes a series of requirements and standardizes the products and form of sale are natural characteristics of franchising, because the franchisor cannot allow its name, its greatest asset, to be exposed in just any way. Any failure in the marketing or quality of the product will cause losses to the brand, i.e., the possible dissatisfaction of the customer will not be directed against the specific commercial establishment, but rather against the brand covered by the franchise agreement. Therefore, the rigorous control of the franchisor over the franchisee, the only way to maintain the value of its name (as said, its greatest asset), does not make the former a service taker and the latter a service provider, to enable recognition of residual liability of the first for the possible labor debts of the second.89

88. Tiziane Machado (org.), Manual Jurídico para Franqueadores e Franqueados. São Paulo: Editora Aleph, 2006, p. 40.

89. 5th Regional Labor Court of Appeal, Ordinary Appeal 5059/00, 5th Panel, Reporting Judge Fernando Luiz Gonçalves Rios Neto, published on September 9, 2000.

In another case, the labor appellate panel held that “the franchise agreement, governed by Law 8,955/94, is not a legal figure able to attract joint and several/residual liability of the franchisor, which does not have any responsibility for the labor debts of the franchisee. The franchise agreement does not cover certain types of labor outsourcing arrangements, so the criterion for liability of Enunciation 331, no. 490 from the Superior Labor Tribunal does not apply.91 In still another appellate decision, the panel ruled that “whether the commercial relationship between the parties is one of representation, subject to Law 4,885 of 1995, commercial purchase and sale with consignment, as defined in the Brazilian Civil Code, or franchising, covered by Law 8,955 of 1994, the elements of a labor relationship subject to Article 3 of the CLT are not present.92

However, there are cases where the labor courts have found the factual situation to prevail over the formal elements. For example, in one review appeal,93 the TST stated, in upholding the regional appellate court’s decision, that “the plaintiff was not, in fact, a franchisee or independent insurance broker, because the elements of an employment relationship were present, especially subordination.”94 In this case, the employment relationship between the franchisee and franchisor was recognized. In another case,95 the appellate court recognized joint and several liability of the franchisor for the franchisee’s labor debts because of payments made by the franchisor to the franchisee to help it meet its obligations to employees.96

90. An enunciation (enunciado) is a statement of consolidated position from a higher court.

91. 5th Regional Labor Court of Appeal, Ordinary Appeal 4148/01, 5th Panel, Reporting Judge Ricardo Antônio Mohallem, published on May 26, 2001.

92. 5th Regional Labor Court of Appeal, Ordinary Appeal 0017200-53.2006.5.05.0193, Reporting Judge Yara Trindade, published on October 15, 2007.

93. Recurso de revista, the name of the standard appeal to the Superior Labor Tribunal (TST).

94. Superior Labor Tribunal, 3rd Panel, Review Appeal 2663000-80.2007.5.09.0029, Reporting Judge Rosa Maria Weber, published on October 28, 2010.

95. 3rd Regional Labor Court of Appeal, 8th Panel, Ordinary Appeal 01499-2005-013-03-00-5, Reporting Judge Olívia Figueiredo Pinto Coelho, published on August 8, 2006.

96. The judges held that:

The franchise agreement covers the use of all the structure necessary for the commercial aspects for expansion of the brand and the names that individualize and identify a company, product or line of products, there being no legal subordination between franchisor and franchisee, with the latter paying the royalties for use of the information and know-how detained by the former. Indeed, the labor obligations assumed by the franchisee are not transferred to the franchisor if for any reason the first is unable to satisfy them. However, when the franchisor pays the franchisee a monthly stipend to cover the expenses of the franchisee’s undertaking, including to pay salaries of personnel and ‘pró-labore’ of the partners, the existence of the franchise agreement can be disallowed, since the franchisor acts as the owner of the business, bearing its operational costs and thus assuming the risks of the franchisee’s

M. Validity of the Franchise Agreement

The Franchising Law, in Article 6, establishes that the franchise agreement must always be in writing and signed in the presence of two witnesses, and shall be valid regardless of registration at a public records office.97 However, this validity applies to the effects between the parties, not to third parties. Although the law provides for the validity of the franchise agreement with the presence of two witnesses, in the case involving VF do Brasil Ltda. (franchisor) v. Ipanema Rio Boutique Ltda.,98 the appellate chamber recognized the validity of a verbal franchise agreement and decided that the lack of a written agreement did not prevent the formalization of the relationship by the parties.

IV. CONCLUSION

With the growth of franchising in Brazil has come a growth in litigation over a wide variety of franchise-related issues. Some disputes may be unavoidable and, in those instances, existing case law may provide a useful road map for litigators to understand the key issues and facts to consider in asserting and defending claims. Many other disputes may be avoided, however, by a careful understanding of the problems that typically arise under franchise agreements and relationships in Brazil, and by ensuring that the franchise offering circular and the franchise agreement itself contain clear and thorough definitions of the mutual rights and obligations of the parties. Particularly with respect to the various types of disputes described above that franchisors and franchisees have fought in Brazil, franchisors, trademark owners, investors, and others would do well to anticipate and account for these issues in the offering circular and the franchise agreement, so as to avoid unnecessary disputes later.

business activity. In this case it is necessary to recognize the existence of joint and several liability between the companies with respect to employment, based on Article 2, paragraph 2, of the CLT.

97. Article 6. The franchise contract must always be in writing and signed in the presence of 2 (two) witnesses and shall be valid irrespective of registration with a notary public or public office.

98. Pernambuco State Court of Appeal, Civil Appeal 2196274 PE, 2nd Private Law Chamber, Reporting Judge: Adalberto de Oliveira Melo, decided on February 5, 2013.