This article is taken from Lexology GTDT’s Practice Guide to Franchise. Led by DLA Piper, the publication examines key themes topical to cross border franchising.
Regulation of franchising activities: a brief history
The commercial backdrop: expansion of franchising around the world
Today we see that franchising has metamorphosed into an international phenomenon. The trademarks, the signage, the advertising slogans of franchise chains, both huge and modest in size, have become familiar icons from A to Z. Franchising has successfully penetrated scores upon scores of markets, both foreign and domestic. It has been over four decades since Colonel Sanders introduced Kentucky Fried Chicken to crowds of fascinated customers and a blaze of press coverage in Japan. Before then, to US franchisors (essentially the only ones even considering cross-border franchising) ‘abroad’ principally meant one or a few units in Canada or, very occasionally, Mexico.
International franchising today has expanded into approximately 160 countries, with the number increasing each month as one or more new markets are opened and not always by the major US chains. A survey by the International Franchise Association showed that their members are eyeing overseas expansion as an important way of diversifying their portfolios: 61 per cent of respondents currently franchise or operate in international locations, and 16 per cent generate between 25 per cent and 30 per cent of revenue from international activities.2 Almost three-quarters of respondents said they plan to start or accelerate international ventures. And we have seen companies not traditionally associated with franchising in the United States turning to franchising as a vehicle for distribution abroad.3 These developments are opening up whole regions.
The past quarter century has been especially active. In virtually every country in the world, there is now an awareness of franchising, ranging from a modest portion of the overall economy and society in the country to a position rivalling the status it has attained in the United States. The reasons for its growth around the world are essentially the same as they are in the United States: the advantages accruing to both the franchisor and the franchisee, taken together with a growing middle class in many markets, a growing ‘youth market’ and the increasingly homogenised culture of consumption.
Who was leading this wave of expansion? As before, we begin in the United States, with the expansion of US companies into foreign markets. It is a bit over-simplistic, but largely true, that the large US franchisors have been responsible for this extraordinary movement. A recent study reports that of the world’s largest 100 franchisors, 84 are US-based.4
The origin of franchise regulation in North America
In the years immediately after World War II, franchising came of age as a method of distributing products and services by levering other investors’ capital and efforts. The rapid growth of the franchising industry continued at a fairly steady pace through the ensuing decades. This outpaced any legislative or regulatory response, which did not emerge until the end of the 1960s.
After unsuccessful attempts in various states, California adopted the first franchise law in the United States, effective in January 1971. Subsequently, a number of other states adopted legislations regulating the offer and sale of franchises. Before the adoption of the federal regulation in 1979, there were congressional hearings on the regulation of franchising and different bills were introduced. However, the federal regulation did not emerge until October 1979.
In the United States, franchise regulations have taken two forms:
- an obligation that franchisors provide prospective franchisees with certain prescribed information about the franchise, the system and the franchise agreement terms; and
- a range of restrictions upon the franchisor’s freedom of action in dealing with franchisees.
At the federal level, the Federal Trade Commission Franchise Rule (the FTC Rule) requires that a highly detailed ‘disclosure document’ be provided to the prospective franchisee before the parties’ entering into the relationship.5 This disclosure obligation also exists in certain states where the franchise disclosure document must be registered with the state agencies before a franchisor is permitted to offer or sell franchises there.6 An even larger number of states regulate the relationship between franchisors and franchisees.7 Many of these state franchise relationship laws prohibit franchisors from terminating franchise agreements without ‘good cause’ (a standard that varies from state to state). Many state franchise relationship laws also prohibit franchisors from refusing to renew or extend the franchise terms without good cause, and restrict franchisors’ contractual freedom to approve or disapprove proposed transfers by franchisees. Some state franchise relationship laws also contain unusual elements such as prohibition against discriminating among franchisees, limiting a franchisor’s contractual right to ‘encroach’ on a franchisee’s territory, affording franchisees the freedom to form associations and requiring a franchisor to buy back certain items in the case of termination.
What would be the consequences if a franchisor fails to comply with one of these laws? At the federal level, the FTC Act contains a broad range of enforcement sanctions available to the FTC in case of violations of the FTC Rule. However, a person injured does not have a private right of action against the franchisor who violated the FTC Rule; it should be noted that a number of states have ‘little FTC acts’, which makes failure to comply with the FTC Rule a per se violation of the state law.8
The FTC itself can commence actions in federal courts against franchisors that fail to comply with the FTC Rule, and seek monetary penalties, injunctive relief and consumer redress. The FTC Act also authorised the Commission to seek a temporary restraining order, preliminary injunction or permanent injunctive relief. The Commission can also issue cease-and-desist orders against franchisors and require franchisors to stop from engaging in any unfair or deceptive act or practice.
Unlike the FTC Rule, state franchise laws provide a private right of action for franchisees, in addition to actions that can be taken by the state authorities. And these state and private sanctions may apply not only against the franchisor, but franchisors’ officers and directors, brokers, and sub-franchisors, on a joint and several basis.
The state authorities are vested with the authority to issue cease-and-desist orders against further offer or sale of franchises, or stop orders ending the effectiveness of a franchisor’s franchise registration in that state. Most state franchise laws also provide that the state regulators, either themselves or through attorneys general, may bring an action in a state court to enjoin franchisors from engaging in unlawful acts or to compel compliance. Other remedies under the state franchise laws include consumer redress in the form of actual and sometimes consequential damages, or rescission, injunctions, civil penalties and criminal sanctions against unlawful practices.
Beyond the United States itself, there have been other activities in North America. The first jurisdiction to enact a franchise law outside the United States was the Province of Alberta in Canada; today, five other Canadian provinces have followed suit, although there is no federal law governing franchising throughout the country.9
The proliferation of franchise regulations in the past four decades
The first franchise legislation in the United States, in California, dated to 1971. By 1979, the pattern of state regulation in the United States was falling into place, and in that year the US Federal Trade Commission promulgated its Trade Regulation Rule on Franchising.
Regulation beyond North American borders was slow to follow. By the end of the 1980s only France had acted.10 Not until the 1990s did momentum begin to gather for regulation. In that decade, first came Mexico, which has now broadened its regulation.11 Brazil took its first step in that direction.12
In western and southern Europe, Spain enacted legislation, adding pre-contractual disclosure obligations soon thereafter.13 Following Albania’s highly ambiguous 1994 law,14 the most prolific source of activity was from the former Soviet bloc: first, Russia itself,15 and within a few years, Moldova,16 Romania,17 Kyrgyzstan,18 Belarus,19 Turkmenistan,20 Azerbaijan,21 Latvia22 and Estonia.23
Perhaps the most striking developments were those in Asia. For a long time the least regulated region on the planet, it became the most regulated. China24 (which is especially important because of the sheer volume of its franchise activity), Indonesia25 and Malaysia26 have all adopted comprehensive franchise laws and regulations.
Elsewhere in Asia, Taiwan27 and Macao28 joined in the 1990s. Japan addressed franchising through its 1983 Fair Trade Commission Guidelines,29 replacing them, together with other legislation, with greater or lesser impact depending upon the size of the affected businesses.
After a long history of a self-regulatory regime, Australia adopted a Franchise Code of Conduct with extensive requirements.30 The Code itself is quite comprehensive and has undergone numerous reviews and expansions in the year since then; the latest is now in progress.
In the following decade and the next, every region of the world saw legislation enacted, for example, Italy,31 Sweden,32 the Netherlands33 and Belgium34 in Europe, Saudi Arabia35 in the Middle East, and Thailand36 in Asia. Kuwait’s Commercial Agency Law is also made to explicitly apply to franchise agreements.37
Franchise regulations around the world: a brief summary
As set out in the Annex to this chapter, as of February 2021, in addition to the United States, there are 35 jurisdictions38 that have some form of franchise-specific law or regulation that requires the delivery of a disclosure document to a prospective franchisee before the prospective franchisee purchases the franchise.
Not all franchise disclosure laws, however, are created equal. Some jurisdictions’ franchise laws and regulations do require pre-sale disclosure, but their disclosure requirements lack any specificity: Albania,39 Azerbaijan,40 Georgia,41 Latvia,42 Moldova,43 Mongolia,44 Romania45 and Turkmenistan.46
A few jurisdictions’ franchise disclosure laws are far narrower than what is typically required. For example, Argentina passed its new Argentine Civil and Commercial Code (Law No. 26,994), with provisions (in Book 3, Title IV, Chapter 19) governing franchise relationships. One of the provisions of this law requires that before signing a franchise agreement, a franchisor must provide the franchisee with economic and financial information covering the past two years for units that are similar to those offered to the franchisee. This information can be about other units in Argentina or abroad.
Many jurisdictions seem to agree with the FTC’s view that franchise regulations should be limited to a robust pre-sale disclosure regime: Belgium, Brazil, France, Spain, Sweden and Taiwan are in this group. They all require extensive disclosure from the franchisors to the franchisees before entering into the arrangement, but do not otherwise regulate the substantive terms of the parties’ contracts.
A greater number of jurisdictions, however, seem to have taken the view of some states in the US that, in addition to regulating the pre-sale disclosure, the franchise regulations should seek to regulate other aspects of the franchisor-franchisee arrangement, from ‘pre-qualifications’ to franchise to restrictions on franchisor’s right to terminate the franchise agreement. Of course, the degree of intrusiveness differs substantially from jurisdiction to jurisdiction, but they all reflect the decision to go beyond the disclosure requirements. The following jurisdictions are in this group: six Canadian provinces (Alberta, British Columbia, Manitoba, New Brunswick, Ontario and Prince Edward Island), China, Indonesia, Italy, Japan, Macao, Malaysia, Mexico, the Netherlands, Saudi Arabia, South Africa, South Korea, Thailand, Tunisia and Vietnam.
Before we conclude this section, it is worth noting the potential duties of pre- and post-contract disclosure under civil law in jurisdictions that do not have specific pre-contractual franchise disclosure laws, such as Germany and Norway,47 where legal systems include a general principle that parties owe each other a duty of good faith and fair dealing during pre-contractual negotiations, which can be interpreted to impose a pre-sale disclosure obligation on the part of the franchisors (and, for that matter, on the part of the franchisees).
Registration is a concept that is familiar to all franchise practitioners in the United States – a state agency reviews the franchise offering for compliance with the state’s law (including the franchise disclosure document) before the franchisor is permitted to offer such franchises within that state. Outside the United States, however, such a registration regime is rather rare. Of the jurisdictions that have specific franchise laws and regulations, only China,48 Indonesia, Malaysia, South Korea, Tunisia, Saudi Arabia and Vietnam49 require some form of registration. Spain initially required the registration of all franchisors, then just the non-EU franchisors, and then finally abolished the registration requirement altogether.
It should be noted that there could be a number of other ‘registrations’ involved in a cross-border franchise transaction. For example, in some jurisdictions, the executed franchise agreement (or a summary thereof or a short-form agreement) needs to be registered with the government authorities, often to establish the franchisee’s status as a registered user of the trademarks, or to establish the authenticity of the transaction for foreign exchange approval purposes. This, obviously, is beyond the scope of this chapter.
The proponents of franchise relationship laws contend that while disclosure laws provide protection to the franchisee by affording them the necessary information to make an informed investment decision, they offer no remedy against opportunistic conduct that extends beyond contract formation, and franchise relationship laws are needed to further protect the franchisees during the continuing business relationship of the parties. These laws are intended to restrict franchisors’ discretion in certain areas that are important to franchisees. Today, with a handful of exceptions that are ‘disclosure-only’ jurisdictions, the majority of franchise laws and regulations around the world contain both pre-contractual disclosure and ongoing relationship elements; a few countries have opted for the ‘relationship-only’ approach.
While a detailed examination of the requirements of various franchise relationship laws around the world is beyond the scope of this chapter, it is worth noting that these laws cover a truly wide range of topics, including, for example, the duty of good faith and fair dealing, the duty to provide support, the ‘cooling-off’ period, the minimum contractual term, the restrictions on termination, the requirements around the renewal of franchise agreements, restrictions on transfer and assignment, the franchisor’s right to exercise quality control, the franchisee’s obligation to keep information confidential, the franchisees’ right to associate, the limitations on non-compete provisions, encroachment of franchisees’ exclusive territories, the franchisor’s liabilities towards the franchisees, and the governing law and dispute resolution requirements.
The following three things are also noteworthy.
No major jurisdiction has adopted a relationship-only franchise law for some time. Russia, being one of the few relationship-only countries, recently amended its franchise law, and the amendments appear to be drafted to the franchisor’s benefit.
While the franchise relationship laws in North America mainly deal with restrictions on franchisors and protection of franchisees, franchise relationship laws in other parts of the world often impose obligations on franchisees as well. For example, China’s franchise regulation provides that the franchisee must not transfer the franchise without the franchisor’s approval, and must not disclose or allow others to use the franchisor’s trade secrets. Malaysia’s franchise law stipulates that the franchisee and its employees must not carry on any business similar to the franchised business both during the franchise agreement term and for two years after the expiration or termination of the franchise agreement.
In addition to these franchise relationship laws, a number of countries have enacted commercial agency or distributorship laws that are not specifically targeted at franchise relationships, but that under a variety of circumstances may apply to franchises.
Key concerns with franchise regulations: a brief examination
Disparities and discrepancies
In the European Union – where one might expect a symmetrical and uniform approach from country to country – there are disparities and differences between franchise legislation. As one European commentator has observed:
Franchising has been identified by the European Commission’s Competition Directorate as being of great economic importance to the European Union. Indeed, European jurisprudence, . . . underscore[s] the important role of franchising in furthering the establishment of a single market in the EU. However, although European competition law treats franchising in a relatively benign manner, member state law takes a somewhat different and entirely heterogeneous approach. Eight EU member states have franchise-specific regulatory regimes, but no two are the same. The remaining 19 member states regulate franchising entirely by the application of general laws, again with little homogeneity.50
It should not be concluded that the only obstacle to effective regulation of cross-border franchising by franchise-specific laws and regulations is their diversity. There are other recurring concerns, for example:
- Consequences for violating franchise laws outside of the United States are somewhat unpredictable compared with similar consequences in the United States. As such, the degree of severity a franchisor who fails to comply will confront has to be examined on a case-by-case basis. In some countries, governmental authorities may respond to complaints by aggrieved parties (eg, in Sweden that can even be an association of business people). In other countries, there is no governmental enforcement, leaving a dispute in the hands of the parties. Also, in some countries, the government takes a more proactive role. In some cases, violations can constitute criminal offences.
- In the United States, distribution arrangements are seldom characterised as being franchises under one state statute but not under another, or be characterised differently under federal and state law. There are some aberrations (eg, in New York, if the payment prong of the definition is met, but only one of the other two definitional prongs are, it nonetheless constitutes a franchise). But that is fairly rare and more common outside the United States. For example, in France, the description of the types of arrangements covered by the Loi Doubin does not use the term ‘franchising’; in Russia, distribution arrangements are viewed as a species of ‘commercial concession’. As a result, it is not possible to make a generalisation about whether a particular distribution arrangement is covered by foreign laws with the same degree of confidence as in the United States.
- It seems that in some countries the governmental intent is to make it as difficult as possible to engage in franchising (or at least in a fashion that makes commercial sense). In Indonesia, for example, it is difficult, following termination or non-renewal of a franchise, to install a new franchisee without the agreement of the former franchisee, who can block or delay the new registration. While the official termination of this process is a ‘clean break’, there is nothing ‘clean’ about the ‘break’. In fact, the reference obscures what it more closely resembles – extortion.
- Mandatory requirements or mandatory prohibitions in some countries are contradicted by those in other countries. ‘Earnings claims’ or financial projections or estimates of likely profits or sales revenues are strictly regulated in the United States, and if proffered, are usually objected to as the easiest target for a disappointed franchisee. Conversely, in South Korea, franchisors (except for certain small franchisors) are required to provide information on projected sales revenue and the supporting materials for its projections.
Even in the absence of a franchise statute, there may be a disclosure obligation. While it may be natural to think that ‘disclosure’ occurs only if mandated by statute and that in the absence of a mandatory requirement a franchisor would have no legal obligation to make pre-contractual disclosures to a prospective franchisee, that is not true across all jurisdictions. For example, in Germany, where there is no statutory franchise disclosure law, franchisors still choose to disclose to their potential partners, in writing, all information deemed to be necessary by decisions of the German courts, which roughly track the disclosures required by countries with franchise disclosure statutes. Failure can result in liability of the franchisor.
Prerequisites to franchising
Some countries have gone beyond more or less traditional prohibitions of conduct or requirements of pre-contractual disclosure, and set up barriers to franchising in their countries based on other motivations. These may take the form of efforts to ensure that a franchisor is financially stable, and capable of discharging its obligations. Examples include certain states in the United States, where a net worth below a certain level will prevent franchising unless certain steps are taken (eg, a bond or guarantee; placing the initial fee in escrow). In other countries (eg, China, Vietnam) the putative franchisor must demonstrate that if it has already successfully expanded through corporate-owned units. In other countries, certain regions or industries are barred – for example, in the interest of national security or (although rarely acknowledged) to protect local business. Quite apart from the deterrence to franchising that may be created by any one of these discrepancies, the lack of a common pattern poses special barriers to multi-country expansion.
Lack of sensible exemptions
One of the more frustrating aspects of current franchise regulation, from a public policy perspective, is the lack of any recognition of the fact that not all franchisees are in need of the same level of protection. The consequence is unnecessary costs to franchisors and needless use of governmental resources.
There is some evidence of awareness of this concern by legislators and policymakers, and there are some examples of excluding from coverage those not truly in need of it. The International Institute for the Unification of Private Law (UNIDROIT) Model Franchise Disclosure Law is a useful starting point: among those it would exclude are substantial franchisees (ie, those who either commit to an investment of a certain size or have net worth or turnover in excess of a certain amount). The purpose is to relieve the franchisor of the cost, time and burden of compliance when there is reason to conclude that the franchisee is ‘a person of such level of sophistication and knowledge that he/she has access to the advice of legal counsel’ or ‘who by virtue of his/her net worth or turnover is assumed to have such a level of sophistication and prior business experiences’, and thus that ‘he/she does not require the protection of this law.’ This is similar to the theory of exempting ‘accredited investors’ from certain aspects of the protection of the securities law, using income and net worth as an admittedly arbitrary proxy for sophistication and experience.
But this approach has found little support. The FTC Rule (which preceded the UNIDROIT formulation) from the outset contained two exemptions for circumstances in which it was concluded that there was inadequate evidence that a prospective franchisee required the protection of disclosure:
- a very minimal investment; and
- a ‘fractional franchise’ (defined as when the franchisee or its principals have had at least a specified minimum period of prior experience in the same type of business, and the parties anticipate that the sales from the proposed relationship will represent no more than a specified percentage of the dollar volume of the franchisee’s total projected gross sales).
More recently, the FTC expanded this effort to narrow the protection of the FTC Rule to those deemed in most need of it, exempting very large investments and franchisees with large net worth. Several of the states with franchise registration and disclosure laws have exemptions for large franchisees (meeting certain minimum net worth or experience requirements) or large investments (meeting a threshold level of investment in the franchise), but some of the exemptions provide a relief only from registration, not from disclosure.
Outside the United States, however, there is little about which one can be encouraged. Except for Australia and certain Canadian provinces there has been no adoption of the fractional franchise, large investment, or sophisticated or large net worth exemption approaches.
Narrowing the target of the franchise laws seems both sensible and cost-effective. Unfortunately, far too few countries have taken this common-sense approach, and we regretfully conclude that we believe it is too late to reconfigure the landscape in this fashion.
The way forward: a brief preview
The efforts to standardise franchise regulations
An even more common source of frustration is the lack of consistency across borders in the content and approach of franchise regulation. Franchisors are required to become knowledgeable about and comply with widely varying requirements, dealing with both presale disclosure and relationships. This is especially problematic for multinational franchisors, raising the cost and reducing the efficiency of penetrating multiple jurisdictions.
A small step toward ameliorating this concern was taken in the 1980s by a group of practitioners working under the aegis of the International Bar Association and the International Franchise Association to address the threshold problem of inconsistent terminology (sometimes within the same country, or even the same law firm). Different terms were frequently being used to refer to similar or even identical relationships, concepts and legal structures. The result of their deliberations was International Franchising: Commonly Used Terms, published by the International Bar Association in 1989, and including a section entitled ‘Recommended Terminology’. But anyone who works in this field knows that the use of the same term to refer to different concepts or structures, or of different terms to refer to the same concept, continues to plague international franchising.
Far more significant, of course, is the ‘crazy quilt’ nature of the laws themselves. Efforts to rectify this obviously suboptimal situation have been notably unsuccessful. While there have been several such attempts, perhaps the best known is that of UNIDROIT, an independent, intergovernmental body devoted to seeking common solutions to legal issues arising in multiple countries. Its office in Rome was the site of numerous meetings of experts over a period of years. Those gatherings led to the approval of a draft that, while limited in scope, was salutary. But the laws in different countries adopted since then reveal almost no practical effect: the UNIDROIT formulation could have served as a model, but it was not so much rejected as simply ignored.
Back to basics
If, however reluctantly, we must conclude that the genie is out of the bottle, and that nations will continue to feel impelled to adopt franchising laws; and if we conclude further that no uniformity can be expected to emerge from the ensuing welter, either in terms of prerequisites, exceptions, or the nature and extent of the prohibitions or requirements, perhaps it is time to acknowledge the inevitability of the impulse to legislate, by a nation’s own perception of what it needs.
In that case, perhaps the most straightforward approach to improving the climate for regulation of international franchising is to turn to the education of legislators considering such a course of action. We can, in our judgement, do no better in that regard than follow the path set by UNIDROIT. Here is UNIDROIT’s articulation of the standards legislators should demand be met by those proposing franchise legislation:
- whether it is clear that there is a problem, what its nature is, and what action, if any, is necessary;
- whether prospective investors are more likely to protect themselves against fraud if they have access to truthful, important information in advance of their assent to any franchise agreement;
- whether the nation’s economic and social interests are best served by legally requiring a balance of information between the parties to a franchise agreement;
- whether there is a pattern of abusive conduct, or whether this conduct is isolated or limited to particular industries;
- the nature of the evidence of abuse;
- whether existing laws address the concerns and whether they are adequately applied;
- whether an effective system of self-regulation exists;
- the financial burden the new legislation will place upon franchisors and investors as compared to the benefits of legally required disclosure; and
- whether the proposed legislation inhibits or facilitates entry to franchisors, and its effect on job creation and investment.
This review of the regulation of franchising around the world is, of necessity, transient and simplified. Transient, because change occurs rapidly and, frequently, remains unreported for some time. Simplified, because while basic structures reappear, the changes – and the omissions – follow no clear pattern. A practitioner, an active participant or one who is considering entering the field is challenged by the need to keep pace with developments, understand them and seek to plan accordingly. It is hoped that this overview will be useful in that regard.
The goal of rationalising the many disparities remains elusive. Perhaps a more achievable aspiration is to arm those in countries where no franchise legislation yet exists with a body of experience upon which one can base a rational discussion as to whether such legislation, if proposed, is necessary and appropriate.
We have sought to do so in this chapter.
List of franchise statutes and regulations around the world
|Antigua and Barbuda||X|
|Canada (Alberta, British Columbia, Manitoba, New Brunswick, Ontario, Prince Edward Island)||X|
|United States – Federal||X|
|United States – Certain States||X||X||X|
|United States – Certain States||X||X|
|United States – Certain States||X|