Further demonstrating the longevity and recognition of the expanding success of the franchise model overseas, within merely a few weeks of each other, Saudi Arabia, a monarchy with the largest economy in the Arab world, and Indonesia, a democracy with the largest economy in Southeast Asia, have announced major changes to their respective franchise regulatory landscapes.
The legal frameworks of the two countries were and remain vastly different. Prior to the publication of the Law on Commercial Franchise System (Saudi Franchise Law) on October 25, 2019, there were no franchise-specific laws in Saudi Arabia; rather, Saudi Commercial Agency Law governed such arrangements. In contrast, Indonesia’s regulation of franchising began in 1997 and, since then, its franchise laws have gone through several rounds of changes, the most recent of which is the issuance of the Minister of Trade Regulation No. 71 of 2019 on the Implementation of Franchises (Regulation 71) on September 3, 2019.
In the wake of these developments, as detailed below, franchisors seeking to expand into Saudi Arabia will face significant regulatory hurdles, and those eying Indonesia will generally find a more relaxed regulatory regime. The circumstances are different, but, for any franchisor interested in these two important markets, these developments warrant attention.
Franchising caught fire in Saudi Arabia many years ago, facilitated by the absence of franchise-specific legislation, the fact that a majority of the country’s population resides in urban areas, and, more recently, the country’s concerted effort to diversify its economy away from oil. Consequently, the publication of the Saudi Franchise Law was anticipated, and, in some eyes, overdue, to align franchise regulation in Saudi Arabia with international best practices.
The Saudi Franchise Law and implementing regulations (Regulations) by the Ministry of Commerce and Investment (Ministry), which, it is hoped, will clarify a number of gray areas in the Law, will become effective 180 days after the Law’s issuance (or on April 22, 2020). Key provisions of the Law include:
- Scope: The Law applies to any Franchise Agreement implemented in Saudi Arabia and expressly excludes: (1) franchises granted or issued pursuant to royal decrees; (2) agreements subject to Saudi Arabia’s Commercial Agency Law; (3) arrangements under which the franchisee is wholly owned, directly or indirectly, by the franchisor; (4) agreements limited to the purchase and sale of goods or the provision of services under a particular trademark or the use of a trademark or other intellectual property in connection with any good or service; and (5) other arrangements excluded under the Regulations. In addition, the Law’s definition of "franchise" excludes as a qualifying payment amounts paid by the franchisee to the franchisor in consideration of the goods or services provided, thereby appearing to exclude standard distributorship arrangements from the Law as well.
- 2+1 requirement: Taking a page out of China’s franchise regulatory regime, before the franchisor may offer or sell franchises in Saudi Arabia, the business to be franchised must be operated for at least one year and by at least two persons (which can include the franchisor or its affiliates) or in two separate outlets. With respect to a master franchising arrangement, the master franchisee may not offer or sell franchises in Saudi Arabia unless and until the master franchisee (or another franchisee) has operated an outlet for at least one year in Saudi Arabia.
- Registration and disclosure: Both the Franchise Agreement and the Disclosure Statement must be registered with the Ministry, with the procedures to be detailed in the Regulations. Tracking the FTC Rule, at least 14 days prior to execution of the Franchise Agreement or payment of consideration to the franchisor, the franchisor must provide the franchisee a copy of the Disclosure Statement. The Disclosure Statement and the Franchise Agreement must be in Arabic or accompanied by an accredited Arabic translation. If the franchisor materially breaches its registration and disclosure obligations, the franchisee may (1) by written notice to the franchisor, terminate the Franchise Agreement, without compensation to the franchisor; or (2) claim compensation from the franchisor for any losses suffered by the franchisee as a result of such failure but without termination of the Franchise Agreement. Such claims must be made within one year of becoming aware of the breach or three years from the date on which the breach took place, whichever is earlier.
- Financial performance representation: If the franchisor provides the franchisee with historical or projected financial performance information regarding outlets owned by the franchisor or its affiliates, the franchisor must include that information in the Disclosure Statement and comply with the Regulations. Hopefully, the Regulations will answer the obvious question as to whether this obligation also would apply with respect to information regarding franchised outlets.
- Termination: In addition to imposing certain restrictions on transfers and renewals, the Law limits the franchisor’s right to terminate to 10 "legitimate causes," the last of which is a catch-all for "any other matter deemed a legitimate cause for termination" under the Franchise Agreement. Any claim for compensation as a result of termination of the Franchise Agreement in violation of these restrictions will not be heard after three years from the date of termination.
- Good faith: The Law imposes an obligation on the franchisor and the franchisee to comply with their respective obligations in good faith, the meaning of which, not surprisingly, is not fleshed out.
- Penalties: A violation of the Law will be subject to a fine not exceeding 500,000 Saudi Riyals (currently, over US$133,000). The Law also provides for the creation of a committee that will evaluate violations of the Law and impose penalties.
- Limitation on claims: Any claim of compensation by the franchisor or franchisee that arises from a violation of the Law or the Franchise Agreement will not be heard after one year from the date on which the non-violating party became aware of the breach or three years from the date of the violation, whichever is earlier.
- Retroactivity: Certain provisions of the Law will not apply to franchise agreements executed prior to the effective date of the Law, including the 2+1 requirement, the registration and disclosure requirements, and the translation requirements.
In sharp contrast to Saudi Arabia's nascent stage of franchise regulation, Indonesia’s regulation of franchises has been evolving for many years. Regulation 71 revokes a number of earlier regulations to address, in large part, complaints regarding or perceived inadequacies of Indonesia’s franchise legislation, which was driven, in significant part, by local protectionism. Key modifications arising from Regulation 71, which became effective on September 4, 2019, include:
- Local sourcing: Regulation 71 relaxes a much maligned regulation that required franchisors and franchisees to use domestically produced goods and services for at least 80 percent of the raw materials, business equipment, and merchandise used in the franchised business and certify their compliance with this 80/20 requirement in their annual filings with the Ministry of Trade (MOT). While the ostensible objective of the 80/20 requirement was to protect and promote local business interests, the onerous requirement, in fact, deterred many franchisors from entering the Indonesian market; others simply flouted the requirement. Under Regulation 71, a franchisor is only required to "prioritize" the use of domestically produced goods and services, provided that they meet the franchisor’s standards, and “prioritize” the processing of raw materials domestically. The franchisor also must "cooperate with" small- and medium-sized entrepreneurs in the local area as franchisees or suppliers if they meet the franchisor's terms and conditions. The franchisor must still certify its compliance with the revised requirement in its annual MOT filing, and the MOT may question, among other things, the local sourcing information. As to how "prioritize" and "cooperate with" should be construed, franchisors will have to take a wait and see approach.
- Limitation on number of outlets and number of master franchisees: Regulation 71 removes, with respect to the restaurant/café and "modern store" sectors, the limitation on the number of outlets that a master/franchisee can operate in Indonesia. The Regulation also permits a franchisor to appoint more than one master/franchisee in Indonesia, provided that there is a clear separation of territory.
- Franchise registration certificate (STPW): Before entering into a Franchise Agreement in Indonesia, a franchisor must obtain an STPW. Regulation 71 eliminates the requirement under the previous regulations to renew the STPW every five years. Regulation 71 does not recognize renewals. Now, an STPW is valid until (1) the franchisor or franchisee ceases to do business; (2) the Franchise Agreement expires; or (3) the Directorate General of Intellectual Property does not approve the pending trademark application, or the trademark registration expires or is not renewed. A franchisor with an STPW issued under the prior regulation, however, must apply, upon the expiration of that STPW, for a new STPW.
- Restriction on franchisor-related franchisees: Regulation 71 rolls back the prohibition on franchisors appointing franchisees that have a controlling or subordinate relationship with the franchisor.
While many of the developments in Saudi Arabia and Indonesia detailed above will need to be clarified in the ensuing months, it is notable that two significant economies have put their legislative efforts into retooling their approach to franchise regulation − but in very different directions, with Saudi Arabia implementing a comprehensive registration and disclosure regime resembling that of the FTC Rule and Indonesia liberalizing many of its franchise requirements. Notwithstanding the new regulatory hurdles, because of the significant investment opportunities in the Saudi market, the passage of the Saudi Investment Law is unlikely to dampen the enthusiasm of franchisors considering that market. As to Indonesia, the issuance of Regulation 71 will undoubtedly invite franchisors previously leery of the country's local sourcing and other restrictions to take another look at the Indonesian market.