Business overviewTypes of vehicle
What forms of business entities are relevant to the typical franchisor?
In the United Kingdom, it is usual for a franchisor to operate as a limited liability company. This is also true for most substantial businesses operating outside of the franchising sector. A company is a separate legal entity, distinct from its shareholders, which enables it to enter into contracts in its own name.
A franchisor may also operate as a limited liability partnership (LLP). An LLP combines the flexible structure of a partnership with the benefits of limited liability for its members. Like a company, an LLP has a legal personality separate from that of its members, one of which must be a natural person.
The franchisor may also operate as a sole trader or as an unlimited partnership. Unlike an LLP, an unlimited partnership is not a distinct legal entity from its partners, and, therefore, its partners are jointly and severally responsible for the business’ debts and liabilities.Regulation of business formation
What laws and agencies govern the formation of business entities?
Companies are formed under and governed by the Companies Act 2006, and LLPs are formed under and governed by the Limited Liability Partnership Act 2000. Unlimited partnerships are governed by the Partnership Act 1890.Requirements for forming a business
Provide an overview of the requirements for forming and maintaining a business entity.
Companies must be registered at Companies House. In order to incorporate a company, those looking to set one up will need to pick a suitable company name, identify an address that will act as the registered office address of the company, have at least one director that is a natural person, and have at least one shareholder. Companies also need to adopt a set of articles of association, which are the written rules that will govern the running of the company and relationship between the shareholders. Companies generally use standard model articles, but these can be tailored to the company’s structure or business. Once incorporated, Companies House will issue an incorporation certificate and company number. A set of company books must be maintained that detail certain information about the company and should be updated to reflect any changes. Certain changes and information will need to be filed at Companies House, including confirmation statements (detailing the shareholders) and company accounts. When incorporating, companies are required to identify and record the people who own or control the company, known as People with Significant Control (PSC). Information about a company’s PSC is kept within a central public register at Companies House. The PSC register helps to increase transparency over who owns and controls UK companies.
Limited liability partnerships must also be registered at Companies House. They are also required to file annual confirmation statements, annual accounts and update Companies House of any changes to its membership or registered office address. There is no specific requirement within the Limited Liability Partnerships Act 2000 for an LLP to have an LLP agreement. In the absence of such an agreement, the governance of the LLP is detailed in the default provisions set out in the Limited Liability Partnerships Regulations 2001. It is unlikely that the default provisions set out in those Regulations would be adequate for the governance of most modern LLPs. LLPs are also required to provide information about its PSC to Companies House.
Partnerships are not registered at Companies House, and are deemed to have been formed once they satisfy the definition of a partnership under the Partnership Act 1890. The governance of a partnership is detailed in that Act, except where the provisions of the Act have been amended by any partnership agreement entered into between the partners. As with LLPs, it is unlikely that the provisions set out in the Act would be adequate for the governance of most modern partnerships.Restrictions on foreign investors
What restrictions apply to foreign business entities and foreign investment?
The United Kingdom is a popular destination for foreign businesses seeking to expand overseas. Business regulation in the United Kingdom is relatively light-touch, as evidenced by its approach to franchising (see responses below).
The Department for International Trade promotes foreign businesses trading in the United Kingdom and encourages investment from overseas. In general, there are no restrictions on ownership by foreigners of UK assets and foreign businesses and individuals are allowed to be both shareholders and directors in UK companies. UK immigration laws highlight how foreign investment is encouraged, allowing individuals from overseas to apply for visas based on their investment into certain UK companies.Taxation
Briefly describe the aspects of the tax system relevant to franchisors. How are foreign businesses and individuals taxed?
UK resident companies are required to pay corporation tax on their worldwide profits. Companies are taxed based upon their accounting reference period, and can choose when their accounting period ends. Companies are required to file their annual accounts with a tax return with HM Revenue and Customs (HMRC) within 12 months of the accounting reference period. The accounts must also be filed with Companies House (there is reduced disclosure for smaller companies), and, therefore, the accounts become a matter of public record.
A non-resident company will not be liable to tax merely as a result of trading with UK businesses. However, when a non-resident company is trading through a permanent establishment in the United Kingdom (or is controlled from the United Kingdom), it will be subject to corporation tax on the profits made by that permanent establishment. Any corporation tax suffered in the United Kingdom by a non-resident company may be reduced or eliminated as a result of a relevant double tax treaty (DTT). In some cases, accounts from the permanent establishment are also required to be filed at Companies House.
Where a franchisor establishes a UK resident subsidiary that company will be taxed in its own right, as set out above.
LLPs are not subject to corporation tax, but members, as with partners in a partnership, will be taxed individually.
The tax year for individuals ends on 5 April, and an individual is taxed on the profits of his or her accounts year ending in the tax year. He or she can choose when his or her accounting year ends. The accounts are required to be filed with a tax return with HMRC on 31 January following the end of the tax year.
Individuals are now subject to a statutory residency test that determines if that person is resident in the United Kingdom or not. The test is based on both the number of days of physical location in the United Kingdom and some further connection factors.
An individual resident in the United Kingdom is taxed on his or her worldwide profits and capital gains (although in some cases resident but non-domiciled individuals may only be taxed on profits remitted to the United Kingdom). As a general rule, individuals who are non-resident in the United Kingdom will be liable to income tax on profits arising in the United Kingdom. However, the DTT with the country in which they reside will determine which country has the taxing rights and any income tax suffered in the United Kingdom is likely to be relievable against tax in their domestic country in accordance with the DTT.
A non-resident company or individual generating royalties, licence fees and interest in the United Kingdom may suffer a withholding tax on that income retained and paid to HMRC by the paying company. The DTT between the United Kingdom and the company’s or individual’s country of residence may reduce the rate of the withholding tax. The non-resident may be able to recover this withholding tax against their own domestic tax.
The franchise agreement therefore should stipulate whether the franchisee is obliged to gross up any payment or cooperate with the franchisor in recovering any sums paid to HMRC (where appropriate) under any DTT.Labour and employment
Are there any relevant labour and employment considerations for typical franchisors?
There are a number of employment law duties and discrimination protections that franchisors must be mindful of (some are ‘time served’ protections and others are ‘day one’ employee rights).
The employment disputes environment had become relatively benign because, five years ago, the government introduced a fee to be paid to progress an employment claim in the tribunal system. However, this fee was quashed by the Supreme Court in 2017 and the number of claims has risen sharply in consequence.
In addition to this, there are a range of business immigration controls for franchisors to consider for any employees of the franchisor who are non-EU nationals and, with the ongoing uncertainty surrounding the United Kingdom’s withdrawal from the EU scheduled for 31 October 2019, it remains to be seen what the arrangements will be for EU nationals going forward too.
The area of employment status has been a fast moving area of case law development in recent years, and it is entirely possible, if the relationship is not structured and documented correctly, for a relationship described as franchisor and franchisee to be deemed to be one of employer and employee or engaged worker.
There have also been legal challenges in the use and perceived abuse of ‘zero hours’ contracts whereby workers are not entitled to any specified number of hours’ work.Intellectual property
How are trademarks and know-how protected?
Trademarks in relation to goods or services can be registered at the Intellectual Property Office (IPO) as a UK mark or at the European Union Intellectual Property Office as a community mark.
Anyone considering franchising in the United Kingdom should ensure that its trademarks are registerable as the registration of the trademark normally gives the owner the exclusive right to prevent others from using the mark, and there is a market expectation that any trademark being licensed is registered or at the very least in the process of being registered.
The registration of trademarks at the IPO is a relatively simple and inexpensive process so long as no opposition to the registration is logged.
However, where a franchisor has either not yet registered or cannot register a trademark, then the franchisor may have a claim for ‘passing off’ if a competitor imitates the goods and services it offers in such a way that the public believes them to be those of the franchisor. A claim will be successful if there is goodwill and a reputation attached to the goods or services it offers and the franchisor has suffered a loss.
Know-how relating to the franchise system will invariably be detailed in the manual. It cannot be protected by registration and is, therefore, protected through the franchise agreement. The franchise agreement will contain a requirement on the franchisee to keep any know-how and other confidential information belonging to the franchisor confidential both during and after the currency of the franchise agreement.Real estate
What are the relevant aspects of the real estate market and real estate law?
Property law in England and Wales is based on the common law system and as such proprietary interests in land derive from either freehold or leasehold interests. How the property from which the franchise business operates is occupied usually depends on the franchisor’s business model, and it is crucial that the agreements to occupy any premises dovetail with the franchise agreement.
It is common for a franchisee to take a direct lease, in which case the franchisor may require step-in rights, which can usually be exercised (depending on the terms of those step-in-rights) in the event of default by the franchisee of the terms of the lease or termination of the franchise agreement. These would allow the franchisor to take on the franchisee’s rights and obligations under the lease.
Where the premises are critical to the success of the franchise, the franchisor may take a head-lease and grant a sub-lease to its franchisee. This allows the franchisor to have more control over the premises, but it comes with an increased financial risk.
If the franchisor owns the freehold itself and grants a direct lease to its franchisee or is granting a sub-lease to the franchisee, it is crucial that the security of tenure provisions otherwise conferred by the Landlord and Tenant Act 1954 are excluded. This legislation does not apply in Scotland, which has a different real estate system.Franchising in the market
How widespread is franchising in your jurisdiction? In which sectors is franchising common?
The franchise sector in the UK continues to grow. According to the latest franchise survey published in 2018 by NatWest Bank and the British Franchise Association (BFA) it is estimated that the sector contributed in excess of £17 billion to the United Kingdom’s economy, an increase of £2 million since the survey was last undertaken in 2015. In that time, the number of franchise units operating has increased by almost 25 per cent.
Given its strong economy and relatively benign regulatory environment, coupled with the fact that English is widely spoken throughout the rest of the world, the United Kingdom is internationally recognised as a popular destination for franchisors from outside of the United Kingdom looking to expand their overseas operations.
While the food and beverage market remains buoyant within the franchising space, given the United Kingdom’s ageing and health-conscious population, the number of both domiciliary care and health and fitness franchises continues to rise.
Laws and agencies regulating the offer and sale of franchisesLegal definition
What is the legal definition of a franchise?
The 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:
Franchise laws and agencies
[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.
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 (see question 19).
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 (see question 26).
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 imposing contractual requirements, including a cooling off period. These requirements would make franchising an unattractive business model.
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 retention of any quantifiable directly related expenses 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 contract.
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. However, the same advice regarding pre-contract disclosures given in question 16 would apply to sub-franchisors. 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 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 question 16 for an indication of the BFA’s requirement regarding disclosure.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 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?
Not applicable, but see question 26.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?
Not applicable, but see question 26.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 (see question 26).
The parties must be mindful of the concept of caveat emptor (buyer beware) and, therefore, carry out an appropriate level of due diligence (see question 18). 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 (see question 41).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 of pre-sale disclosures, but see question 16.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 contract. 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.
Legal restrictions on franchise contracts and the relationship between the partiesFranchise relationship laws
Are there specific laws regulating the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?
There are no specific laws that govern the ongoing relationship between the franchisor and the franchisee.
The rights and obligations of the parties are governed by the franchise agreement, the enforceability of which is subject to the general principles of contract law. As highlighted previously, provisions in the franchise agreement that seek to exclude or limit liability will be subject a test of reasonableness under the Unfair Contract Terms Act 1977. Owing to the iniquity of the parties’ bargaining positions, courts will generally favour franchisees. Furthermore, franchise agreements will usually contain restrictive covenants on franchisees which apply after their termination or expiry. See question 44 for further analysis of post-term restrictive covenants.Operational compliance
What mechanisms are commonly incorporated in agreements to ensure operational compliance and standards?
Franchise agreements will normally contain an obligation on franchisees to provide the franchisor with financial information including management accounts, annual accounts and VAT returns (if applicable) enabling the franchisor to both monitor the franchisee’s financial performance and to provide guidance and feedback on it. Where applicable, franchisees should allow franchisors online access to this data. Franchisees may also be required to provide the franchisor with a business plan each year.
In addition, there will typically be an ability for the franchisor to carry out a complete audit of the franchisee’s business to ensure compliance with operational standards. Where the franchisee’s business is falling below those standards there will be a requirement to remedy those failings. In the event that the franchisee fails to do this then such a provision may allow the franchisor to treat the failure as a breach of the franchise agreement, remove a franchisee’s exclusivity in its particular territory or terminate the franchise agreement.Amendment of operational terms
May the franchisor unilaterally change operational terms and standards during the franchise relationship?
Yes, the franchise agreement will allow the franchisor to unilaterally change the operational terms and standards by amending the manual, with which the franchisee will be required to comply. This assumes the change does not conflict with the franchise agreement. While the franchise agreement will contain an obligation on the franchisee to comply with the manual in its entirety, where there are key policies and procedures that the franchisor envisages being updated periodically, it is advisable that the franchise agreement makes specific reference to the franchisee’s need to comply with those policies and procedures.Other laws affecting franchise relations
Do other laws affect the franchise relationship?
Although not specifically governing the franchise relationship, the new General Data Protection Regulations (GDPR), which stipulate how data is processed, apply both to franchisors, their networks and their employees and customers. Certain organisations are required to appoint a data protection officer. In the event of data breaches, there is a requirement to notify the Information Commissioner’s Office, which is the UK regulator set up to uphold information rights. The breaching organisation may also be subject to substantial fines.
Franchisors should also consider the Privacy and Electronic Communications Regulations, which sit alongside GDPR and give individuals privacy rights in relation to electronic communications.Policy affecting franchise relations
Do other government or trade association policies affect the franchise relationship?
The BFA is the main voluntary self-regulatory body in the franchise sector. The aim of the BFA is to promote ethical franchising in the United Kingdom. Accordingly, its members agree to be bound by the Code of Ethics which, at its core, promotes fair dealing between the franchisor and the franchisee.Termination by franchisor
In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?
The circumstances in which a franchisor may terminate the franchise relationship are detailed in the franchise agreement. Typically, there is a right to terminate the franchise agreement with immediate effect if the franchisee ceases to operate the business, brings the brand into disrepute, commits a criminal offence, is the subject of an insolvent event or proceedings, in the case of repeated breaches of the franchise agreement or a failure to remedy a breach within an agreed time frame.
The franchisor also has the right at common law to terminate the franchise agreement in the event of a repudiatory breach of it by the franchisee. A repudiatory breach is essentially a breach that goes to the core of the contract and deprives the innocent party of its benefit.Termination by franchisee
In what circumstances may a franchisee terminate a franchise relationship?
Generally, a franchise agreement will not contain any express provisions allowing the franchisee to terminate it prior to the expiry of its term. However, the franchisee has the right at common law to terminate the franchise agreement in the event of a repudiatory breach of it by the franchisor.Renewal
How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?
The franchisee will be required on renewal to enter into the franchisor’s standard franchise agreement. There are no laws setting out how franchise agreements are to be renewed or containing any requirements to be complied with on their renewal.Refusal to renew
May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?
There are no laws stipulating whether and on what terms the franchisor must renew the franchise agreement. Furthermore, there is no requirement under the Code of Ethics that there must be a renewal of the franchise agreement.
The basis of renewal is a contractual one, and the franchise agreement will set out conditions that must be met for the franchisor to agree to renew it. These will typically include a requirement that the franchisee is not in breach of the agreement, pays a renewal or administration fee and undertakes any required updating of its business operations or premises.Transfer restrictions
May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?
A franchisor can and normally does restrict such transfers. The franchise agreement usually stipulates that the franchisor’s consent to any transfer is required, which will be given subject to certain conditions being met. These conditions include the franchisor being satisfied that the purchaser is a suitable candidate as a franchisee and the franchisee paying all sums owed to the franchisor, as well as certain costs associated with the transfer process. These provisions normally contain a right of pre-emption in favour of the franchisor, allowing it to buy the franchise business from the franchisee.Fees
Are there laws or regulations affecting the nature, amount or payment of fees?
There are no such laws or regulations.Usury
Are there restrictions on the amount of interest that can be charged on overdue payments?
A franchisor may impose interest on overdue payments, and this is typically specified in the franchise agreement. However, a franchisor must be wary that if the rate of interest is too high it may be considered a penalty clause and, therefore, be unenforceable.
Where no express provision is included in the franchise agreement, the default rate pursuant to the Late Payment of Commercial Debts (Interest) Act 1998 shall apply and currently stands at 8 per cent above the Bank of England base rate.Foreign exchange controls
Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?
Generally, there are no such laws or restrictions. However, in the event that a franchisor is operating in a country on which the United Kingdom has imposed financial sanctions, then restrictions may apply.Confidentiality covenant enforceability
Are confidentiality covenants in franchise agreements enforceable?
Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?
As the law currently stands, there is no implied duty of good faith in all commercial contracts.
Case law on this has been for some time unsettled. In Yam Seng Pte Ltd v International Trade Corporation Ltd (2013), the courts commented on the importance of recognising the concept of good faith in ‘relational contracts’, including franchise agreements. However, in Carewatch Care Services Ltd v Focus Caring Services Ltd (2014), dismissing an argument from the franchisee that the franchise agreement contained an implied term that the franchisor and franchisee act in good faith towards each other, the courts took the view that, as the franchise agreement contained detailed terms dealing with all aspects of the franchise relationship, it was not necessary to imply any further terms. However, recent case law has suggested that the Courts are becoming ever more willing to imply a duty of good faith into certain contracts including potential franchise agreements. (See ‘Update and Trends’ at question 49.)
The Code of Ethics requires parties to a franchise agreement to exercise fairness in their dealings with each other and to resolve complaints, grievances and disputes with good faith.Franchisees as consumers
Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?
Franchisees are not currently treated in law as consumers.Language of the agreement
Must disclosure documents and franchise agreements be in the language of your country?
There is no such legal requirement. However, the Code of Ethics requires that the franchise agreement is translated into the language of the franchisee’s country and in which the franchisee is competent.Restrictions on franchisees
Describe the types of restrictions placed on the franchisees in franchise contracts.
Given the nature of franchise systems and the level of control that franchisors will wish to retain over the network, during the term of the franchise agreement franchisees will typically be subject to a number of restrictions. These include obligations to operate from specific premises or within specific territories, to purchase certain products or services from the franchisor or its nominated suppliers and not to be involved or interested in another business. Franchise agreements may also place restriction on franchisees from selling goods or services above a particular price.
In addition, after the term of the franchise agreement, franchisors will seek to restrict franchisees from being involved or interested in a competing business from the premises or the territory which the franchisee previously operated from or from competing with the rest of the network. These may also include restrictions on poaching certain employees or soliciting customers. While these restrictions will only be enforceable to the extent that they go no further than are reasonably necessary to protect the franchisor’s legitimate business interests, recent case law makes it clear that well drafted post termination restrictive covenants that last for no longer than a year after termination or expiry of the franchise agreement are likely to be enforceable.Competition law
Describe the aspects of competition law in your country that are relevant to the typical franchisor. How are they enforced?
Article 101 of the Treaty of the Functioning of the European Union (article 101) prohibits agreements that affect trade between member states and have as their object or effect the prevention, restriction or distortion of competition within the EU. This is enacted into domestic legislation through the Competition Act 1998.
As to whether a franchise agreement falls within the scope of article 101 will depend on a number of factors including the relevant market share of the parties to it. In practice, most franchisors draft their agreements so that they benefit from the safe harbour of falling within the Vertical Restraints Block Exemption (Block Exemption). A five-year initial term is common in franchise agreements, so that the non-compete provisions contained within it do not fall outside the benefit of the Block Exemption. If the franchise agreement falls within its terms, it will be exempt from article 101. The test of relevant market share is also pertinent to the application of the Block Exemption.
Furthermore, any ‘hard core restrictions’ contained in the franchise agreement will lead to the exclusion of the franchise agreement from the scope of the application of the Block Exemption. These include an obligation on franchisees to sell their goods and services for a minimum price (resale price maintenance) or restrictions on franchisees from responding to unsolicited requests from customers to provide goods or services outside an agreed territory (passive sales). Restrictions on passive sales also prevent franchisors from prohibiting franchisees from operating their own websites, but not on requiring that such websites meet certain specifications.
Competition issues are regulated domestically by the Competition and Markets Authority. Sanctions include financial penalties or the voiding of provisions within the franchise agreement.Courts and dispute resolution
Describe the court system. What types of dispute resolution procedures are available relevant to franchising?
The United Kingdom is made up of more than one legal jurisdiction, with England and Wales along with Scotland being the largest two jurisdictions. Civil claims proceed differently in each jurisdiction, although the burden of proof is the same, namely the balance of probabilities. In England and Wales, a franchisor would be expected to follow a pre-action protocol prior to commencing proceedings. A claim would be heard in either a local county court or the High Court. The High Court will ordinarily only hear claims with particular complexity, high value or cross-jurisdictional elements. Claims in Scotland proceed in the local sheriff court or in the Court of Session. Unlike in England and Wales, a claim can be commenced without the need to follow a pre-action protocol.
There is a strong emphasis on resolving disputes without resorting to litigation, and different forms of alternative dispute resolution, such as mediation, are encouraged. Unreasonably refusing to engage in alternative dispute resolution can result in a party being punished in costs, regardless of whether they are the successful party at court. The BFA runs a mediation and arbitration scheme to resolve franchise disputes. It is common for franchise agreements to contain provisions requiring the parties to consider mediation before commencing proceedings, or that disputes are to be resolved by way of arbitration, rather than through the courts.Arbitration – advantages for franchisors
Describe the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction.
The advantages of arbitration in the United Kingdom are similar to most jurisdictions, in that it generally offers a speedier and less costly alternative to court proceedings, hearings are confidential to the parties and if the matter has particularly technical points an arbitrator with relevant expertise can be selected. The London Court of International Arbitration is recognised as a world-leading institution. The United Kingdom is a signatory to the New York Convention, allowing for enforcement of arbitral awards through convention protocols.National treatment
In what respects, if at all, are foreign franchisors treated differently from domestic franchisors?
Foreign franchisors are treated in the same way as domestic franchisors.
Update and trendsNew legislation and regulation
Are there any proposals for new legislation or regulation, or to revise existing legislation and regulation? Are there other current developments or trends to note?New legislation and regulation49 Are there any proposals for new legislation or regulation, or to revise existing legislation and regulation? Are there other current developments or trends to note?Brexit
The spectre of Brexit and the uncertainty surrounding it continue to loom over the United Kingdom, creating instability for business and the economy. The United Kingdom’s scheduled withdrawal date of 31 March 2019 was extended by agreement with the EU to 31 October 2019. However, the terms upon which the United Kingdom will leave the EU and the basis of its future relationship with the EU are still unclear, and there is a growing sense that the United Kingdom may not ultimately leave the EU. All of this means that the extent to which EU laws (either enacted into, or which have a direct effect on, domestic legislation) will be affected, remains unknown.Duty of good faith
The question of whether a duty of good faith should be implied into commercial contracts has recently been revisited by the Courts. While as the law currently stands there is no implied duty of good faith in all commercial contracts, Mr Justice Leggatt (now Lord Leggatt) in the case of Sheikh Tahnoon Bin Saeed Bin Shakhboot Al Nehayan (2018) (Al Nehayan v Kent) held that the parties to a joint venture arrangement, entered into orally, owed each other a duty of good faith. Subsequently in Bates v Post Office (2019), Mr Justice Fraser held that a duty of good faith should apply as a matter of law to all ‘relational’ contracts and provided some guidance as to what a ‘relational’ contract might be. Under this guidance, franchise agreements may well be classed as relational contracts. However, given the importance and broad scope of the ruling we await to see whether this decision is subject to appeal.
It is also worth noting that Lord Leggatt who was the Judge in both Al Nehayan v Kent and Yam Seng Pte Ltd v International Trade Corporation Ltd (2013) (see question 41) now sits in the Court of Appeal giving him an elevated forum with which to bring this issue nearer to a conclusion, namely a ruling that a duty of good faith is implied into all commercial contracts.