Laws and agencies regulating the offer and sale of franchises

Legal definition

What is the legal definition of a franchise?

The British Franchise Association (BFA)'s Code of Ethics incorporates the European Franchise Federation’s European Code of Ethics for Franchising, which only applies to BFA members.

There is no legal definition of franchising under UK law, and as such is an indication of the absence of regulation in the sector. However, the Code of Ethics defines franchising as:

[A] system of marketing goods or services and/or technology which is based upon a close and ongoing collaboration between legally and financially separate and independent undertakings, the franchisor and its individual franchisees, whereby the franchisor grants to its individual franchisees the right, and imposes the obligation, to conduct a business in accordance with the franchisor’s concept.

Franchise laws and agencies

Which laws and government agencies regulate the offer and sale of franchises?

There are no government agencies or specific legislation that regulate the offer and sale of franchises.

However, the Code of Ethics, although not legally binding, places an obligation on franchisors to disclose certain information to franchisees.

When conducting its offer and pre-sale process, the franchisor must be careful to ensure it does not become subject to a claim for misrepresentation.

Franchising arrangements may well be subject to the Trading Schemes Act 1996 and Trading Schemes Regulations 1997, which were enacted to tighten up the existing legislation regulating pyramid selling through trading schemes, namely the Fair Trading Act 1973. Franchisors must be mindful of the legislation owing to its broad drafting.

Principal franchise requirements

Describe the relevant requirements of these laws and agencies.

The Trading Schemes Regulations 1997 (the Regulations) do not place a prohibition on trading schemes. However, in the event that the franchising relationship is considered a trading scheme, then the Regulations place obligations on franchisors in relation to advertising, as well as impose contractual requirements, including a cooling off period. These requirements would make franchising an unattractive business model. In practice therefore, franchise networks in the United Kingdom are structured to ensure that a franchisor is exempt from the legislation.

A franchisor can ensure that it is exempt from the legislation by either operating as a single tier, namely by having one level of franchisee or by being, and making certain that all the franchisees (and all other relevant participants) are, VAT registered.

If the franchisor is unable to benefit from one of the exemptions and subsequently breaches the legislation, it may become subject to criminal sanctions or the franchisor may find itself subject to civil claims from a franchisee for breach of its statutory duties. In addition, any obligation on the franchisee to pay fees to the franchisor will be unenforceable.

Exemptions

What are the exemptions and exclusions from any franchise laws and regulations?

Not applicable, as there are no franchise-specific laws or regulations.

Franchisor eligibility

Does any law or regulation create a requirement that must be met before a franchisor may offer franchises?

There are no specific laws or regulations.

The Code of Ethics requires that, prior to franchising, the franchisor has operated at least one pilot unit, has the right to use its brand and provides its franchisees with initial training and continuing assistance.

It is important to note that where, as part of the process of offering and subsequently awarding the franchise, the franchisor requires the franchisee to pay a deposit. The Code of Ethics requires that the deposit is refundable, subject to the franchisor retaining any quantifiable directly related expenses incurred by it, and that the terms upon which any deposit is taken are set out in writing.

Franchisee and supplier selection

Are there any laws, regulations or government policies that restrict the manner in which a franchisor recruits franchisees or selects its or its franchisees’ suppliers?

No, there are no such laws, regulations or government policies.

However, the Code of Ethics states that the franchisor shall only select and accept franchisees who appear to possess the basic skills, education, personal qualities and financial resources to carry on the franchise business.

Pre-contractual disclosure

What is the compliance procedure for making pre-contractual disclosure in your country? How often must the disclosures be updated?

There is no legal requirement to disclose information to a prospective franchisee.

The Code of Ethics requires that franchisees are provided with a copy of the present Code of Ethics, and with a full and accurate written disclosure of all information material to the franchise relationship within a reasonable time prior to execution of the franchise agreement. This should include the business and financial position of the franchisor, the people involved in the franchisor business, the franchise proposition, the franchisees, the financial projections and the franchise agreement.

Even where a franchisor is not a member of the BFA, it should consider preparing some form of disclosure document to give to prospective franchisees to enable it to give accurate and consistent responses to due diligence enquiries.

Pre-sale disclosure to sub-franchisees

In the case of a sub-franchising structure, who must make pre-sale disclosures to sub-franchisees? If the sub-franchisor must provide disclosure, what must be disclosed concerning the franchisor and the contractual or other relationship between the franchisor and the sub-franchisor?

There is no legal requirement to disclose information to a prospective sub-franchisee. 

The Code of Ethics requires that franchisees are provided with a copy of the present Code of Ethics, and with a full and accurate written disclosure of all information material to the franchise relationship within a reasonable time prior to execution of the franchise agreement. This should include the business and financial position of the franchisor, the people involved in the franchisor business, the franchise proposition, the franchisees, the financial projections and the franchise agreement.

Even where a franchisor is not a member of the BFA, it should consider preparing some form of disclosure document to give to prospective franchisees to enable it to give accurate and consistent responses to due diligence enquiries.

It is advisable for the sub-franchisor to explain clearly its relationship with the franchisor to its prospective franchisees.

Due diligence

What due diligence should the parties undertake before entering a franchise relationship?

The franchisor should satisfy itself that franchisees are of suitable character and have the necessary skills base and (if applicable) qualifications to operate the franchise. Franchisors should also ensure that franchisees have sufficient funding to both open and operate the franchise. It is important to ensure that the individuals who will be operating the franchise have the legal right to reside in the United Kingdom throughout the currency of the franchise agreement.

A franchisee should review in detail any disclosure document provided by the franchisor, to ensure an understanding of the costs involved in running the franchise, as well as the expected financial returns. A franchisee should check that the franchisor has the right to licence the relevant trademarks to the franchisee and it is market practice for a franchisee to instruct a lawyer to prepare a report on the franchise agreement highlighting its key commercial terms and any issues that should be raised with the franchisor. A franchisee should enquire about the number of franchises within the network, including the number of franchise failures and speak to existing franchisees to understand their views on operating within the network.

What must be disclosed

What information must the disclosure document contain?

There are no legal disclosure requirements in the United Kingdom, but please see below for an indication of the BFA’s requirement regarding disclosure.

The Code of Ethics requires that franchisees are provided with a copy of the present Code of Ethics, and with a full and accurate written disclosure of all information material to the franchise relationship within a reasonable time prior to execution of the franchise agreement. This should include the business and financial position of the franchisor, the people involved in the franchisor business, the franchise proposition, the franchisees, the financial projections and the franchise agreement.

Even where a franchisor is not a member of the BFA, it should consider preparing some form of disclosure document to give to prospective franchisees to enable it to give accurate and consistent responses to due diligence enquiries.

Continuing disclosure

Is there any obligation for continuing disclosure?

No.

Disclosure requirements – enforcement

How do the relevant government agencies enforce the disclosure requirements?

Not applicable. However, the BFA may take steps to expel a member in the event of a serious breach of the Code of Ethics, including its disclosure requirements.

Disclosure violations – relief for franchisees

What actions can franchisees take to obtain relief for violations of disclosure requirements? What are the legal remedies for such violations? How are damages calculated? If the franchisee can cancel or rescind the franchise contract, is the franchisee also entitled to reimbursement or damages?

A franchisor may find itself the subject of a claim for misrepresentation. Such a claim would arise where the franchisor has made an untrue statement of fact that has subsequently induced the franchisee to enter into a franchise agreement. This would typically be some form of earnings claim, with little basis in fact. Depending on the circumstances in which the statement is made, the franchisor may then be subject to a claim for one or more of innocent, negligent or fraudulent misrepresentation. The statement can be made either orally or in writing. In the case of a successful claim for misrepresentation, depending on the facts, the franchisee will be able to rescind the agreement or, where it has suffered loss, claim for damages, or both.

The franchisor will invariably insert provisions into the franchise agreement to restrict or exclude liability for misrepresentation. The effectiveness of such clauses is subject to both statute and common law. Where a clause seeks to limit liability for misrepresentation, it would be subject to the test of reasonableness under the Unfair Contracts Terms Act 1977. Any clauses seeking to restrict or exclude liability from fraudulent misrepresentation will be ineffective. Recent case law suggests that the courts are reluctant to allow franchisors to benefit from such provisions, and, as such franchisors should ensure that they are careful and organised about the information provided to franchisees rather than solely relying on exclusion or limitation of liability clauses.

Disclosure violations – apportionment of liability

In the case of sub-franchising, how is liability for disclosure violations shared between franchisor and sub-franchisor? Are individual officers, directors and employees of the franchisor or the sub-franchisor exposed to liability? If so, what liability?

A franchisor may find itself the subject of a claim for misrepresentation. Such a claim would arise where the franchisor has made an untrue statement of fact that has subsequently induced the franchisee to enter into a franchise agreement. This would typically be some form of earnings claim, with little basis in fact. Depending on the circumstances in which the statement is made, the franchisor may then be subject to a claim for one or more of innocent, negligent or fraudulent misrepresentation. Such statement can be made either orally or in writing. In the case of a successful claim for misrepresentation, depending on the facts, the franchisee will be able to rescind the agreement or, where it has suffered loss, claim for damages, or both.

The franchisor will invariably insert provisions into the franchise agreement to restrict or exclude liability for misrepresentation. The effectiveness of such clauses is subject to both statute and common law. Where a clause seeks to limit liability for misrepresentation, it would be subject to the test of reasonableness under the Unfair Contracts Terms Act 1977. Any clauses seeking to restrict or exclude liability from fraudulent misrepresentation will be ineffective. Recent case law suggests that the courts are reluctant to allow franchisors to benefit from such provisions, and, as such franchisors should ensure that they are careful and organised about the information provided to franchisees rather than solely relying on exclusion or limitation of liability clauses.

General rules on offer and sale

In addition to any laws or government agencies that specifically regulate offering and selling franchises, what are the general principles of law that affect the offer and sale of franchises? What other regulations or government agencies or industry codes of conduct may affect the offer and sale of franchises?

The offer and subsequent sale of franchises will be subject to general principles of contract and tort law, and therefore the laws relating to misrepresentation will offer protection to franchisees as follows.

The Code of Ethics requires that franchisees are provided with a copy of the present Code of Ethics, and with a full and accurate written disclosure of all information material to the franchise relationship within a reasonable time prior to execution of the franchise agreement. This should include the business and financial position of the franchisor, the people involved in the franchisor business, the franchise proposition, the franchisees, the financial projections and the franchise agreement.

Even where a franchisor is not a member of the BFA, it should consider preparing some form of disclosure document to give to prospective franchisees to enable it to give accurate and consistent responses to due diligence enquiries.

The parties must be mindful of the concept of caveat emptor (buyer beware) and, therefore, carry out an appropriate level of due diligence. The concept of culpa in contrahendo, common in civil jurisdictions, placing a duty to negotiate with care, which could extend to making pre-contract disclosures, does not apply. Nor is there, as the law currently stands, a general implied duty of good faith.

General rules on pre-sale disclosure

Other than franchise-specific rules on what disclosures a franchisor should make to a potential franchisee or a franchisee should make to a sub-franchisee regarding predecessors, litigation, trademarks, fees, etc, are there any general rules on pre-sale disclosure that might apply to such transactions?

There are no specific rules on pre-sale disclosure.

The Code of Ethics requires that franchisees are provided with a copy of the present Code of Ethics, and with a full and accurate written disclosure of all information material to the franchise relationship within a reasonable time prior to execution of the franchise agreement. This should include the business and financial position of the franchisor, the people involved in the franchisor business, the franchise proposition, the franchisees, the financial projections and the franchise agreement.

Even where a franchisor is not a member of the BFA, it should consider preparing some form of disclosure document to give to prospective franchisees to enable it to give accurate and consistent responses to due diligence enquiries.

Fraudulent sale

What actions may franchisees take if a franchisor engages in fraudulent or deceptive practices in connection with the offer and sale of franchises? How does this protection differ from the protection provided under franchise sales disclosure laws?

A franchisor may find itself the subject of a claim for misrepresentation. Such a claim would arise where the franchisor has made an untrue statement of fact that has subsequently induced the franchisee to enter into a franchise agreement. This would typically be some form of earnings claim, with little basis in fact. Depending on the circumstances in which the statement is made, the franchisor may then be subject to a claim for one or more of innocent, negligent or fraudulent misrepresentation. Such statement can be made either orally or in writing. In the case of a successful claim for misrepresentation, depending on the facts, the franchisee will be able to rescind the agreement or, where it has suffered loss, claim for damages, or both.

The franchisor will invariably insert provisions into the franchise agreement to restrict or exclude liability for misrepresentation. The effectiveness of such clauses is subject to both statute and common law. Where a clause seeks to limit liability for misrepresentation, it would be subject to the test of reasonableness under the Unfair Contracts Terms Act 1977. Any clauses seeking to restrict or exclude liability from fraudulent misrepresentation will be ineffective. Recent case law suggests that the courts are reluctant to allow franchisors to benefit from such provisions, and, as such franchisors should ensure that they are careful and organised about the information provided to franchisees rather than solely relying on exclusion or limitation of liability clauses.

Law stated date

Correct on

Give the date on which the above content is accurate.

28 April 2020.