The United Kingdom is one of the more 'mature' franchise markets of all the nations that have embraced franchising as a vehicle for business growth. At the time of writing, the latest published NatWest/British Franchise Association Franchise Survey (the Survey) was the 2018 Survey. The 2018 Survey reported a total of 935 franchise systems in the United Kingdom. The Survey also reported that the overall contribution of franchising to the UK economy was in excess of £17 billion, an increase of over £2 billion since the previous survey in 2015.
The Survey reports that between them, the franchise systems in the United Kingdom operate an estimated total of 48,600 franchised units, which is the highest number ever reported, and nearly two times more than 25 years ago. On average, these businesses are becoming larger as the sector matures, with 60 per cent of those surveyed claiming a turnover in excess of £250,000.
The majority (80 per cent) of franchise systems in the United Kingdom are UK-owned, which is a huge contrast to 25 years ago, when the majority of systems were imported from the United States. One in three systems has operations outside the United Kingdom and, for those franchisors that do not currently operate internationally, 4 per cent have a definite business plan to do so, and a further 30 per cent are considering it as a future option. The number of franchisees operating multiple units is continuing to rise, with 36 per cent of respondents to the Survey owning more than one unit, up from 29 per cent in 2015, and 25 per cent in 2013. The Survey comments on how the bargaining power between franchisor and franchisee will likely start to change with the increase in multi-unit franchisees, often increasing the bargaining power of the franchisee.
Sectorally, the Survey concludes that while more systems were added in every category, the largest growth was seen in hotel and catering, and personal services. These two sectors now account for over 60 per cent of the UK franchising market by unit number, up from 40 per cent in 2008. While growth in the store retailing sector appears to have been relatively flat over time, the Survey reminds us that this should be viewed in the context of a highly challenging retail business environment, and as such the growth that there has been is a positive indication of the state of the UK franchising market. Furthermore, 93 per cent of franchisee-owned units reported profitability, and closure of a unit due to commercial failure was reported at less than 1 per cent – low when compared with failure rates for small and medium-sized enterprises generally.
The Survey also comments on changes to those entering the UK franchise market. While it found that 70 per cent of franchisees are male, the Survey reports that more females are becoming franchisees, with a 20 per cent jump since the previous survey in 2015. More under 30s are also becoming franchise owners, with 18 per cent of all franchisees now under the age of 30. The industry has also embraced the agile working trend, reporting that nearly four in 10 franchise systems can be operated from a home office.
The United Kingdom's national franchise association is the British Franchise Association (BFA), which was formed in 1977. The BFA is a voluntary self-regulating body whose stated aim is 'to promote ethical franchising practice in the United Kingdom and help the industry develop credibility, influence and favourable circumstances for growth'.
II MARKET ENTRY
Typically, there are no restrictions faced by foreign franchisors in terms of the granting of master franchises or development rights to a local entity in the United Kingdom. The United Kingdom is generally considered to be a relatively easy and regulation light place in which to do business. Foreign ownership and investment in the United Kingdom – in terms of foreign franchisors owning equity in a local business or owning commercial or residential property (or other assets) – is subject to very few regulations. With relatively benign immigration laws (subject to the impact of the United Kingdom leaving the European Union, which is due to take place on 29 March 2019) and no mandatory approval conditions, there is little by way of legal barriers to, or restrictions on, foreign franchisors entering the UK market.
ii Foreign exchange and tax
There are no foreign exchange controls or restrictions on foreign currency payments that are applicable to cross-border franchising in the United Kingdom. It is, however, important that the franchise agreement expressly details the choice of payment currency, together with the rate and time of the conversion for payments where applicable. For information regarding tax, refer to Section V.
III INTELLECTUAL PROPERTY
i Brand search
The key intellectual property rights that will form part of a franchise business concept are trademarks; domain names; copyright – particularly in respect of materials such as the operations manuals, website and social media text and advertising, marketing and promotional literature – and database rights. To a lesser extent patents, design rights and image rights may play a role in the franchise business concept.
As copyright is a non-registrable right the key registered (or registrable) right is the trademark, or the franchisor's brand rights as they are commonly referred to. For the franchisor looking to register its trademarks in the United Kingdom and the EU, the recommended searches are, with respect to registered trademarks, the centralised systems offered on the trademarks section of the UK Intellectual Property website and the trademarks section of the European Union Intellectual Property Office (EUIPO) website (for European Union trademarks, or EUTMs).
Searches should be carried out for both identical and similar marks and consideration given as to whether the trademarks are being used against identical or similar goods and services to those of the franchisor.
It is also recommended that general internet searches be carried out to check what trademarks are being used in the public domain, particularly those that are not registered and thus not identifiable on the trademark registers but that could still pose a threat to the franchisor's trademarks because of their use in the public domain.
If the franchisor's trademark is not registered and there are no registered trademarks identified through the searches that are identical or similar to that of the franchisor's trademark, an application for registration should be made as quickly as possible. If, however, searches identify that there are already registered trademarks identical or similar to that of the franchisor, the franchisor could be at risk of having infringement proceedings brought against it for the use of its trademark and should therefore stop all use of its trademark and consider what changes could be made to its trademark so that the mark cannot be deemed identical or similar to any others currently registered. The new trademark should then be registered to ensure it is protected going forwards.
In addition to carrying out regular trademark searches, it is advisable – particularly so that expensive opposition, invalidity or infringement proceedings can be avoided – that a trademark-watching service be set up to ensure that the franchisor or franchisee is continually notified of any potentially conflicting trademarks that other parties are applying to have registered with one of the trademark registries. The costs of such a service varies depending on the search criteria, in particular the number of trademarks required to be watched and what trademark classes need to be covered.
With regards to domain name searches, there is no centralised system as there is for trademarks. It is, however, possible to check whether a domain name has been registered using a WHOIS service.
ii Brand protection
To protect the franchisor's brand it is important that the franchisor's trademarks and domain names are correctly registered.
For UK trademarks, applications are made to the UK Intellectual Property Office (UKIPO). For franchisors looking at additional expansion in Europe it is advisable to obtain (depending on the precise European markets that a franchisor is looking to promote and provide its goods and services in an EUTM, which provides trademark protection in each Member State of the EU. An EUTM application is made to the EUIPO in Alicante, Spain. Alternatively, an international registration can be applied for (specifying the individual countries in which it is desired to protect the trademarks) through the World Intellectual Property Organisation (WIPO) under the Madrid Protocol.
The franchisor will need to determine which of its goods and services should be subject to registered trademark rights for the purposes of the franchise business and provide a description of each. It is often advisable to seek the advice of a specialist trademark solicitor when preparing the trademark application, in particular which goods and services should be included in the trademark specification. For UK and EU trademarks registered with the UKIPO and the EUIPO respectively, the classification system is divided into different classes, with goods in classes 1 to 34 and services in classes 35 to 45.
It is important to ensure that the franchisor's registered trademark specifications are sufficiently broad to cover all the goods and services currently offered by the franchise business to ensure that no other entity can use identical or similar trademarks in relation to identical or similar goods and services, thus causing the consumers of the franchise business to be confused as to the origin of the goods and services being offered to them. The trademark specification should also cover goods and services that the franchise business might be looking to expand into in the future and thus not limit the direction of the franchise business.
In relation to domain names, as with the searches, there is no centralised system for domain name registration, therefore registration of a domain name is carried out through a registrar. There are a large number of registrars and the choice of registrar will be determined by price, reputation for reliability and other services offered such as website hosting, and domain name portfolio management. A domain name is registered for a set period (for example, two years) and will have to be renewed once that period is up.
There is an array of potential protection techniques enforcing intellectual property rights (IPRs), as well as protection in the event that a franchisor's franchisee (or master or developer) infringes the franchisor's IPRs. A number of IPR enforcement strategies are, however, equally applicable to the scenario in which an independent third party infringes the franchisor's IPRs.
Part of an effective strategy is to ensure that the franchisor's IPRs are correctly protected in the first place.
In addition to formal or registered protection for IPRs such as trademarks, domain names, patents and designs (as discussed above) a well-drafted franchise agreement should provide the franchisor (at least in terms of its franchise network) with contractual protection against infringement of its IPRs by franchisees.
As a minimum, the franchise agreement should include:
- an appropriately worded grant of rights clause defining the extent and limits of the franchisee's right to use the franchisor's IPRs;
- confidentiality provisions obliging the franchisee to only use and disseminate the franchisor's IPRs, know-how and confidential information to the extent necessary for the operation of the business;
- IPRs clauses regarding the franchisee's permitted uses of the franchisor's IPRs, together with express provisions regarding non-infringing use of the IPRs and how infringement actions are to be dealt with; and
- provisions regarding the collection, use and sharing of data and related database rights.
In addition to the above in-term provisions regarding the appropriate use of IPRs and materials featuring IPRs, it is important that the franchise agreement expressly details appropriate post-termination or expiration provisions regarding a terminated or expired franchisee's non-use of the franchisor's IPRs, including debranding obligations and time lines for so doing.
Operational and organisational methods
Closely tied in with and backed up by contractual provisions should be certain operational and organisational measures, including:
- initial and ongoing training emphasising key messages regarding the use of IPRs, know-how and confidential information;
- appropriate confidentiality, copyright and no copying notices on key operational documentation, including the manual – as well as technical and IT safeguards for such operational information as the franchisor makes available online;
- template stationery and promotional materials provided by the franchisor to ensure that the franchisor's IPRs are used in the correct manner; and
- appropriate policies and training regarding the franchisee's use of branded email accounts and branded social media.
With regard to enforcement for registered trademarks, if 'cease-and-desist'-style letters fail to resolve the issue, then a franchisor can seek injunctive relief to stop the infringing use by the franchisee (or third party) together with a claim for damages or an account of profits unlawfully made by the franchisee. In determining whether injunctive relief should be granted the court will have regard to the balance of convenience between the parties' interests and the prospect of unquantifiable or irreversible harm (or both).
With unregistered trademarks, a claim can be brought under the common law for the tort of 'passing off'. The franchisor will be required to establish that:
- it has goodwill in its unregistered marks;
- that the franchisee has made misrepresentations to customers or prospective customers that amount to a false imitation of the franchisor's branded goods or services; and
- that as a consequence of the franchisee's actions, the franchisor has suffered loss (i.e., loss or diversion of business).
As passing-off actions tend to be more complex and costly as compared with relatively simple trademark infringement actions, well-advised franchisors tend to invest in a brand protection (including searches) and registration programme at the outset.
In respect of domain name actions, proceedings can be initiated against cybersquatters and others infringing trademarks through use of a domain name. The relevant rules and procedure differ depending on the type of domain name. For example, disputes over .com, .net and .org domain names are governed by the ICANN Uniform Domain Name Dispute Resolution Policy (UDRP)2 and .co.uk by the Nominet Dispute Resolution Service policy.3 Disputes under the UDRP are heard by a number of tribunals, for example, WIPO.4
Disputes in relation to UK domain names are heard by the Nominet Dispute Resolution Service. Domain name dispute resolution proceedings are generally simple and low cost. Proceedings are conducted on paper and hearings are extremely rare.
With regard to the protection of IPRs such as copyright and items such as know-how and confidential information, much like with trademarks, the franchisor's enforcement options will initially start with correspondence between the franchisor's and franchisee's legal advisers, which, if unsuccessful, may result in an application for an injunction by the franchisor and depending on the nature of the franchisee's conduct, a subsequent court-based trial to determine the franchisor's possible remedies.
iv Data protection, cybercrime, social media and e-commerce
After a period of incremental development, the laws that regulate data protection, privacy and security in Europe have undergone considerable change.
For many years the key pieces of data protection and privacy legislation in the EU were Data Protection Directive 95/46/EC (the Data Protection Directive) and Privacy and Electronic Communications Directive 2002/58 EC (the ePrivacy Directive). The former regulated all personal data processing, the latter electronic and telephone direct marketing, the use of online tracking technologies such as cookies and a number of other communications issues.
In May 2018, the Data Protection Directive was replaced by Regulation (EU) 2016/679 – the General Data Protection Regulation (GDPR). While the GDPR did not have to be implemented by domestic legislation in EU Member States, it affords a significant degree of leeway for Member States to supplement, and derogate from, various provisions. The United Kingdom has implemented this by passing the Data Protection Act 2018 (DPA 2018).
A pan-EU replacement for the ePrivacy Directive has been expected for some time; however, at the time of writing, its progress through the legislative process has been slow. It is increasingly unlikely that it will be passed before the United Kingdom is scheduled to leave the EU in March 2019. It therefore remains to be seen how the UK Privacy and Electronic Communications (EC Directive) Regulations 2003 (which currently implement the ePrivacy Directive) will be updated once the EU's replacement for the ePrivacy Directive has been finalised.
An introduction to current obligations under the GDPR and DPA 2018
The GDPR and DPA 2018 impose obligations upon franchisors and franchisees with respect to any personal data that is processed by them or on their behalf. They also grant data subjects rights in respect of their personal data.
Personal data is information that relates to an identified or identifiable living person, such as a customer, member of staff or a supplier. The laws impose obligations on data controllers (those who alone or jointly determine the purposes and means of processing personal data), and data processors (those who process personal data on behalf of data controllers, such as their suppliers). In many situations, franchisors and their franchisees will each process personal data as a data controller, but the specifics of data processing arrangements will need to be reviewed to determine the precise role of each.
The GDPR has introduced significant new obligations and much higher fines than were previously imposed under the Data Protection Directive – the maximum fine that can be imposed under the GDPR is a figure equivalent to the greater of 4 per cent of the non-compliant data controller or processor's worldwide turnover or €20 million.
Franchisors and franchisees will have to notify the UK Information Commissioner's Office of their data processing activities and pay an annual registration fee, which is calculated with respect to their annual turnover.
Other obligations include the requirement to abide by the data protection principles. For instance, this will mean ensuring that notice is given to relevant individuals about what data will be collected, with whom the data will be shared and how the data will be used. Also, data controllers must ensure that they can point to a lawful basis for their personal data processing activities, such as: for the purposes of fulfilling a contract; the legitimate interest of the controllers or a third party; or because the data subject's consent has been obtained. The data should not be used in any other way that is incompatible with the specified purposes, and appropriate steps should be taken to ensure data is accurate, kept secure and only for as long as necessary and that it does not go beyond what is necessary to meet the purpose.
Individuals will obtain significant new rights under the GDPR and DPA 2018, including the right to demand, in certain circumstances, that their personal data is transferred to a replacement service provider (the 'right to data portability'), rights in respect of automated decisions and the right to demand erasure (the 'right to be forgotten').
The GDPR and DPA 2018 have also introduced a requirement for data breaches to be proactively notified to regulators and to individuals affected by the breach. The terms of this notification are onerous with controllers obliged to notify the regulator without undue delay and, in any event, within 72 hours of the controller having become aware of a breach.
New accountability or data governance measures will also have to be implemented by data controllers and data processors, including running data protection impact assessments, audits, policy reviews, activity records and (in certain prescribed circumstances) the obligation to appoint a data protection officer. Where a data processor is engaged to process personal data, a long list of provisions set out in the GDPR must be agreed in writing in favour of relevant data controllers. Where two or more data controllers act jointly to agree processing activities, they must enter a written agreement confirming their respective responsibilities for meeting the obligations imposed by the GDPR and the DPA 2018.
Another significant requirement of the GDPR and DPA 2018 relates to international transfers of personal data. If such data is being made available from the United Kingdom to a third party located outside the EEA, then the UK organisation (i.e., most typically a UK master franchisee or developer) will have to consider the data transfer restrictions, which only allow transfers to a country that ensures adequate data protection for the rights of data subjects (measured against the protections offered under EU data protection laws). Transfer adequacy mechanisms such as standard contractual clauses or certification schemes (e.g., the US–EU Privacy Shield) approved by the European Commission are options.
Taking all the above points together, franchisors and franchisees would be well advised to review their contractual and operational procedures to ensure that they have appropriately amended these to comply with the changes that Europe's new data protection laws have brought.
On 19 July 2016, the European Parliament published its Directive on network and information security across the EU (the Cybersecurity Directive). The Cybersecurity Directive is the first comprehensive piece of EU legislation addressing the area of cybersecurity risk. Its objective is to achieve a high level of commonality of approach in the way that Member States address the urgent need to improve security in networks and information systems. Following the publication of the Cybersecurity Directive, Member States had until 9 May 2018 to implement the Directive in national law, and a further six months thereafter to declare for their jurisdiction the identities of 'operators of essential services'. In the United Kingdom, the Directive was implemented on 10 May 2018 in the form of the Network and Information Systems Regulations 2018 (NISRs).
The NISRs apply principally to two categories of organisation: (1) operators of essential services (OES) and (2) relevant digital service providers (RDSP). The United Kingdom's enactment of the Directive includes a number of compliance obligations and carries material sanctions for non-observance. It is therefore important for businesses to determine whether they qualify as an OES or a RDSP, or both.
A RDSP is an operator that provides (1) an online search engine, (2) cloud computing service, or (3) an online marketplace. It should be noted that the NISRs do not apply to RDSPs that are considered small or micro businesses, which are companies employing fewer than 50 people and with an annual turnover or balance sheet total below €10 million. The operator must also offer its services within the EU and be headquartered in the United Kingdom or have nominated a UK-based representative.
The NISRs detail the sectors in which OESs are identified by the UK government, which include energy, transport, health, drinking water supply and distribution, and digital infrastructure where the relevant entity provides a service that is essential for the maintenance of critical societal or economic activities; the provision of the service is dependent on network and information systems; and an incident affecting the network and information systems of that service would have significant disruptive effects on its provision. The NISRs also provide detailed thresholds to ensure they apply only to material operators.
The requirements of the NISRs for RDSPs and OESs include the need to take appropriate and proportionate technical and organisational measures to manage risks to network and information systems. They also require the relevant entities to take appropriate and proportionate measures to prevent and minimise the impact of incidents that affect security of the networks and information systems used, with a view to ensuring continuity of those services.
The NISRs impose reporting obligations requiring RDSPs to report 'any incident having a substantial impact on the provision of any of the [relevant] digital services'. Similarly, OESs are required to report any incident that 'has a significant impact on the continuity of the essential service which that OES provides'. In each case, organisations must report the incident to the competent authority within 72 hours of the incident occurring.
While the legislation focuses on RDSPs and OESs, it is inevitable that suppliers to those entities will be contractually drawn into compliance as the entities pass down their own compliance obligations to their supply chains.
The sanctions regime for breach is significant, with competent authorities having rights to serve information notices, conduct inspections, and serve enforcement and penalty notices. The ultimate fine available under the NISRs is £17 million for a 'material contravention which the enforcement authority determines has caused, or could cause, an incident resulting in immediate threat to life or significant adverse impact on the United Kingdom economy'.
Whether franchisors will be affected or not by the NISRs, what should they be doing now?
- accept that a cybersecurity incident is a matter of 'when', not 'if';
- stop regarding cybersecurity as solely an IT issue;
- balance your approach between prevention and preparation for when an incident occurs;
- adopt a multidisciplinary approach, including: IT and IT forensics, legal and compliance, and PR; and
- do not seek to address cybersecurity resilience without simultaneously looking at compliance with the requirements of the GDPR, and vice versa.
- establish your cybersecurity team – with senior board engagement;
- review your current cybersecurity technology and, if necessary, implement data monitoring and behaviourally based detection systems;
- prepare a cyber-response strategy – cyber-response plan, cyber-response teams and reporting mechanisms;
- train and test; and
- review cybersecurity-related insurances.
When the franchisor or franchisee posts personal data on a social networking site, message board or blog, or downloads personal data from one of these sites, they must ensure they have complied with the GDPR (and, for marketing materials, the CAP code). Anyone running an online forum or downloading personal data for business purposes should take the following steps:
- have clear acceptable-use policies;
- clearly inform individuals (by way of a privacy notice) how their personal data will be used. Where an intended practice is unusual, unexpected or particularly invasive, it may be necessary to draw specific attention to this use – such as through the use of pop-ups and other more active notices;
- consider whether you require consent – and whose consent to get. For example, posting sensitive information (such as data concerning health, race, ethnicity, political or religious views, criminal activity or sexual orientation) or any information that is particularly embarrassing is likely to need prior consent. You may also need consent if you use an individual's name or likeness for promotional purposes. Where posts or data relate to children, parental consent may be required;
- give individuals the opportunity to opt out or correct inaccurate information. Individuals must have access to easy-to-find procedures to dispute the accuracy of posts and ask for them to be removed. Organisations must respond to such requests quickly (and at the latest within one month) and have procedures to remove or suspend access to content at least until any disputes have been settled; and
Franchisors should also consider whether they want to manage social media platforms on behalf of their franchisees or place restrictions on franchisees' use of social media (such as requiring pre-approval of the platforms, profiles and any trademarks or brand logos being used; ensuring compliance with all laws and relevant codes of practice, including the GDPR, relevant laws and codes on advertising such as the CAP code; mechanisms to take down content at the franchisor's request or following a third-party complaint; and obligations to comply with the franchisor's social media policy). The level of control a franchisor wishes to exert – which to a large extent will depend on the franchisor's level of resources – will thereby determine the level of brand consistency for the franchise business across the internet, including on social media.
IV FRANCHISE LAW
There are no specific franchise laws in the United Kingdom. The franchisor–franchisee relationship is governed by contract law with a number of statutes, voluntary codes and case law affecting both the franchisor–franchisee relationship and the franchise agreement itself. Franchisors who are members of the BFA are obliged to comply and ensure that their franchise agreements conform with the BFA Code of Ethics (the BFA Code) (see below).
The Trading Schemes Act 1996 governs pyramid-selling schemes, and brands seeking to franchise in the United Kingdom should structure their franchising arrangements to fall outside the scope of this act. To be exempt by virtue of the Trading Schemes (Exclusion) Regulation 1997, parties should ensure that: (1)the franchise is a single-tier trading scheme (with a single level of franchisees beneath the franchisor), or (2) the franchisor and all franchisees are registered for VAT, or both of these.
ii Pre-contractual disclosure
As a starting point there is no mandatory pre-contractual disclosure requirement in the United Kingdom. This statement, however, is not particularly helpful for ethical franchisors or franchisors wishing to adopt best practice. The BFA Code to some extent enshrines best and recommended practice in relation to pre-contractual disclosure requirements. Members of the BFA are required to disclose certain information in writing to prospective franchisees within a reasonable (not defined) period prior to signature of the franchise agreement. This information includes:
- the business and financial position of the franchisor;
- the main officers of the franchisor;
- details of the franchise business;
- details regarding the franchise network and franchisees;
- any financial projections or historical financial performance data; and
- key terms of the franchise agreement.
With the exception of the BFA requirements there is no statutory or other pre-contractual obligation on franchisors to disclose relevant facts. Generally the principle of caveat emptor or 'buyer beware' applies to the pre-contractual phase of the franchisor–franchisee relationship. The laws of misrepresentation, however, apply to the pre-contractual phase of the franchisor–franchisee relationship. The concept of misrepresentation is enshrined both in the Misrepresentation Act 1967 and common law.
There are two main types of misrepresentation claims relevant to pre-contractual disclosure, which vary according to the level of belief held by the franchisor in the truth of the statement. If the franchisor makes a false statement knowingly, or without belief in its truth, or recklessly as to its truth, then they may be liable for fraudulent misrepresentation. If, however, the franchisor only made the statement carelessly, or without objectively reasonable belief in its truth, then the franchisor may be liable for negligent misrepresentation.
If a franchisee can demonstrate that the franchisor's misrepresentations were statements of fact that induced the franchisee to enter the franchise agreement, as a result of which the franchisee suffered loss, the franchisee will be entitled to seek compensation for the loss. The franchisee may also be entitled to rescind the franchise agreement. Recent case law has shown that the courts are increasingly willing to award substantial damages for misrepresentation by franchisors.
In Peart Stevenson Associates Ltd v. Holland,5 the franchisor was awarded £20,000 for a breach of contract by the franchisee in relation to overdue payments and post-termination restrictions. The franchisee counterclaimed, however, stating that a number of representations, including those relating to projected turnover and profit, had induced it to enter the agreement and it transpired that the statements had been misleading. The court agreed with the franchisee and awarded £170,000 in damages, vastly offsetting the sum awarded to the franchisor.
Many franchisors use a 'non-reliance' clause in their franchise agreements, which involves either a warranty, undertaking or contractual obligation by the franchisee that no statement has been relied upon other than those contained in the written agreement. Such a clause is stronger if the franchisee is allowed an express opportunity to attach any relied-upon pre-contractual statements to the franchise agreement. It is important to note that non-reliance clauses cannot protect a franchisor against fraudulent misrepresentation, only negligent misrepresentation. Any clause that attempts to exclude liability for fraudulent misrepresentation will be unenforceable under common law as a matter of public policy. In principle, non-reliance clauses in business-to-business dealings are legitimate, but any clause that attempts to limit or exclude liability for misrepresentation or excludes any remedy for misrepresentation is enforceable only to the extent that it satisfies the test of reasonableness under the Unfair Contract Terms Act 1977 (UCTA) (by virtue of Section 3 of the Misrepresentation Act 1967). Whether a particular clause is, in fact, enforceable will be subject to the facts of each case. This is highlighted in the cases of Henry Boot v. Foodco6 and Papa Johns (GB) Limited v. Elsada Doyley.7
The court in Papa Johns v. Doyley (a case involving the provision of financial information and financial performance projections by the franchisor to the franchisee during the recruitment process) examined a number of relatively typical and common boiler-plate provisions in the franchise agreement that are normally designed to protect the franchisor against misrepresentation claims.
Despite case law having largely upheld such clauses in commercial contracts, the court in Papa Johns held the entire agreement and non-reliance clauses to be unenforceable as they failed to satisfy the reasonableness tests under the Misrepresentation Act 1967 and UCTA. The court's findings were largely based on:
- the inequality of bargaining power between the parties;
- Papa Johns' insistence that the agreement was non-negotiable; and
- the standard boiler plate clauses in the franchise agreement had not been brought to Ms Doyley's attention.
In contrast, in the case of Henry Boot v. Foodco (a case that involved performance projections provided by a landlord to franchisee tenants regarding motorway service stations) the bargaining power between the parties was more equal than in comparison with Papa Johns. The court held that the non-reliance clause was enforceable. In this specific dispute the court held that there was 'no doubt' that the clause was reasonable after considering the following factors under UCTA:
- certainty is desirable;
- there was no substantial imbalance of bargaining power between the parties;
- each of the tenants were advised by solicitors;
- the non-reliance provision was open to negotiation; and
- the clause permitted reliance by the tenants upon any replies given to them by Henry Boot's solicitors.
In Lloyd v. Browning,8 the Court of Appeal endorsed the Henry Boot reasoning under UCTA and stated that the general purpose of a non-reliance clause is to achieve certainty and forestall disputes, and that Henry Boot 'set out the features which are relevant to the assessment of reasonableness' and the approach of the courts in Henry Boot was to be 'endorsed'.
Despite the contrast in outcomes between Henry Boot and Papa Johns it is advisable for international franchisors looking to enter the United Kingdom to ensure that any financial projections regarding the franchisee's business provided in the pre-contractual recruitment phase are not only capable of objective substantiation but are provided in writing with appropriate background information and health warnings. Express non-reliance clauses are important for franchisors' risk management but franchisors must be aware that their enforceability is not always guaranteed, especially in circumstances where the franchisee is an individual or small business inexperienced in commercial matters.
In 2018, the High Court considered statements made by the franchisor's development manager in a franchise arrangement structured through joint-venture agreements in Ali v. Abbeyfield VE Ltd.9 Representations made by the development manager concerning the suitability of a location, anticipated business projections and success rates of the franchisee businesses were found to be fraudulent misrepresentations in that the defendant, through its development manager, either knew, or was reckless as to whether or not, the representations were false. While this judgement does not change the law in this area, it is a reminder to franchisors to ensure their employees and representatives carefully consider any assurances they give to potential franchisees.
There are no registration requirements in the United Kingdom that impact on the franchisor–franchisee relationship or with regards to the franchise agreement itself. There is no requirement to register either the franchise agreement or the trademark licensing provisions as a registered trademark licence agreement.
iv Mandatory clauses
There are no mandatory clauses prescribed by statute or case law. Franchisors who are BFA members will need to ensure that their contracts comply with the BFA Code as well as the BFA's Extension and Interpretation of the Code. While the BFA Code does not specify mandatory clauses it does contain a list of terms to be contained in the franchise agreement.
It is therefore important that a UK franchisor or an international business franchising in the United Kingdom who wishes its master or developer to become a member of the BFA has its franchise documentation drafted by advisers familiar with the BFA Code.
v Guarantees and protection
In the event that a franchisor contracts with a sole trader then the sole trader franchisee will be personally liable for its performance and payment obligations and therefore a guarantee would not be required. In the event, however, that a franchisor contracts with a partnership or limited liability company franchisee, it is certainly advisable that a franchisor obtains a contractual guarantee from either the primary director or shareholder or partner as the case may be – or more than one key individual if commercially appropriate.
Where the franchise business involves an element of product supply by the franchisor to the franchisee it may also be prudent for the franchisor to request that the franchisee provides a letter of credit from a bank acceptable to the franchisor to cover payment defaults by the franchisee.
Provided that the contractual guarantee agreement is not unreasonable to the extent that it is legally unenforceable, then guarantees from individuals and companies to the franchisor are enforceable.
i Franchisor tax liabilities
UK tax-resident companies carrying on a franchising trade (which will generally include UK-incorporated companies unless 'treaty non-resident'), or companies carrying on a franchising trade in the United Kingdom through a permanent establishment, will be subject to UK corporation tax on the profits of that trade. For corporation tax purposes the main acts are the Corporation Tax Act 2009, Corporation Tax Act 2010 and Taxation (International and Other Provisions) Act 2010. Although less common, UK resident individuals carrying on a franchising trade will be subject to income tax in accordance with the provisions of the Income Tax Act 2007 and the Income Tax (Trading and Other Income) Act 2005.
Individual shareholders receiving dividends will, if UK tax resident, generally be subject to income tax on any dividends received in accordance with the provisions set out in Part 4 of the Income Tax (Trading and Other Income) Act 2005. In general, UK resident corporate shareholders should be able to rely on one of the exemptions from corporation tax on the dividends they receive. If the supply of IPRs by the franchisor is segregated and a royalty is paid to a non-UK resident corporate franchisor that is not trading in the United Kingdom, there may be withholding tax on the royalty payment subject to relevant treaty (or other) relief; however, if the other provisions of the franchising agreement are supplied by the same company as the intellectual property, then it is possible that the non-UK resident corporate franchisor may itself be trading in the United Kingdom as a result of the franchising arrangement. From April 2019, the United Kingdom will impose an income tax charge on the gross revenues of non-resident entities that have intangible property that is used to make supplies to UK customers. Although this is targeted at multinational groups, it could also affect franchisors, as the provisions extend to indirect, but substantial, exploitation of that intangible property in the UK market through unrelated parties.
The franchisor may need to register for and account for VAT on supplies to the franchisee. If the franchisor is not based in the United Kingdom, it is likely that the VAT on such supplies would be accounted for by the franchisee under the 'reverse charge'.
ii Franchisee tax liabilities
If the franchisee is a UK-incorporated company, then consistent with the main tax liabilities faced by franchisors discussed above, the franchisee company's profits will also be subject to corporation tax. If the franchisee is a partnership or sole trader then the partners' or individual's income will be taxed under income tax rules and corporate partners will be taxed under corporation tax rules as per the above. Individual sole traders (and partners) will also be subject to National Insurance contributions – albeit at fairly low rates.
Withholding tax may also be payable – as also specified above. If there is a gross-up provision in the franchise agreement or IP licence then the liability for this could fall on the franchisee.
Subject to the nature of the goods and services sold or provided by the franchisee and supplied by the franchisor, the supply may be subject to VAT, which is governed by the Value Added Tax Act 1994. If the franchisee carries out an exempt (or partially exempt) business, then it may not be able to recover VAT (in full or in part) on the supplies made to it, including those of the franchisor.
iii Commonly used structures
Under modern tax regimes, it is very difficult to put in place 'tax-efficient structures'. However, steps can be taken to ensure that structures are not tax inefficient. For example, if both franchisor and franchisee are UK entities, VAT registration for both parties is recommended to ensure that VAT is not a cost for either business.
For both tax reasons and contractual ring-fencing, franchisors may wish to consider which of their group companies should be the contracting entity in respect of each supply (intellectual property, products, services to the franchisees, etc.).
Franchisors may wish to hold valuable functions (e.g., intellectual property) in a tax-friendly offshore jurisdiction to accrue income and potentially realise gains at lower tax rates. However, this is likely to require a presence in that jurisdiction and may also require transferring valuable rights to that jurisdiction, which may trigger exit taxes. The UK government discourages the holding of intellectual property in low-tax jurisdictions. If such a structure were to be used, consideration would have to be given to the UK's diverted-profits tax and the new offshore-receipts rules, which are targeted at offshore companies holding intellectual property exploited in the United Kingdom. Where the company holding the intellectual property is a subsidiary, the 'controlled foreign company' or other anti-avoidance rules for the parent company will also have to be considered.
For overseas-based franchisors receiving royalties from UK franchisees, the royalties may be subject to withholding tax and may be mitigated by treaty relief. Such treaty relief typically reduces the rate of royalty withholding taxes to a lower (or zero) rate but may require clearance from the relevant tax authority before payments can be made at the lower rate.
The structure of the fee arrangements may have a positive or negative effect on the tax treatment of both franchisor and franchisee, so careful drafting in the franchise agreement will be required. A franchisee will wish to maximise its tax deductions and the franchisor will wish to minimise its taxable income.
VI IMPACT OF GENERAL LAW
i Good faith and guarantees
The traditional and long-standing position under English law was that a 'good faith' clause was not ordinarily binding, or capable of being enforced. Franchise purists historically have claimed that there is no overarching duty of good faith that can be implied into a franchisor–franchisee relationship under English law.
The idea, however, that good faith is not part of English law business-to-business contracting is now outdated. It remains broadly correct in relation to the pre-contract phase, but it is now clear that an implied concept of good faith is steadily gaining recognition as a legally binding concept during the performance phase of contracts particularly long-term 'relational agreements' such as franchise agreements.
Prior to the recent, and some would say ground-breaking 'good faith' case of Yam Seng Limited v. International Trade Corporation Limited,10 two franchise cases provided examples of where the English courts inferred a position equivalent to good faith into a franchise agreement. In MGB Printing v. KallKwik,11 the court implied an obligation on the franchisor to ensure that it provided services to the franchisee using reasonable skill and care on the basis of 'business efficacy'. In Stream Healthcare v. Pitman,12 the court ruled that services should be provided to the franchisee by the franchisor where reasonably required or requested.
In the Yam Seng case, Leggatt L J (as he is now) analysed whether English law should impose an obligation of good faith in a distribution agreement. Leggatt L J's judgment drew together the pre-existing, disparate strands of English case law on the issue of good faith in commercial contracts and explained the importance of implied good faith in what he called 'relational' agreements, which are long-term agreements requiring extensive cooperation, a high degree of communication, mutual trust and confidence and expectations of loyalty. The judgment referred expressly to franchise agreements, long-term distribution agreements and joint venture agreements as examples of these relational agreements.
While arguably Leggatt L J's conclusion in the Yam Seng case that an implied duty of good faith did exist was potentially based on the facts of the particular case, including the fact that there was clear evidence of bad faith on the distributor's behalf, his judgment does clearly imply an objective duty of good faith between parties in long-term 'relational' contracts. The fact that franchising was specifically referenced as one of these forms of 'relational' agreements highlights its relevance to the performance phase of a franchisor–franchisee relationship.
In the July 2014 decision of Bristol Groundschool v. IDC,13 the High Court ruled that a duty of good faith should be implied into a 'relational contract' for the production and distribution of training materials for pilots. The judge said that it is clear from the Yam Seng decision that 'good faith extends beyond, but at the very least includes, the requirement of honesty' and '[t]he relevant test is that of conduct which would be regarded as “commercially unacceptable” by reasonable and honest people in the particular context involved'.
However, these cases can be contrasted with the July 2014 High Court decision in Carewatch Services Ltd v. Focus Caring Services Ltd & Others14 in which the defendant franchisee tried unsuccessfully to argue that (among other alleged implied terms) the franchise agreement contained an implied term that the parties would conduct themselves in 'good faith and/or deal with each other fairly and in particular not in a manner that would damage each other's business interests'. The judge in Carewatch agreed with the reasoning of the judge in the case of Hamsard v. Boots15 (which concerned the termination of a supply agreement between the parties for the supply of children's clothes to Boots stores), who said that he did not regard the Yam Seng case as authority for the proposition that there is a general obligation of good faith implied into all commercial agreements or that there is some sort of positive obligation implied that a party to a contract should subordinate its own commercial interests (in this judgment, the franchisor's) to those of the other contracting party.
More recently, in the 2016 case of Apollo Window Blinds Ltd v. Mr McNeil & Mr Taylor, the franchisees argued that there was an implied obligation of good faith that obliged the franchisor to remind the franchisees of an obligation in the franchise agreement to give the franchisor notice that they wished to renew between six and nine months prior to the expiry date. While the judge did not discount the possibility that there may be an implied obligation of good faith in relation to some parts of the agreement, the judge said that he could not see a court implying a term that imposes a duty on one party to tell the other of its contractual rights. As the giving of notice was a requirement of a right to renew, the judge took the view that the franchisees had no automatic right of renewal, as they had failed to give the requisite notice.
Even more recently, the Court of Appeal has commented (obiter) that parties to a long-term contract, classified as a relational contract, of 'massive length, containing many infelicities and oddities' should not latch onto such oddities to disrupt the contractual project and maximise their own gain.16 Interestingly, Leggatt L J has also recently commented on his decision in Yam Seng in the High Court case of Al Nehayan v. Kent.17 Acknowledging that his observations made in Yam Seng 'have provoked divergent reactions', he proceeded to comment that 'there appears to be a growing recognition that such a duty may be readily implied in a relational contract' before concluding that the long-term joint venture to develop hotels and associated travel businesses before him was a relational contract and was therefore subject to an implied duty of good faith.
For BFA-registered franchisors, a failure to act in good faith may constitute a breach of the BFA Code and therefore such challenges from unhappy franchisees may well increase. A standard of good faith is taking shape under English commercial contract law as seen in the Yam Seng and Bristol Groundschool decisions, and in judgments from the past year. By contrast, the Carewatch and Apollo Window Blinds decisions illustrate that the concept of good faith has its limitations and courts will not allow franchisees who are treated roughly, but commercially fairly, to use the concept to benefit from rights and protections that the written agreement did not give them.
ii Agency distributor model
In the United Kingdom, a genuine franchisor–franchisee relationship will not be treated as one of principal and agent or manufacturer and distributor. It is, nevertheless, advisable to have an express provision in the franchise agreement confirming that the franchise relationship will not be construed as one of employer and employee (see below), or principal and agent or manufacturer and distributor.
iii Employment law
In a genuine franchisor–franchisee relationship, franchisees are not and cannot be treated by the courts as employees.
iv Consumer protection
Franchisees are not generally treated as consumers under English law and therefore are not afforded consumer protection rights.
Notwithstanding this, it is important for franchisors to be fully aware of consumer-facing laws as these will nevertheless have an impact on the franchisor, whether dealing with consumers directly or through its franchisees. A franchisor will need to ensure there are suitable provisions in the franchise agreement requiring its franchisees to comply with all consumer protection legislation.
The Consumer Contracts (Information, Cancellation and Additional Charges) Regulations 2013 (the Consumer Contracts Regulations) contain provisions that will be relevant to all franchisors and franchisees who deal with consumers (referred to in the legislation as 'traders'), but will have a particular effect on the protections available to consumers when they purchase goods or services using a means of distance communication such as the internet. The Consumer Contracts Regulations require all traders to provide consumers with certain specific pre-contractual information prior to entering into any contract (e.g., on the total costs of the relevant products or services, and the arrangements for payment and delivery). Where orders are placed using the internet or other electronic means, the trader must clearly label the order button to indicate that placing the order entails an obligation to pay (e.g., by using words such as 'order with obligation to pay'). For distance contracts, traders in most circumstances must also offer consumers a period of 14 calendar days in which they can cancel the contract. The Consumer Contracts Regulations also contain specific provisions governing refunds, returning goods, delivery and risk, inertia selling and help-line charges, and introduced specific new rules regarding the supply of digital content.
A large proportion of domestic consumer law was codified under the Consumer Rights Act 2015 (CRA). The CRA is a complex piece of legislation but key provisions include: (1) a fairness test applicable to most terms of business-to-consumer (B2C) contracts, which, if failed, results in the infringing term being unenforceable against the consumer; (2) a transparency test that requires all terms of B2C contracts to be in plain and intelligible language, failing which a court will take the most consumer-friendly interpretation of the term at issue; and (3) implied warranties in all B2C contracts that vary depending on whether the subject matter of the contract is the provision of goods, services or digital content, and implied remedies available to a consumer for breach of contract by a business.
Other important consumer laws include the Consumer Protection from Unfair Trading Regulations 2008, which prohibit various unfair commercial practices by traders, such as providing misleading information or omitting material information, and include a 'blacklist' of commercial practices that are automatically prohibited (e.g., 'bait advertising'), and the E-Commerce Regulations 2002, which require website operators to provide additional specific information about themselves and their services.
v Competition law
The BFA Code does not provide a minimum term for a UK franchise agreement. Instead, it states that, as a minimum, the agreement should be long enough for the franchisee to amortise its initial investment. Franchise agreements in the United Kingdom are typically granted for an initial term of five years. This is often supplemented in the agreement by providing for two further five-year periods subject to the franchisor's approval and certain renewal criteria being met at the end of each period.
The five-year term approach in the United Kingdom is mainly a response to European competition law (as further discussed below), and in particular Article 101 of the Treaty for the Functioning of the European Union (Article 101 TFEU). If an agreement is found to be contrary to Article 101 TFEU, then either the prohibited provision – or in some circumstances the entire agreement – will be declared void and the relevant parties may be liable to fines. Chapter 1 of the UK Competition Act 1998 (the 1998 Act) largely replicates the key provisions of Article 101 TFEU.
In-term non-compete provisions, including product ties or an obligation on the franchisee not to be involved in a similar business, are common in franchise agreements, which means that franchise agreements are typically regarded as having the potential to affect competition – contrary to the principles of Article 101 TFEU and the 1998 Act. In-term non-compete provisions are those that provide that, for the duration of the franchise agreement, the franchisee must not sell products or services that are in competition with those of the franchisor. Product ties are those provisions that restrict the franchisee to buying specified products, including those that the franchisee will sell on to customers, from the franchisor or its nominated supplier only.
As franchise agreements are classified as 'vertical agreements' (in that the franchisor and franchisee operate at different levels in the production or supply chain), subject to meeting certain conditions regarding market shares, they receive the benefit of an exemption found in the Vertical Block Exemption (VBE)18 and the European Commission's accompanying guidelines (the Guidelines). The VBE guarantees that the whole agreement does not infringe competition law provided it does not contain certain prohibited restrictions (called 'hardcore' restrictions).
A number of other provisions are 'excluded' under the VBE. Although these excluded restrictions cannot receive the benefit of the VBE themselves, and must therefore be assessed separately to understand if they infringe competition law, the remainder of the agreement will continue to benefit from the VBE. One such excluded restriction is a non-compete obligation that lasts indefinitely or for longer than five years. As mentioned previously, most franchise agreements in the United Kingdom therefore adopt a five-year term.
Nonetheless, there is an exception to the five-year duration rule under the Guidelines,19 which is applicable to franchises. This states that a non-compete obligation on the products or services purchased by the franchisee may not be contrary to Article 101 TFEU if it is necessary to maintain the common identity and reputation of the franchised network. If this exception applies, the duration of the non-compete obligation is immaterial, and can be indefinite, provided that the obligation does not survive beyond the duration of the agreement itself. A very limited (no more than one year) post-term non-compete may be lawful if it is necessary to protect know-how and relates to the same premises that the franchisee used during the lifetime of the franchise agreement.
Price-fixing or resale price maintenance is classified as a hardcore restriction. Franchisors should not set a fixed price, a minimum price or a maximum discount. However, franchisors are permitted to set a maximum price or recommend a pricing structure for their franchisees but cannot take steps (contractual or otherwise) to enforce those recommended resale prices.
E-commerce has been one of the more topical and contentious areas. The European Commission carried out an EU-wide investigation into e-commerce, which culminated in a final report in May 2017. Internet or web-based sales are generally classified as 'passive' sales by the European Commission and cannot be prohibited by franchisors. Passive sales are typically reactive sales by a franchisee (i.e., where the customer seeks out the franchisee rather than the other way round). Franchisors can, however, prohibit a franchisee from making active sales (whether internet-based or otherwise) into any territory exclusively reserved for the franchisor or another of its franchisees.
Franchisors cannot prevent franchisees from operating their own websites, although franchisors can impose quality standards, particularly in relation to representations of the brand and the general look, feel and content of the website. Franchisors cannot prevent the franchisee setting up a website in a language other than that (or those) of the territories it is allocated; the European Commission considers that to be passive selling. Price-comparison-tool restrictions imposed on franchisees will most likely be treated as hardcore restrictions by the European Commission. However, following the Coty judgement,20 sales via online marketplaces can be restricted in the context of the distribution of luxury products through a selective distribution network.
The European Commission indicated in the Final Report on the E-commerce Sector Inquiry that bans on using price comparison tools are likely to amount to hardcore restrictions. Of particular relevance to franchise arrangements, the European Commission highlighted concerns relating to information flows between a supplier and its retailers where the supplier competes with the retailer. This is highly likely to occur in the context of franchising and adequate information barriers should be set up to prevent exchange of commercially sensitive information.
vi Restrictive covenants
Non-compete and other restrictive covenants will typically be caught by competition or antitrust law principles (see Section VI.v on competition law, above).
In terms of enforcement, if a franchisee is in breach of in term non-compete or restrictive covenants, the franchisor's initial course of action may be to terminate the franchise agreement. Following termination, the franchisor will either bring a claim against the franchisee for breach of contract or, depending on the nature of the franchisee's breach, apply for an injunction to compel the franchisee to either cease their infringing conduct or to comply with their obligations, if appropriate. The criteria for the grant of an injunction by the court are discussed elsewhere in this chapter. If the franchisor is successful in a contractual claim, the likely remedies include damages to compensate the franchisor for any losses it has suffered and potentially an account of profits that the franchisee has made from the competing business.
Termination of a franchise agreement is dealt with under common law principles. It is therefore crucial that the termination provisions in the franchise agreement be not only clear but also significantly flexible so as not to limit or restrict the franchisor's ability to terminate.
Best practice dictates that the grounds for termination are clearly stated in the franchise agreement with a clear distinction between conduct that will result in immediate termination and conduct that is potentially remediable and therefore not damaging to the long-term or overall relationship.
The BFA Code dictates that franchisees must be notified of any breaches the franchisor claims have been committed and be given a reasonable time period to remedy the breach.
Under competition law principles, post-termination non-compete provisions are prohibited unless the provisions are necessary to protect the franchisor's know-how, which may be difficult for franchisors to prove. If the know-how is deemed secret (and therefore requires protection), then the VBE recognises the right for franchisors to impose a limited 12-month non-compete restriction from the premises at which the franchisee operated its business.
Fortunately, case law has taken a more sensible approach than that set out in the VBE, recognising that a wider post-termination geographical restriction may be permitted provided the aim of the provision is to prevent the franchisor's know-how being used by competitors.
Enforcement of post-termination restrictive covenants will typically involve the franchisor applying to the court for an order injuncting the former franchisee (i.e., preventing it from trading or otherwise acting in breach of its covenants).
Post-termination restrictive covenants will only be upheld if the court considers them reasonable. Typically, the court will look at the geographical width of the restriction and the duration. A 12-month restriction not to operate a competing business in the franchisee's former territory is likely to be enforceable, whereas a 24-month restriction for the whole of the United Kingdom is likely to constitute an unlawful restraint of the former franchisee's right to trade. Each case will, however, be examined on its own facts.
In the case of Carewatch Care Services Limited v. Focus Caring Services Limited and others, the High Court held and reaffirmed the position that restrictive covenants may be enforceable if it can be proven that they were designed to protect the company's legitimate business interests and went no further than necessary to achieve that purpose.
In the case of Apollo Window Blinds referred to above, the franchisees, who had 45 years of experience in the window blinds business, successfully defended the franchisor's application for an injunction against them on the basis that the restrictive covenants were not justified as the franchisees received no training and no goodwill; the franchisor was purely used by them as a source of good quality products.
viii Anti-corruption and anti-terrorism regulation
Within a contractual context, a franchisor's liability for fraud will largely be related to fraudulent misrepresentation as detailed above. In the event that the franchisee or principal shareholder or director commits an act or omits to act in circumstances that amount to fraud, it will often constitute an express ground for termination of the franchise agreement by the franchisor.
The UK Bribery Act 2010 (the 2010 Act) sets out a range of offences relating to bribery that may apply to the franchise relationship. The 2010 Act targets the payment or receipt of a bribe (which is not restricted to providing someone with a financial advantage) to a person when the bribe is made with the intention of persuading that person to perform a function or activity improperly. The 2010 Act covers bribes paid and received by UK citizens, and also extends to bribes paid by UK citizens to foreign public officials.
The Money Laundering Regulations 2007 (the Regulations) aims to prevent money or assets that were obtained by criminal means, including money raised for the purposes of terrorism, being exchanged for money or assets that were legitimately obtained. Franchisors should ensure compliance with the Regulations by putting in place strict controls to verify the identity of their business partners and the sources of their wealth, along with having a clear reporting procedure for any suspicious activity.
Along with ensuring their own internal compliance, franchisors should have clear anti-bribery, anti-corruption and money-laundering policies in place for their franchisees. These policies should form part of the operating manual, as well as being part of the initial and ongoing training provided by the franchisor. The policies themselves, and any guidance given on them, should include key messages for the franchisees and practical considerations that flow from them. This should then be backed up by express contractual provisions in the franchise agreement so that a breach of any of the policies triggers a breach of the franchise agreement.
ix Dispute resolution
In domestic franchise disputes depending on the nature of the franchisee's conduct or breach a franchisor may seek an injunction to either stop or compel certain conduct by the franchisee. For most breach of contract claims litigation as opposed to arbitration is the typical form of dispute resolution in the United Kingdom. While mediation is a recognised form of alternative dispute resolution and actively encouraged by the Civil Procedures Rules, it is not mandatory. However, the parties can incorporate a mandatory mediation process in the dispute resolution clause in the franchise agreement, which is likely to be upheld by the courts in the United Kingdom.
For international franchisors, the English courts will recognise and uphold foreign choice of law and jurisdiction clauses. It is, however, advisable to ensure that a franchise agreement is reviewed by an English law expert in franchising to ensure that there are no clauses that would be unenforceable or contrary to public policy.
There is no specific procedure for franchise disputes in the United Kingdom – most are settled before reaching formal alternative dispute resolution methods or court-based litigation. The BFA offers both a mediation and arbitration scheme although the latter has not experienced a significant take-up rate. Certainly, for international franchisors and more sophisticated disputes, it is probably advisable to use one of the more experienced international arbitral bodies such as the London Court of International Arbitration. Before the parties engage in mediation or arbitration, the BFA also offers an informal conciliation scheme, aimed at facilitating an amicable discussion between the parties and allowing each of the parties to make representations about their case.
The English litigation procedure, as governed by the Civil Procedure Rules, is a world leader. The rules of full and frank disclosure are particularly appealing to claimants, and a compelling reason to elect for disputes (contractual or otherwise) to be settled by the English courts. Commencing in January 2019, a mandatory disclosure pilot scheme will run for two years in the Business and Property Courts, which will have an effect on the disclosure process for new claims (and certain existing claims) heard in these courts. Franchisors or franchisees party to disputes heard in these courts should be mindful of the new requirements under the scheme.
Where a franchisor seeks an injunction against a franchisee, the reasons for which may include, for example, a former franchisee continuing to trade in breach of a non-compete provision or using the franchisor's trademarks or other IPRs, once the application is issued it may be heard on a without notice preliminary basis within one to three days or on notice with three clear days' notice to the opposing party. The courts will normally only grant an interim injunction on a without notice basis if there is a real risk that the franchisor will suffer severe harm if the franchisee is given notice of the application or it is extremely urgent. It is more common for an application to be made on notice in order that the franchisee has time to prepare for and be represented at the hearing.
The court's decision to award an injunction will be based on a consideration of the balance of harm to the franchisor caused by allowing the franchisee to continue to trade or use the IPRs against the harm caused to the franchisee by requiring the cessation of the conduct. If monetary compensation is deemed to be an adequate remedy for the franchisor, the court will not grant an injunction.
An interim injunction will be granted until trial or the end of the contractual period of restrictions, whichever is sooner.
It may take between 12 and 18 months before a dispute reaches full trial. By this point the restrictive covenants (and the injunction) will most likely have expired and the dispute will primarily focus on the level of harm suffered by the franchisor and the level of damages to which the franchisor (if successful) is entitled.
If a franchisor is successful in a breach of contract claim against a franchisee, it will be entitled to damages to put it in the position it would have been in had the contract been performed correctly by the franchisee. There are two limbs to the damages that can be claimed: those that flow directly and naturally from the breach and those that are indirect but that were in the reasonable contemplation of the parties at the time that the agreement was entered into. The types of losses that may be recoverable could include the franchisor's profit on the royalty fees for the remaining term of the agreement or until the franchisor could reasonably be expected to appoint a new franchisee; the costs of appointing a new franchisee; loss of profit on product sales that the franchisee would have bought; damage to the franchisor's goodwill or reputation (although this can be very hard to quantify); the costs of taking over and running the franchisee's territory until it can be refranchised. The heads of loss available to a party will be dependent on how the underlying agreement has been drafted, so it is essential, as the first port of call in any dispute, to consider the limitations on liability that have been included in that agreement (both in terms of quantum and the types of loss that can be recovered).
As stated above, in the event that a party is looking to terminate an agreement by reason of the other party's failings, this can potentially be achieved under either the provisions of the contract or common law. A well-drafted contract should contain specific termination provisions, which may provide for termination in the event of material breach. This term 'material breach' is a nebulous concept with no specific definition under English law, so unless specifically defined in the contract in question, a party looking to terminate should be careful as to whether a 'material' breach has been committed, which will be determined by the facts and circumstances of the contract. Where a breach is so severe that it goes to the root of the contract, it would be considered repudiatory under common law, giving the injured party the right to terminate and claim the full value of the contract. Where a repudiation has happened under common law, the injured party has the right to terminate or affirm (that is continue with) the contract; such an election need not be taken immediately. However, an injured party would be advised to elect within a reasonable period, as otherwise the law may intervene and treat the contract as affirmed (damages would still be available in either scenario).
If a franchisee is successful in a claim for negligent or fraudulent misrepresentation, it could be entitled to rescind the agreement (i.e., treat it as set aside) and damages to put it in the position that it would have been in had the agreement not been entered into. This could entitle the franchisee to claim a refund of the initial and all other franchise fees paid; refund of all set up and running costs (minus any profits made); a refund of the costs of any bank lending; and compensation for lost opportunity based on what the franchisee would or could have done had it not entered into the franchise agreement. The damages can therefore be substantial.
As a general rule, the successful party to litigation will be entitled to an order that the losing party pays its legal costs; however, the costs are always at the discretion of the court and unreasonable conduct by the successful party, such as issuing a claim without going through the appropriate pre-action protocols, refusing to enter into alternative dispute resolution or informal negotiations, or refusing to accept a without prejudice offer that it then failed to beat at the final hearing could result in it only recovering a proportion of its costs or even being ordered to pay the other side's costs. Costs are also subject to assessment by the court to ensure they are reasonable and proportionate and, as a general rule of thumb, a party can expect to receive around 70 per cent of its costs under assessment.
For claims over £25,000, the costs will not be capped (although they are subject to assessment, as explained above). For claims between £10,000 and £25,000 the costs will be capped and for claims below £10,000 ('small claims') the successful party will not be able to claim any costs from the losing party other than court fees.
Brexit means a certain degree of uncertainty when it comes to the enforcement of agreements within the EU. As regards where disputes will be heard (i.e., jurisdiction), because the United Kingdom is currently an EU Member State, the UK courts recognise and enforce court judgments from other EU Member States by virtue of the Recast Brussels Regulation and Lugano Convention. The problem post-Brexit is that both these Conventions require reciprocity to be effective, therefore they cannot simply be incorporated into UK law upon the country leaving the EU, because the United Kingdom will not be recognised by the other signatories to the Conventions. The United Kingdom is set to sign up to the Hague Convention on Choice of Court Agreements, which means that where a contract confers exclusive jurisdiction on the English courts, that choice shall be honoured; however, this will not extend to non-exclusive or asymmetric clauses. What will happen in the event of a 'no-deal' Brexit remains unclear at present, but parties would be well advised to make any choice of jurisdiction exclusive. Domestic disputes and international disputes without an EU element should not be affected.
Furthermore, it is important for international franchisors to note that the United Kingdom is a signatory to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitration Awards (the New York Convention) and the English Courts will readily recognise and enforce foreign arbitral awards from other Convention countries. This will remain the same post-Brexit, and we may see a marked increase in the adoption of arbitration clauses as a means of resolving disputes.
Governing law clauses will be unaffected by Brexit, as the EU Rome Convention on governing law will honour express choices of governing law without the same need for reciprocity, and is set to be incorporated into English Law post-Brexit.
VII CURRENT DEVELOPMENTS
In terms of specific legislation and case law that deals directly with franchising, 2018 has produced little that impacts significantly on either domestic franchise arrangements or relationships between an international franchisor and a UK developer, master or unit franchisee. There have, however, been other notable legal developments that will impact on the franchisor–franchisee legal arrangements and on both the franchisor's and franchisee's relationship with the ultimate consumer.
Following the implementation of the GDPR and the DPA 2018, most franchisors should have reviewed (or if not, should review now as a matter of urgency) not only the data protection provisions in their franchise agreements, but also more importantly the policies, processes and data handling training that these organisations provide to both their franchisees and employees.
The Supreme Court has ruled decisively on whether parties can vary a contract orally despite the presence of a valid 'no oral modifications' (NOM) clause in a contract in the case of Rock Advertising v. MWB.21 Previous decisions of the Court of Appeal suggested it would be possible to enter into a legally binding oral variation, despite the existence of a NOM clause, as freedom of contract would prevail.22 However, the Supreme Court rejected this argument as a 'fallacy', instead finding that NOM clauses (1) prevented attempts to undermine a written contract by informal means; (2) avoided disputes regarding variations; and (3) provided formality in recording variations, enabling contracting parties to restrict those that can vary their contractual relations. The Court agreed that all of these were legitimate commercial reasons for using a NOM clause, which should not simply be overridden. This ruling has largely been welcomed for bringing greater certainty to long-term commercial arrangements; however, parties to contracts should now carefully consider their record-keeping and contracting procedures to ensure that any oral variations made to commercial arrangements are properly documented and that they are enforceable. The Supreme Court did acknowledge the risk that a party to a contract could act on the contract as orally varied and then find itself unable to enforce it; however, this risk can be partially offset by the principle of estoppel.
In the wider commercial context, UK franchisors continue to make considerable investments in technology, not only as a means for improving business efficiency, but also to enable their franchisees to offer a uniform digital marketing platform and integrated e-commerce channel. The twin issues of investment in technology and the evolving landscape around handling, storing, processing and protecting data are likely to continue as trends and developments in 2019.
Finally, it is impossible to ignore the seismic political decision of the United Kingdom to leave the European Union, which has both wide-reaching legal and commercial implications for franchisors, master franchisees, developers and franchisees. While at the time of writing the full extent of Brexit is still unknown, the possibility of a no-deal exit from the EU is becoming increasingly likely, and franchisors should be reviewing their brand protection strategies, their franchisees' employment policies, and the constitution of their employee workforce, as these are areas that will have to be addressed whatever the outcome of the discussions between the UK government and the EU. In addition to free-movement-of-labour issues, key considerations for international franchisors looking at entering the United Kingdom will focus on currency and import-versus-export prices, and the potential impact of enhanced customs checks of goods at borders with EU Member States.
1 Graeme Payne is a partner at Bird & Bird LLP.
5  EWHC 1868.
6  EWHC 358 (High Court).
7  EWHC 2621 (QB).
8 November 2013.
9  EWHC 669 (Ch).
10  EWHC 111.
11 MGB Printing and Design Limited v. Kall Kwik UK Limited, High Court of Justice Queen's Bench Division  EWHC 624 (QB).
12 Stream Healthcare (London) Ltd v. Pitman Education & Training Ltd, High Court of Justice Chancery Division  EWHC 216 (Ch).
13 Bristol Groundschool Ltd v. Intelligent Data Capture Ltd  EWHC 2145 (Ch).
14  EWHC 2313 (Ch), 2014 WL 3002765.
15  EWHC 3251 (Pat), Hamsard 3147 Limited Trading as 'Mini Mode Childrenswear', JS Childrenswear Limited (in liquidation) v. Boots UK Ltd 2013 WL 5826153.
16 Amey Birmingham Highways Ltd v. Birmingham City Council  EWCA Civ 264.
17  EWHC 333 (Comm).
18 Commission Regulation (EU) No. 330/2010.
19 Paragraph 190(b).
20 Coty Germany GmbH v. Parfümerie Akzente GmbH Case C-230/16.
21  UKSC 24.
22 See for example, TRW Lucas Verity v. Globe Motors  EWCA 396 (Court of Appeal).