[Annex 3 to the UNIDROIT Guide to International Franchise Arrangements, periodically updated on this website]
(Prepared by the Secretariat of UNIDROIT in collaboration with Philip F. Zeidman of Rudnick, Wolfe, Epstien & Zeidman, Washington, D.C. - The Washington D.C. office of Rudnick & Wolfe, Chicago)
A healthy commercial law environment is of paramount importance for franchising. Indeed, without it franchising is not able to function. A "healthy commercial law environment" may be defined as one with general legislation on commercial contracts, with an adequate company law, where there are sufficient notions of joint ventures, where intellectual property rights are in place and enforced and where companies can rely on ownership of trademarks and know-how as well as on confidentiality agreements.
Franchise arrangements are subject to a considerable number of laws and regulations in addition to those regulating commercial contracts or intellectual property rights. Essentially, these additional laws and regulations fall into two separate categories. The first category includes laws and regulations that are applicable to contracts in general, the second those that are applicable to the specific contract concerned (franchise-specific legislation, where it exists, for example).
A. BRANCHES OF LAW RELEVANT TO FRANCHISING
Franchising is a form of business that touches upon a great many different areas of law, the majority of which are regulated domestically and at times also internationally.
I. GENERAL CONTRACT LAW
The agreement will naturally be subject to general contract law. In countries that separate the regulation of commercial contracts from that of other contracts, some aspects of the agreement will be subject to provisions in the laws or codes that regulate commercial contracts.
II. AGENCY LAW AND THE LAW REGULATING OTHER DISTRIBUTION CONTRACTS
There may be aspects of the relationship between a franchisor and its franchisees that are covered by agency law, independently of whether the courts actually assimilate the franchise relationship concerned to one of agency,1 or by the law regulating other distribution contracts.2 The legislation that regulates agency relationships and distributorships should therefore be considered.
III. LEASING AND SECURITY INTERESTS
Equipment and premises might be leased and security interests might be involved. This is particularly the case where specific equipment is needed for the franchise and where the franchisor provides that equipment.3
IV. FINANCIAL INVESTMENTS
Financial investments will be covered by the legislation that specifically regulates those matters.
V. INTELLECTUAL PROPERTY
Intellectual property rights are the basis upon which the franchise relationship is built. They are therefore of fundamental importance.4 In international relationships the international conventions and other regulations of international origin must be taken into account.5
VI. COMPETITION LAW
The terms of the franchise agreement that might be covered by competition law are those that relate to the price that a franchisee should charge for the products or services it offers and those relating to the exclusive rights granted franchisees in a franchise relationship, as they might give rise to suspicions of market sharing and concerted action between the members of the network. The problem in franchising is ensuring that the franchisee is given the best possible protection to develop its territory, for example by being granted exclusive territorial rights, but without the terms of the agreement falling under the terms of the competition legislation. Care should therefore be taken in drafting the agreements.
VII. FAIR TRADE PRACTICES LAW
Fair trade practices law is of relevance in particular when post-term non-competition clauses are considered and in relation to the right that franchisors may reserve to themselves to distribute their products through alternate channels of distribution. It is also relevant in relation to tie-in arrangements.6 Legislation dealing with particular trading schemes, such as the 1996 Trading Schemes Act adopted in the United Kingdom which covers pyramid selling, should also be considered. Although not directly applicable to franchising, this latter legislation has a direct effect also on certain types of franchising. An issue to be determined with reference to pyramid selling is whether the statutes cover also the internal relationship between the parties to the franchise agreement and not only that between the sub-franchisee or franchisee and the consumer.
VIII. CORPORATE LAW
The corporate form the franchisor and the franchisees adopt is also relevant, in particular for questions of liability and taxation.7
Taxation regulation is of considerable importance, not the least because taxation issues often decide the corporate form the parties will adopt, the franchisor for its presence in the host country and the franchisee for its unit. Issues such as who has to pay withholding taxes need to be regulated in the franchise agreement.8
X. PROPERTY LAW
Property law will also need to be considered in relation to the assets of the franchise. It is particularly relevant in case of termination of the agreement.
XI. LEGISLATION ON CONSUMER PROTECTION AND PRODUCT LIABILITY
Legislation on consumer protection and product liability is of relevance particularly where the possible liability of the franchisor for products or services sold by the sub-franchisee or franchisee is concerned.9 Consumer protection must be considered at two levels: firstly, at the level of liability towards the consumer in the ordinary sense, secondly at the level of liability towards the sub-franchisor or sub-franchisee. At the latter level what should be considered is whether the sub-franchisor or sub-franchisee can itself be regarded as a consumer and therefore be covered by the consumer protection statutes. The question is whether the reach of those statutes can be viewed as broad enough to protect sub-franchisors or sub-franchisees that are not purchasing items for consumption, but are making an investment and are therefore traditionally not thought of as consumers, even if they might be treated as consumers for the purpose of the statutes.
XII. INSURANCE LAW
Insurance law is relevant as master franchise agreements will often require sub-franchisors to take out insurance with the franchisor as beneficiary.10
XIII. LABOUR LAW
The issue of the applicability of labour legislation to the franchise relationship has been studied in particular in countries in which the regulation of labour relations is highly developed, such as Germany and Sweden. The different issues involved include:
the relationship between the franchisor and the franchisee;
the relationship (if any) between the franchisor and the employees of the franchisee, for example where the franchisor retains the right to approve the employees of the franchisee; and the position of the employees of the franchisee in the franchise system, which includes questions such as the right of the employees to be consulted on important business decisions. In this connection the possible application of the European Council Directive 94/95/EC of 22 September 1994 on the establishment of a European Works Council or a procedure in Community-scale undertakings and Community-scale groups of undertakings for the purposes of informing and consulting employees11 should be taken into account, although its application to franchising is controversial.
XIV. THE LAW REGULATING THE TRANSFER OF TECHNOLOGY
Franchising may be covered by the broad definition of technology transfer contained some domestic legislations. If the technology transfer legislation is found to apply to the franchise agreement concerned, the latter may have to be approved by the local authorities responsible for contracts for the transfer of technology and registered in the appropriate register. In this context the recent European Regulation on technology transfer agreements should be noted.12 Adopted on 27 April 2004, it replaced the existing regulation on technology transfer agreements. 13
XV. LEGISLATION REGULATING FOREIGN INVESTMENTS CURRENCY CONTROL REGULATIONS AND IMPORT RESTRICTIONS AND/OR QUOTAS
Legislation regulating foreign investments needs to be considered, as do the connected currency control regulations and import restrictions and/or quotas.
XVI. LEGISLATION REGULATING JOINT VENTURES
Joint ventures are frequently used for the international expansion of franchise systems, particularly in situations where the local partners suffer from a lack of financial means. In such cases the legislation on joint ventures will also need to be considered.
XVII. INDUSTRY SPECIFIC LAWS OR REGULATIONS
Any laws or regulations specific to the trade sector involved (for example health regulations for food franchises) need to be carefully considered in each particular case.
B. SPECIFIC LEGISLATION
Although an increasing number of States are considering the introduction of franchise-specific legislation, still only a limited number regulate franchising. Where it does not, its applicability to international franchise transactions, to master franchise agreements and other arrangements needs to be assessed. In part, this lack of franchise-specific legislation is due to the complexity of the relationship and to the great number of areas of law involved in a franchise relationship. With few exceptions the legislation adopted is disclosure legislation and not legislation regulating the relationship between the parties.
With a varying degree of detail disclosure laws will require the franchisor to provide the prospective franchisee with information on a number of points that will enable the franchisee to make an informed decision on whether or not to enter into the agreement. The points on which information should be offered, or documents provided, may include:
- the franchisor and the directors of the enterprise;
- the history of the enterprise;
- the legal constitution of the enterprise;
- the intellectual property concerned;
- the financial situation, with audited financial statements for the two or three preceding years;
- the other franchisees in the network;
- information on the franchise agreement, such as the duration of the agreement, conditions of renewal, termination and assignment of the agreement; as well as
- information on any exclusivities.
It should be noted that although it may not be sanctioned by law, there is also an extensive duty on the part of the prospective sub-franchisor or franchisee to disclose all relevant information to the franchisor, so that the franchisor can evaluate whether or not the prospective sub-franchisor or franchisee fulfils the requirements to become a member of the network. This exchange of information is essential for the building up of trust between the parties, which is a prerequisite for the success of the enterprise.
C. THE EUROPEAN UNION AND FRANCHISING D. THE UNIDROIT MODEL FRANCHISE DISCLOSURE LAW
On 25 September 2002 the Governing Council of UNIDROIT adopted the Model Franchise Disclosure Law finalised by a Committee of Governmental Experts convened by the organisation to examine a draft prepared by the UNIDROIT Study Group on Franchising.
The Model Law is limited to pre-contractual disclosure. It does not deal in an analytical way with the contractual relationship between the parties, nor does it deal with the consequences of termination.
The Model Law is intended to apply to both domestic and international franchising, and to different types of franchise agreement, such as traditional unit agreements, master franchise agreements and development agreements. The Model Law is also intended to cover any new forms of franchise arrangements that might develop in the future. The Model Law does not require disclosure on the part of franchisees, only on the part of franchisors. The reason for this is that it was considered that the experience and economic size of franchisors, which permit them to have access to expert legal counsel, do not make it necessary to provide franchisors with the same degree of protection as franchisees.
The Model Law has ten articles and a Preamble. The articles deal with the scope of application of the law (Article 1); definitions (Article 2); the delivery of the disclosure document (Article 3); the format of the disclosure document (Article 4); exemptions from the obligation to disclose (Article 5); what information has to be disclosed (Article 6); acknowledgement of receipt of the disclosure document (Article 7); remedies (Article 8); the temporal scope of application of the law (Article 9); and waivers (Article 10).
E. VOLUNTARY REGULATION OF FRANCHISING
A number of franchise associations, both national and international, have adopted Codes of Ethics that are to regulate the conduct of their members. These Codes of Ethics often also deal with disclosure, albeit in a more summary manner: in general they provide that prospective franchisees have to be provided with accurate and full disclosure, but do not contain detailed provisions as to what is to be understood thereby. It should also be noted that a number of national franchise associations offer their members assistance in mediation and/or arbitration. 14
7 See, in general, Chapter 2 "Nature and Extent of Rights Granted and Relationship of the Parties" for an examination of the relationship of the parties and Chapter 14, Section A "Vicarious Liability" for questions of liability. [Back to text]
11 OJ EC L 254/64 of 30 September 1995. The Directive was amended by Council Directive 97/74/EC of 15 December 1997 (OJ EC L 10/22, 16.1.1998) and by Council Directive 2006/109/EC of 20 November 2006 (OJ EU L 363/416, 20.12.2006). [Back to text]
12 Commission Regulation (EC) No 772/2004 of 27 April 2004 on the application of Article 81(3) of the Treaty to categories of technology transfer agreements (Text with EEA relevance) (OJ EU L 123/11, 27.4.2004). [Back to text]
13 Commission Regulation (EC) No 240/96 of 31 January 1996 on the application of Article 85(3) of the Treaty to certain categories of technology transfer agreements (Text with EEA relevance) (OJ EC L 31/2, 9.2.1996). [Back to text]
14 This is the case of the Austrian, Belgian, British, French, German and Dutch associations. In Italy the FIF-Federfranchising, the parallel association of the Confesercenti, the business association of small and medium-sized businesses, offers a mediation service. In the USA, the IFA does not itself offer assistance, but adheres to the National Franchise Mediation Program.