In this chapter we analyse franchise agreements from the consumer protection perspective. Consumer protection issues are treated by jurisdictions at a national or regional level. Therefore, this chapter has limited scope; however, we highlight some jurisdictions that, given their peculiarities or the markets involved, are interesting for the purpose of this chapter.
We will begin by dissecting the franchise agreement to identify the different relationships existing within it and identify whether there is a consumer involved. The latter is of utmost importance, since, as an almost universal principle, to apply the consumer protection regime there must be a consumer involved.
In a nutshell, there is a franchise when a party – the franchisor – grants another – the franchisee – the right to use a proven system, with the purpose of marketing certain goods or services under the commercial name, emblem or brand of the franchisor. The franchisor provides technical instructions as well as technical and commercial assistance, and in return the franchisee pays a direct or indirect price.2
The following relationships can be found in any franchise agreement:
- A principal relationship between the franchisor and the franchisee that is to regulate how the franchise will work. In this first relationship the question that we pose, and will try to answer in this chapter, is whether the franchisee would be considered a consumer or not. That is, can the franchise agreement be considered to involve a supplier and a consumer? Or, instead, is it considered to be a joint contract between parties with equal power, or even a standard form agreement? The answer to these questions is essential, as the existence of a consumer determines whether the consumer protection regime applies. Besides, if the franchise agreement were to be drafted as a standard form contract then an intermediate protection arises, which can be quite similar to the one for consumers. All of this has a very important commercial impact.
- A subsequent relationship, which is the direct consequence of the relationship described in the point above, is the relationship existing between the franchisee and its client. There is almost no doubt that the client, except for in some cases, will be a consumer sheltered by the consumer protection regime. However, other queries arise from this second relationship and are related to who is liable towards this client.
But this is not all. Franchise agreements are very complex, and we can find cases in which a particular franchisor wants to extend its entrepreneurship beyond a certain border and to do so, the following third relationship may be needed:
- The franchisor grants to a franchisee a territory or scope of action that is national, regional or provincial, as well as the right to appoint sub-franchisees. In this relationship we have the same questions as above: can any of the parties be considered consumers? Who is responsible if a consumer is hurt?
The concept of consumer
Even though the goals of consumer protection regimes across different jurisdictions may be similar, the scope of the application of different regimes varies. The reason is quite simple: the subjective scope of the regime is usually linked to the notion of consumer, which differs between the different jurisdictions.
Indeed, to consider a certain person as a consumer, a survey of statutory regime shows that there are different ways to face this important issue.
In most countries3 it is clear that the consumer protection regime is designed to protect persons who are the end users of products or services, purchasing them for personal consumption.
Another criterion followed by certain countries4 is identifying a consumer with a natural (ie, physical) person. Hence, if the purchaser is organised as a corporation it cannot be entitled to any of the benefits arising from the consumer protection regime. This criterion usually adheres as well to the end user criterion.
Some countries5 have a third way of resolving this matter. This third way establishes, as a trigger point to applying this protective regime, the characterisation of the purchaser or of the purchase made as very small or micro.
We will now describe the criteria applied in some relevant jurisdictions, which may help us to discover if there are global tendencies and predict how the consumer protection matter is evolving around the world.
Where the European Union is concerned, the notion of consumer is limited to physical persons, and corporations are not included in this protective regime. However, as the community legislation works as the minimum standard of protection, member states can provide more extensive protection, and there are countries that embrace a broader definition of consumer. To be included in the concept of consumer the physical person has to make a transaction that it is not linked to his or her professional activity.6 Therefore, it would be almost impossible for a franchisee to seek protection under the consumer protection regime.
Spain establishes that a consumer must be a physical person acting with a purpose that differs from his or her business, trade or profession. However, it is established that ‘[t]hey are also consumers for the purposes of this regulation, legal entities and entities without legal personality acting in a non-profit way in a field that differs from its commercial or business activity’.7 Even with a broader notion of consumer than the Community Directives, we think that a franchisee would still have a hard time seeking a claim in Spain based on consumer protection rules.
Germany limits the notion of consumer to physical persons and a natural person will be considered a consumer as long as ‘the transaction executed is not linked to his or her business or professional activity’.8 Philip Zeidman sustains that ‘in small transactions where the franchisee is deemed a “founder”, those laws (consumer protection laws) might apply in Germany’.9 In the words of Jiri Jaeger and Frederik Born:
Actually, it is not about whether a person is a consumer according to the statutory definition but, in fact, about whether a person has entered into a consumer business or a non-consumer business. A franchisee is not regarded as a consumer. When the franchisee signs the franchise agreement, this action is already viewed as business conduct and, thus, conducted by an entrepreneur. However, it is a matter of ongoing discussion as to whether the franchisee is entitled to similar protection (a cooling-off period) when it comes to the conclusion of a franchise agreement as a business start-up. Furthermore, consumer protection rights could be invoked if the franchisee is required to make consistent purchases from the franchisor and if the franchisor sells the same products in his or her own franchise outlet.10
France has its particularities as the local legislation does not define consumer.11 Philip Zeidman indicates that a franchisee can be considered a consumer under France’s consumer regime only ‘if the franchisee is viewed as a “non-professional”’.12
Italy also limits the application of the protective regime to cases in which a physical person purchases for purposes unrelated to his or her commercial, professional, industrial or artisanal activity.13 Once again, it is unlikely that a franchisee would be considered a consumer.
In the United Kingdom a consumer is defined as an individual acting for purposes that are wholly or mainly outside his or her trade, business, craft or profession.14 Most scholars disagree that a franchisee falls within the definition of consumer, however, as far as we know, courts have not yet granted franchisees consumers’ rights.
Under Mercosur rules,15 a consumer is any individual or legal entity that acquires or uses products or services for personal use. It is specifically indicated that:
[i]t is not considered a consumer who, without being a final addressee, acquires, stores, uses or consumes products or services with the purpose of integrating them as a direct input to other products or services in the process of production, transformation, commercialization or provision to third parties.
However, these rules establish that each member state can provide a higher standard of protection and, therefore, the end use principle does not apply to all Mercosur members.16 Since it would be difficult for a franchisee to be considered as the end user, it is quite unlikely that a franchisee would be considered as a consumer.
Argentina’s regulation on this matter 17 has undergone various amendments, with the definition of consumer becoming more comprehensive every time. In its last version consumers are not only natural persons but also the legal entities. Even though end use is a requirement, the requirement of integrating the acquired business or product into a commercialisation chain was eliminated. Therefore, some scholars, although still a minority, consider that there are cases where the franchisee can be deemed to fall within the scope of the consumer protection regime, indicating that the franchisee is the end user of the franchise agreement.
Brazil has a wide definition of consumer and it includes not only the physical but also the legal entities that acquire goods and services as end users.18 The case is similar to that described for Argentina.
Chile expressly states the end use to be the distinctive feature that must have a consumer. It is established that anyone who can be considered to be a supplier cannot be protected as a consumer.19 Hence, we interpret that a franchisee will not be considered as a consumer under the Chilean consumer protection regime.
Uruguay considers that both natural persons and legal entities can be considered consumers. However, it is specifically stated that ‘[i]t is not considered a consumer or user who, without constituting final recipient, acquires, stores, uses or consumes products or services in order to integrate them into production processes, transformation or marketing’.20 Hence, we think it would be difficult for a franchisee to be considered a consumer.
Paraguay has a broader definition of consumer, which includes physical and legal entities. However, a consumer has to be the end user of the good or service acquired.21 The same criteria as described for Argentina apply.
Bolivia is also enrolled in a broader definition of consumer (including physical and legal entities) and sustaining the criterion that end use is required.22
The situation in Peru is quite particular since, even though end use is required to be considered a consumer, it is also established that:
1.2 The microentrepreneurs that show a situation of informative asymmetry with the supplier regarding those products or services that are not part of its own business.
1.3 In case of doubt about the final destination of a certain product or service, it is qualified as a consumer to whom acquire it, use it or enjoy it.23
Given the extension of the notion of consumer to other cases in which there is a asymmetry between parties, the franchisee is likely to be considered as a consumer.
Ecuador also defines a consumer as the end user of a particular product or service, no matter if it is a physical person or a legal entity.24 The same criteria as set out for Argentina apply.
There is particular situation and description for Colombian law, as it is established that a person (physical or legal) can fall within the scope of end user even if its use of the product or service satisfies a business need, providing that this is not directly related to its main economic activity.25 Therefore, if a franchisee enters into a franchise agreement but the franchise is not its main economic activity, it can be considered to be a consumer and entitled to all the protection provided within the regime.
Mexican regulation is distinctive since although it establishes the end use criterion as a requirement in order to be considered a consumer, it makes an exception. To qualify for the exception, the franchisee must fulfil the following two requirements: (i) it has to be a small business duly registered as such under the corresponding administrative authorities; and (ii) the transaction of which the small business seeks protection cannot exceed a certain amount.26 If the franchisee fulfils these two requirements then the consumer protection regime applies.
South Africa is an interesting case as it simply opts for forcing the franchisee into the common consumer definition. In this sense, its regulation provides a definition of consumer and then adds that a consumer is also ‘a franchisee in terms of a franchise agreement’.27 Hence, there is no doubt that the franchisee is a consumer. In fact, before the Consumer Protection Act 6828 entered into force, there was no specific piece of legislation that regulated franchises.
The United States must also have a special analysis, as the Federal Trade Commission (FTC), the nation’s consumer protection agency, has prepared a ‘Consumer’s Guide to Buying a Franchise’ addressed to the franchisee (considered a consumer) to help him or her decide if entering into a franchise is the right decision. It states that it:
suggests ways to shop for a franchise opportunity and highlights key questions you need to ask before you invest. The Guide also explains how to use the disclosure document that franchisors must give you – under the FTC’s Franchise Rule – so you can investigate and evaluate a franchise opportunity.29
Australia has its Australian Consumer Law (ACL) that indicates that:
For the purposes of the ACL, a person is a ‘consumer’ if they acquire goods or services that are priced at less than AUD40,000. A person is also a ‘consumer’ if they acquire good or services that are priced at more than AUD40,000 but they are ‘of a kind ordinarily acquired for personal, domestic or household use or consumption’ and it provides the following example: a person who acquires a vehicle for use in the transport of goods on public roads, irrespective of price, is also considered to be a consumer for the purposes of the ACL.30
Therefore, franchisees may be considered as consumers when they acquire goods or services from the franchisor up to that threshold, or in the case of acquisitions, where the person acquired the goods for the purpose of using them.
From the above-mentioned jurisdictions we can conclude that there are jurisdictions that: (i) have a narrow definition of consumer and hence a franchisee would never be considered as a consumer; (ii) may apply their consumer protection regime to franchisees if certain requirements are met (eg, size of the franchisee, amount of the purchase, use given to the purchase); and (iii) simply deem a franchisee to be a consumer.
Consequences of applying the consumer protection regime to the franchise agreement
It is important to determine whether the franchise agreement falls within the scope of application of the consumer protection regime and to what extent. This regime, as every protective regime, provides leverage for the consumer – leverage that the franchisor must be aware of.
The consumer protection regime is based mainly on the premise that the parties involved in a consumer relationship are unequal: an expert and strong supplier and an inexperienced and weak consumer. Following this premise, different jurisdictions follow special obligations that suppliers must comply with and special rights for consumers established to strengthen the consumer.
Duty of providing information
Even though in every contractual relationship parties are generally obliged to act in good faith and not conceal relevant information, the duty of proving information set under the consumer protection regime is an enriched version of said obligation and it is imposed on only one of the parties: the supplier. The product or service’s essential characteristics, as well as the conditions of its commercialisation and any other circumstance relevant to the contract, must be informed to the consumer in a true, clear and detailed way. This obligation is considered to exist from the very beginning – that is, from the advertisement of the product or service – and continues to exist after the agreement is executed, up until the service or good ceases to exist.31
Where a franchise is concerned, the application of this obligation means that the franchisor must provide accurate information about the franchise to the franchisee and that the franchisee (as the supplier of the service or product to the end consumer) must duly inform its clients.
It is worth mentioning that the South Africa Consumer Protection Act provides, regarding franchise arrangements, that false or misleading representations concerning the performance, characteristics and benefits of the business are not allowed. Besides, the franchisor must provide a potential franchisee with a disclosure document at least 14 days before the franchisee signs the franchise agreement. This document must include information relating to the franchisor’s turnover and net profit and projected sales, income and profits for the franchised business or franchises of a similar nature. This is nothing more than an actual application of the duty of providing information.
Under the Franchise Rule enforced by the FTC of the United States of America, the franchisee must receive the franchise disclosure document at least 14 days before he or she is asked to sign any contract or pay any money to the franchisor or an affiliate of the franchisor. This document provides information regarding:
- the franchisor’s background;
- the business background;
- litigation history;
- initial and ongoing costs;
- supplier, territory and customer restrictions;
- the franchisor’s advertising and training;
- renewal, termination, transfer and dispute resolution;
- financial performance representations;
- franchisee and franchise system information; and
- financial statements.32
Similarly, in Australia, the Australian Government Productivity Commission stated that ensuring that consumers are sufficiently well-informed has the purpose of helping to ‘meet the needs of those who, as consumers, are most vulnerable or at greatest disadvantage’.33 It also states that ‘[m]ore-informed consumers not only make better choices, but also drive competition and innovation in markets’.34
Another example of this enhanced duty of providing information is the obligation to inform consumers of their right to withdraw from a contract if certain requirements are met.35 In the event of lack of, or insufficient, information about cooling-off rights, the sanction in some jurisdictions is that the period granted to consumers to exercise this right never ends.36
It is important to mention that not complying with this duty commonly entails for the supplier not only the possibility of being sued by the consumer for damages but also the possibility of being sanctioned by the corresponding administrative authority. In fact, in almost all jurisdictions there is an administrative authority that is empowered to issue infringement notices, conduct investigations and, finally, impose fines37 and, perhaps with greater impact, impose the obligation to publish details of paid infringement notices in a publicly accessible register.
Judicial revision of the legality of contractual clauses
The pacta sunt servanda principle loosens when a consumer is involved, so clauses included in the contracts may be subject, at the consumer’s request, to judicial scrutiny. Some jurisdictions even go further and provide the possibility of having judicial control over what standard form contract is relevant, even when there is no consumer involved. This is particularly important in franchise agreements, since almost all of them are standard form contracts.
This is the case in Argentina, in which, irrespective of being a consumer, if the relationship is based on a standard form contract then a specific regulation is triggered.38 Within this specific regulation, it is established that general predisposed clauses must be understandable and self-sufficient and that the wording should be clear, complete and easily readable, and texts or documents that are not provided to the counterpart before or at the same time as the execution of the contract are considered not agreed upon. The specific regulation establishes that abusive clauses will be null and void, and the notion of abusive clauses includes clauses that import a waiver or restriction to the rights of the adherent, or extend predisposing rights that result from statutory provisions. Hence, in almost all cases, the franchisee, whether considered a consumer or not, will be protected by the standard form contract regulations.
As in Argentina, in Germany, contractual clauses are subject to an in-depth review by the courts, and ambiguous clauses are interpreted in favour of the franchisee. Clauses that are deemed to be contrary to statutory provisions are deemed invalid. Provisions identified as void by the courts are not reduced to a level at which they are legally valid, they are simply invalid as a whole. Even though a franchisee is not a consumer in terms of German law, his or her protection is similar.
The United Kingdom is a jurisdiction that must be watched, since it is evolving and courts’ decisions are embracing new paradigms. The principle of ‘freedom of contract’ is still the main principle, and in business-to-business relationships (such as the one concerning the franchisee and the franchisor) the principle of good faith is applied less. However, if the franchise agreement is entered into as a standard form contract, the franchisee can invoke the Unfair Contract Terms Act 1977, which aims to reduce the possibility of limiting the liability, and if the franchisee is considered a consumer, he or she can claim further protection under the Consumer Rights Act. Courts are adjusting the freedom of contract principle to make it work together with other principles, such as the duty of good faith.
South African regulation must be understood carefully as it establishes several limitations that if not complied with by a franchise agreement, then the franchisee can claim for protection. In this sense, the particularity of the South African regulation is that it regulates the price and the performance description that must be fair, reasonable and just. On the contrary, this issue (price and performance description) cannot be subject to court scrutiny under German, UK39 or Argentinian law.40
Several and joint responsibility for the chain of commercialisation
It is common legal advice that franchisors should include provisions dealing with vicarious liability, indemnification and insurance issues in the franchise agreement. This, of course, is highly recommended, and we are not criticising the inclusion of said defence clauses. However, we want to point out that these clauses are not always infallible and do not create a safe harbour. In fact, when dealing with a consumer, clauses aiming to limit responsibility may not be valid at all, or at least may not be held against the consumer, and are for sure subject to court scrutiny.
One of the leverages for consumers is being able to sue all the people involved in the commercialisation of a certain product or service for damages. So, in the case of a client who buys a certain product from a franchisee and that product causes him or her damage, that consumer will be entitled to sue the franchisee, and also the franchisor and the franchisee that has the right to sub-franchise in a given territory, if applicable.
In Argentina it is established that:
If the harm to the consumer results from the vice or risk of the product or the provision of the service, the supplier, the manufacturer, the importer, the distributor, the seller and the one who has put his brand on the product or service will respond. . . . The responsibility is joint and several and parties may initiate the corresponding recovery actions. Only those who demonstrate that the cause of the damage has been alien to them will be totally or partially released.41
Once again, the pacta sunt servanda principle is applied in a flexible way when a transaction involves a consumer. In this sense, consumers are able to withdraw from a contract within a certain period after signing it. Its justification can be found in the alleged distortion of the decision-making process arising from the inferiority of one party (the consumer).
In this sense, in the European Union it is established that consumers have the right of withdrawal in distance and off-premises contracts.42 This right has been transposed into national law and we can mention, for instance, Germany, whose regulations state that:
If a consumer is given, by statute, a right of revocation under this provision, then he is no longer obliged by his declaration of intention to enter into the contract if he revoked it in good time. The revocation does not have to contain any grounds and must be declared to the entrepreneur within two weeks in text form or by return of the thing; to comply with the time limit, dispatch in good time is sufficient.43
In South Africa it is established that ‘a franchisee may cancel a franchise agreement without cost or penalty within 10 business days after signing such agreement, by giving written notice to the franchisor’.44
Besides, the Australian Franchising Code of Conduct45 provides that a prospective franchisee is entitled to a cooling-off period of seven days after entering into a new franchise agreement.
Argentina also applies the cooling-off right, but only in distance and off-premises contracts, and similarly to what happens in Germany, this right is granted within 10 days as long as it is duly informed.46 The supplier must inform the consumer about the power of revocation by including it in prominent characters in any document presented to the consumer at the negotiation stage or in the document that implements the concluded contract, located as a provision immediately before the consumer’s signature. The right of revocation is not extinguished if the consumer has not been duly informed about his or her right.47
These are just some of the consequences that considering the franchise agreement within the scope of application of the consumer protection regime imply. There are many more that could not be analysed in this chapter, for brevity’s sake, such as proceedings advantages (eg, abbreviated proceedings for consumer’s claims, dynamic distribution of evidentiary burden, the consumer can bring a claim free of judicial costs) and damages that can be claimed, such as punitive damages.
From the jurisdictions we have analysed, we can see that this relatively new protective regime is in continuous growth, expanding not only its subjective scope but also its subject matter scope. Franchise agreements are far from being alien to the paradigm, principles and new rules established by this regime, and both franchisor and franchisee must be aware of it in order to be prepared.