Legal restrictions on franchise contracts and the relationship between the parties

Franchise 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?

Yes.

Good-faith obligation

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.