Franchising in South America remains largely unregulated, despite the steady growth of the franchise sector in the region.2 In countries lacking specific statute, franchise agreements are subject to general laws and regulations on contracts.
According to research conducted by Rizzo Franchise in 2013, Brazil is the leading country in South America with respect to the number of franchised units and franchised brands. Statistics provided by the Ibero-American Federation of Franchising in 2013 indicate Brazil as the leading country in South America in terms of franchised brands, with 2,703, followed by Argentina with 512, Venezuela with 495, Colombia with 430 and Peru with 335.
Brazil is also in the leading position in relation to franchising regulations: Brazil’s franchise law is the most detailed of the region, especially with respect to provisions on pre-contract disclosure requirements.
With regard to pre-contract disclosure requirements, which are usually observed by means of a franchise disclosure document (FDD) provided by franchisor to franchisee, the only countries in South America with specific legal provisions are Brazil and Argentina. Notwithstanding this, because of good faith provisions and general requirements that apply to contracts, an FDD must also be provided by franchisors in Chile and Colombia, before the execution of the franchise agreement.
The purpose of this chapter is therefore to serve as reference guide regarding pre-contract disclosure requirements in South America at the present date, although a definitive legal opinion must be obtained from specialists in each South American country before actually engaging in franchising. FDD requirements in countries with FDD laws (ie, Argentina, Brazil, Chile and Colombia) may be compared as follows.
In Argentina, the Civil and Commercial Code of the Nation specifically regulates franchising and, according to article 1514, a franchisor has the following pre-contract disclosure obligations:
- to provide, before the signing of the contract, economic and financial information on the necessary investments and development of the franchise, including examples of such information in relation to two years of operation by units similar to those offered to the franchisee, as well as an operational manual with specifications related to the operation of the activity under the scope of the franchise agreement; and
- to communicate to the franchisee the set of technical knowledge, even if it is not patented, that is derived from the experience of the franchisor and has been proven apt to produce the effects of the franchisee system.
It is not mandatory to provide the FDD in Spanish, although in the event of recordal of the franchise agreement with the Argentinian Patent and Trademark Office, the FDD will have to be submitted in Spanish for this purpose.
If a franchisor fails to observe said pre-contract disclosure obligations, the franchisee may terminate the franchise agreement or file an action claiming for the applicable damages caused to it.
Another requirement imposed by the Civil and Commercial Code is that products and services provided by a franchisor or third parties indicated by a franchisor for the purposes of the franchise must be reasonably priced in accordance with local or international commercial practices. Such reasonable prices must be reflected in the FDD, if applicable.
Legal requirements in Argentina related to FDDs remain significantly subjective, meaning that conflicts between franchisee and franchisor on exactly which type of financial information must be disclosed, as well as how long in advance the FDD must be provided, are possible. It is recommended that the FDD is produced 14 days in advance to avoid any discussions and to include information usually present in FDDs prepared in accordance with requirements imposed in countries with stricter regulations, such as Brazil.
In Brazil the franchise business is regulated by the Brazilian Franchise Law (No. 8,955/94), which includes provisions on the information to be made available to prospective franchisees by means of the FDD, as well as requirements related to franchise agreements and sanctions in cases of non-compliance. The Brazilian Franchising Association has also created a self-regulating code, which serves as a guide to franchise implementation, although it is not legally enforceable.
The Brazilian Patent and Trademark Office (Brazilian PTO) regulates certain aspects of franchising by means of the Resolutions Nos. 70/2017 and 199/2017. Franchise agreements are subject to recordal with the Brazilian PTO and registration with the Central Bank of Brazil for the following purposes: (i) remittance of royalties abroad; (ii) tax deductibility of payments by the Brazilian company; and (iii) making the agreement valid before third parties. Certain requirements imposed by the regulations issued by the Brazilian PTO also have an impact on the terms of franchise disclosure documents.
Considering that recordal with the Brazilian PTO is necessary for the purpose of remittance of royalties abroad, whenever the franchisor is a foreign company, the franchise agreement and receipt of the FDD must be recorded with the Brazilian PTO. In this regard, sometimes international companies opt to constitute subsidiaries in Brazil for the granting of franchises locally, therefore avoiding the requirement of recordal with the Brazilian PTO.
In Brazil the following mandatory information must be included in the FDD:
- A brief background, corporate organisation and full name or corporate name of both the franchisor and all the companies with which it is directly connected, as well as the respective trade names and addresses.
- The franchisor’s balance sheets and financial statements relating to the past two fiscal years.
- An accurate report on all pending court proceedings involving the franchisor, its parent companies and owners of marks, patents and copyrights relating to that operation, as well as its sub-franchisors, which proceedings specifically question the franchising system or may directly prevent the franchise operation.
- Litigations or other proceedings pending abroad that question the system or may directly prevent the franchise operation should also be added to the FDD.
- A detailed description of the franchise, and a general description of the business and activities that shall be performed by the franchisee.
- A profile of the ‘ideal franchisee’ with regard to prior experience, educational level and other mandatory or preferential characteristics.
- Requirements with regard to the franchisee’s direct involvement in the business operation and administration.
- Specifications as to: (i) the estimated total initial investment required for the franchise purchase, implementation and beginning of operation; (ii) the value of the initial membership fee or franchise and guarantee fee; and (iii) the estimated value of the installations, equipment and initial inventory, and their payment terms. Although it is common to see in FDDs provided in Brazil such estimates in accordance with franchisors’ experience abroad, franchisees may claim to be misled by estimates considering foreign markets. Therefore the FDD should ideally provide all fees, expenses and costs taking into consideration the Brazilian market.
- On the other hand, case law in Brazil indicates that in situations where franchisees have been operating the franchise for years, it is not possible to annul the franchise agreement owing to the lack of an FDD or an FDD containing misleading information.
- Accurate information with regard to periodical fees and other values to be paid by the franchisee to the franchisor, or to third parties appointed thereby, detailing the respective bases of calculation, and what they remunerate or for which purpose they are destined, with the following descriptions: (i) periodical remuneration for utilisation of the system or mark, or in exchange for the services effectively rendered by the franchisor to franchisee (royalties); (ii) lease of equipment or commercial outlet; (iii) advertising or similar fee; (iv) minimum insurance; and (v) other values owed to the franchisor or associated third parties.
- A complete report listing the network’s franchisees, sub-franchisees and sub-franchisors, as well as those who have withdrawn over the past 12 months, with their name, address and telephone number. The Brazilian Franchise Law does not determine that such report is applicable to franchisees, sub-franchisees and sub-franchisors located in Brazil only. Therefore, for avoidance of risks, information should include a complete list.
- With regard to the territory, the following must be specified: (i) if the franchisee is guaranteed exclusivity or preference over a given operation territory, and, if so, under which conditions; and (ii) the possibility for the franchisee to promote sales or render services outside its territory or to make exports.
- Clear and detailed information with regard to the franchisee’s obligation of purchasing any assets, services or inputs required for the implementation, operation or administration of its franchise solely from suppliers that are appointed and approved by the franchisor, and the franchisee being provided with a full list of these suppliers.
- Specification of what the franchisor effectively offers to the franchisee with regard to: (i) network supervision; (ii) advisory and other services rendered to the franchisee; (iii) the franchisee’s training, with specification of its duration, contents and costs; (iv) training of the franchisee’s personnel; (v) franchise manuals; (vi) assistance in the analysis and choice of the outlet where the franchise will be installed; and (vii) the layout and architectonic standards of the franchisee’s premises.
- The status before the National Institute of Industrial Property of the marks or patents authorised for use by the franchisor. Although royalty-bearing recordal of trademark licence agreements is only possible with regard to valid trademark registrations, franchise agreements may be recorded that include trademark applications only, as franchise fees refer to a bundle of rights. Therefore, if one wishes to grant franchises in Brazil, remittance of franchise fees abroad will be possible even if the client only has trademark applications in Brazil, provided the franchise agreement is duly recorded with the Brazilian PTO.
- Details of the franchisee’s position, after expiration of the franchise agreement, in relation to: (i) know-how or trade secrets the franchisee may have access to as a result of the franchise operations; and (ii) activities that may compete with the franchisor’s activity.
- A draft of the standard agreement and, if there is one, a draft of a franchise standard pre-agreement adopted by the franchisor, with full text including the respective annexes and term of validity. The term of the franchise agreement, which must also be disclosed by means of the FDD, is subject to requirements imposed by the Brazilian PTO’s Resolutions Nos. 70/2017 and 199/2017 if the franchise agreement will be submitted for recordal with the Brazilian PTO. In this sense, the term of trademark licence agreements and franchise agreements must be limited by the term of validity of the trademark registration with the latest expiration date, meaning the term of said agreements may not surpass said latest expiration date. Notwithstanding this restriction, it is possible to provide for the automatic renewal of the franchise agreement for an additional term of up to 10 years, which is the term of validity of trademark registrations in Brazil. At the time of the automatic renewal, a request for a new certificate of recordal will have to be made to the Brazilian PTO. In the case of brands franchised by means of trademark applications only, such restriction does not apply and the corresponding agreement may be recorded with a term agreeable to the franchisee and franchisor.
Brazil is also expecting the outcome of Bill of Law No. 219/2015, which is still under analysis by the Brazilian Senate. In brief, the bill aims to introduce the following changes to the current Franchise Law:
- a franchise will not characterise a consumer relationship, ‘economic group’ or an employment relationship between the franchisor and the franchisee or the franchisee’s employees, even during the training period;
- a franchisor will be obliged to be either the owner of the franchised IP rights or be expressly authorised by the owner of such IP rights;
- a franchise may be adopted by state-owned companies, private companies and non-profit organisations, regardless of their field of activities;
- the FDD shall include the following aspects:
- information on the background of the franchised business;
- indication of the corporate taxpayers’ roll numbers of the franchisor and related companies;
- a list of all franchisees, sub-franchisees or sub-franchisors of the chain as well as those who have dissociated themselves within the past 24 months (rather than the past 12 months as required in the current franchise law), including their addresses and contact information;
- indication of the specific rules for territorial competition between the franchisor’s proprietary units and franchised units;
- indication of what is effectively offered to the franchisee by the franchisor, concerning technological innovation implemented by the franchisor with regard to the franchised system;
- indication of what is effectively offered to the franchisee by the franchisor, concerning the layout and architectonic standards of the franchisee’s buildings or premises, including with regard to the physical arrangement of equipment and instruments, descriptive memorial, composition and sketches (the current law already requires an indication of layout and architectonic standards, but the Bill of Law aims to require more detailed information);
- complete description of the trademarks and other IP rights related to the franchise, including their application and registration numbers, the classes and subclasses in which they were filed or granted, and, when concerning plant varieties, the indication of their current status before the National Protection of Plant Variety Service (the current law already requires the inclusion of information with regard to the status or trademarks and patents and, therefore, the Bill of Law aims to request more detailed information on such rights, as well as to make reference to IP rights in a broader fashion and include specific reference to plant varieties);
- the situation of the franchisee after the expiration of the franchising agreement regarding: (i) know-how of the product, process or management technologies; and (ii) confidential information and industrial, commercial, financial or business secrets to which the franchisee may have access in view of the franchise (the current law had a similar provision that merely made reference to know-how and industrial secrets in a broader fashion);
- indication of the existence or non-existence of assignment or succession conditions, and, in the affirmative case, a description thereof;
- indication of the contractual term and renewal conditions;
- indication of situations that result in penalties, payment of fines or indemnifications and the respective amounts as determined in the franchise agreement;
- information on whether there are requirements of minimal quotas for purchases by the franchisee directly from the franchisor or from third parties indicated by the franchisor, as well as on the possibility and the conditions for the franchisee to refuse products or services required by the franchisor;
- indication of the existence or non-existence of a board or association of franchisees of the chain, with information on its attributions, powers and mechanisms of representation before the franchisor, as well as details on the management skills and monitoring of the application of existing funds;
- indication of conditions for limitation of competition between franchisor and franchisees, as well as among franchisees themselves during the term of the franchise agreement, along with details of territorial scope and term of duration of the restrictions, as well as of any penalties applicable in the event of breach; and
- precise specification of contractual term and renewal conditions, if any;
- specific provisions on franchises of public entities and bodies;
- a specific provision regarding franchises wherein the franchisor subleases a commercial point to the franchisee for operation of the franchised business, determining that in such cases: (i) both parties will be legally entitled to file lease renewal actions, as well as expressly prohibiting the exclusion of the parties from the lease and sublease agreements upon renewal thereof, except in the event of breach for non-payment of such agreements or the franchise agreement; and (ii) the rental price to be paid by the franchisee to the franchisor may be higher than the amount paid by the franchisor to the property owner of the commercial point, provided that this aspect is clearly contemplated in the FDD and that the rental amount paid in excess by the franchisee to the franchisor does not result in an excessive burden on the franchisee;
- a provision establishing that the penalty for failure of delivery of FDD to prospective franchisees within the legal term shall also be applicable to those franchisors who fail to include in the FDD any of the information legally required, without prejudice to other suitable criminal sanctions;
- a provision expressly determining that franchise agreements that produce effects only in the Brazilian territory shall be governed by Brazilian law and written in the Portuguese language; and
- provisions determining that the parties to international franchise agreements may choose foreign jurisdiction or arbitration to solve possible disputes.
Chile is currently considered a hot destination for franchising and is ranked by Edwards Global Services’ GlobalVue (an annually updated ranking system for evaluating franchise potential) in second place in the world (in the same position as Spain, Australia, Singapore, Sweden and the United Kingdom), and as the leading country in South America, as a destination for franchises.
However, Chile lacks a specific statute on franchising and relies on general legal provisions on contracts as regulation for franchise agreements. Because of the good faith provisions under Chilean law, however, it is advisable that franchisors provide FDDs to franchisees before the execution of the franchise agreement, including sufficient information on the business to be franchised.
Of course, the lack of specific legal provisions regarding pre-contract disclosure obligations results in uncertainty in connection with the information to be disclosed by the franchisor and thus subject to a case-by-case, and subjective, analysis by local courts. It must also be highlighted that case law in Chile is not binding, and thus judges are not required to rule in accordance with similar previous cases.
Franchisors in Chile benefit from the lack of specific regulations by being able to control the information to be disclosed, especially in the scenario of strong brands that are pursued by many franchisees. On the other hand, it is advisable for franchisors to disclose information on the business to franchisees in accordance with the stricter franchising regulations of other countries, so as to avoid the risk of not meeting the good faith requirement. In addition, the provision of a detailed FDD will most likely speed up the negotiations and help franchisees feel more secure about entering into the business.
There are no legal provisions on franchising under Colombian laws and regulations. As previously mentioned, in Colombia it is understood that the franchisor is bound to provide sufficient information on the business to be franchised to a franchisee before the execution of the franchise agreement, in view of general rules that apply to contractual relationships.
This requirement is therefore a generic one that arises from interpreting the law, as there are no specific legal provisions determining what will be considered ‘sufficient information’ in connection with the franchised business. In the event of disputes between franchisees and franchisors in this regard, local courts assess on a case-by-case basis whether or not the franchisor disclosed sufficient information. Any information that may make an impact on the operation of the franchise may be deemed as under the pre-contract disclosure obligation, and failing to provide it may constitute a breach of the franchise agreement.
On the other hand, in October 2006, the Colombian Institute of Technical Standards and Certification, in collaboration with a group of entrepreneurs and consultants, issued the Good Franchising Practices Guide (the Guide), which consists of a series of guidelines to be taken into account by franchisees for the purpose of deciding whether to execute the franchise agreement or not.
The Guide is focused on the provision of information that is usually present in FDDs, as well as the prevention of acts of unfair competition, however, it has no force of law. The Guide is therefore a voluntary document that companies may or may not follow, but observation of it may be considered sufficient for a franchisor to be compliant with the obligation related to the pre-contract disclosure requirement.
The disclosure document shall be used as a reference for the business by the franchisee, although the franchise agreement may be executed with broader or narrower rights for each party. It is understood that the minimum information to be included in the document should comprise, as applicable:
- the corporate name and address of the franchisor and other necessary information for its identification;
- a list of closed or completed franchises and a list of franchises under operation, as well as information on the experience of the franchisor in connection with the franchised business;
- whether the franchisor has been in proceedings such as bankruptcy, financial restructuring or insolvency, and details thereof if applicable;
- whether there are ongoing lawsuits or legal proceedings in connection with the franchise, and details thereof if applicable;
- information on the scope of the franchise, its products, services, activity and business;
- the franchisee’s rights and restrictions in relation to the territory of the franchise and clientele;
- the franchisee’s rights and obligations related to the term, renewal, transfers and termination of the franchise agreement;
- non-competition obligations;
- fees and amounts that the franchisee is required to pay to the franchisor or third parties;
- all intellectual property rights and assets under the franchise;
- whether there are conditions or obligations applicable to the franchisee in relation to the purchase or provision of products and services under the franchise, including, but not limited to, raw materials;
- information on the main obligations of the franchisor, including, but not limited to, training, assistance, advertising, systems, information and manuals;
- certified financial statements of the franchisor; and
- information on the main obligations of the franchisee in connection with issues such as operation, training, advertising, control systems, and information and manuals.
The Brazilian Franchise Law was inspired by US franchising laws, and therefore is the most complete of the region, especially with regard to FDD requirements, as it includes several straightforward provisions. Although Argentina also has a specific legal provision on FDD requirements, it is significantly generic and subject to discussions, which is the reason why, in practical terms, Argentina is similar to Colombia and Chile with regard to FDD requirements, as Chile and Colombia require the provision of FDDs as a result of good faith provisions and general rules that apply to contractual relationships. Therefore, there is no legal certainty in Argentina, Chile and Colombia with respect to the content of the FDDs to be distributed by franchisors in such countries, and the recommendable approach is to follow FDD requirements that apply in countries with stricter regulations, such as Brazil. Although players in the franchise sector in unregulated countries of South America often comment on the need for specific regulations on franchising in their countries, such specific laws may take a long time to be enacted and it is also possible that these countries will remain unregulated.