The Kingdom of Saudi Arabia continues to prove very appealing to franchisors. Among the factors that encourage potential franchisors are its large population, residents' high income, ease of brand recognition and government support.
Saudi Arabia is the most populated country in the Gulf Cooperation Council (GCC) with a population of approximately 32.5 million people. Among those, a significant proportion are under the age of 25. The World Bank Group categorises Saudi Arabia as a 'high-income' state, with a gross national income of US$20,080 per capita.2 According to Trading Economics, Saudi Arabia's gross domestic product at the end of 2017 was over US$638 billion, which represents 1.1 per cent of the world economy.3 Saudi Arabia's government has incentivised local and foreign investment within the country to facilitate a nation-wide economic shift from reliance on oil revenues to other sources of income.
The food and beverage sector has proven very successful, while the retail sector continues to gain popularity. It must be noted that franchising opportunities within Saudi Arabia are not limited to foreign brands. The past few years have seen an increase in the number of local concepts being franchised within Saudi Arabia and out to the rest of the GCC.
II MARKET ENTRY
There are a few legal restrictions on local and foreign franchisors in Saudi Arabia. Franchisors, franchisees and developers are subject to foreign investment laws. Pursuant to the Economic Agreement between the GCC states, nationals of other member countries of the GCC4 are not considered 'foreign investors' under the law, therefore it is permissible for a foreign brand to be operated by 'GCC nationals' as opposed to 'Saudi nationals'.
For those franchisors looking to set up their own business, or for franchisees looking to trade directly in Saudi, restrictions on foreign investment vary according to how the activity is classified. The Saudi Arabian General Investment Authority's (SAGIA) requirements also depend on the classification. Non-GCC investors wishing to engage in 'service-based' activities have the option of establishing a local branch office or 100 per cent owned limited liability company (LLC). For entities engaged in service-based activities, such as restaurants and maintenance operations, no minimum paid-up capital is imposed by SAGIA. Non-GCC investors wishing to engage in 'trading-based' activities have to (1) establish an LLC with at least 25 per cent of the company owned by a Saudi national or company; (2) hire and train Saudi nationals to make up 15 per cent of their employees; and (3) restrict their activity to one store per district. SAGIA imposes a minimum capital requirement of around 27 million Saudi riyals for such companies – 20 million Saudi riyals of which is imposed on the foreign investor as a minimum contribution. This figure is only imposed on the company's non-Saudi shareholders. Note in mid to late 2015 there were discussions within the Saudi legislature on potentially reducing this 25 per cent figure.
Foreign investors may also set up local manufacturing facilities that manufacture and distribute products to franchisees within Saudi Arabia. SAGIA imposes a minimum share capital requirement of 1 million Saudi riyals for such entities.
Certain activities such as oil exploration, drilling and production, manufacturing civilian explosives and security services are restricted to Saudi nationals.5
ii Foreign exchange and tax
Although there is no exchange control in Saudi Arabia, transactions are generally made in Saudi riyals. Saudi Arabia has a corporate tax and zakat (Islamic wealth tax), but no individual income tax.
As with most countries, tax depends on the entity's structure. Zakat is set at the flat rate of 20 per cent, and is obligatory for all legal persons who make any payments to foreign individuals. Additionally, a withholding tax of 5 to 20 per cent is imposed on companies engaging in specific activities.
III INTELLECTUAL PROPERTY
i Brand search
Trademark searches, including company name registrations, are made in the trademark office at the Ministry of Commerce and Industry (MOCI).
ii Brand protection
The MOCI allows the registration of distinctive marks that are not contrary to shariah (Islamic) law and are not names of geographic locations. In cases of globally recognised brands, only a rightful owner or their authorised representative can register their trademark in Saudi Arabia. Saudi Arabia operates on a 'first-to-file' basis, giving priority and ownership to the first legal person to register the mark.
To register a trademark for a franchise, the owner of the mark or an authorised representative must submit an application that sets out a list of the goods or services and their class, along with a copy of the mark's foreign registration certificate. Each class of goods and services requires a separate application. The MOCI generally decides whether a trademark is granted within 60 days of filing. The MOCI notifies the applicant if it requires changes to be made to the application. The applicant is then given 90 days to amend the application in accordance with the MOCI's instructions.
If approved, trademark protection is granted for a period of 10 years and may be renewed up to six months after the registration expires.
If the trademark application is not approved, the applicant can appeal the MOCI's decision with the MOCI within 60 days of the rejection date. If the MOCI rejects the appeal, then the applicant may appeal to the Board of Grievances, an independent administrative judicial commission, within 30 days of the date of the rejection being issued.
The MOCI and the Board of Grievances have enforcement authority over trademark infringement. Upon receiving evidence of possible counterfeiting activity, the MOCI conducts an investigation and passes its findings on to the Board of Grievances. The latter may then bring both civil and criminal claims against alleged perpetrators. If the trademark owner can prove the existence of an imminent need for protection, the Board has the authority to issue injunctions.
iv Data protection, cybercrime, social media and e-commerce
Privacy rights are protected under the Basic Law of Governance, which is essentially Saudi Arabia's constitution. The Basic Law of Governance generally prohibits the confiscation, delay, eavesdropping and surveillance of communications. Breaches of privacy or confidentiality are punishable offences under the Basic Law of Governance, and the non-breaching party may be awarded compensation for damage caused by such unlawful disclosure. Non-economic punitive measures, such as sanctions, may also be imposed on the breaching party.
Saudi Arabia does not have a specific code tailored towards data protection, but data protection is derived from other codes such as the Anti-Cyber Crime Law. The Anti-Cyber Crime Law protects 'information, commands, messages, voices and images' that are or can be 'saved, processed, transmitted or constructed by computers'.6 Breaches of the Anti-Cyber Crime Law can result in fines of over US$800,000 and prison sentences of up to four years. In the absence of any relevant legislation, courts will apply relevant shariah law principles, which place a high value on privacy.
IV FRANCHISE LAW
Saudi Arabia has recently approved the Commercial Franchise Law (the New Franchise Law).7 The New Franchise Law creates a regulatory framework for the relationship between the franchisor and the franchisee on a basis that promotes transparency. The New Franchise Law shall apply to any franchise agreement implemented within Saudi Arabia. The implementing regulations of the New Franchise Law have yet to be released. The New Franchise Law is expected to come into force in April 2020.
Saudi Arabia previously did not have a law specifically governing franchising, but the Commercial Agencies Law and its Regulations, which govern the principal agent relationship, also cover the relationship between a franchisor and a franchisee. The Commercial Agencies Law Regulations also set out the procedure for registering a franchise in Saudi Arabia, as well as the rights and obligations of all parties involved. The current Commercial Agencies Law regime fails to differentiate between franchise agreements, distribution agreements and agency agreements, and all three may be construed as a commercial agency capable of registration.
Until such time as the New Franchise Law comes into effect, franchises will continue to be governed by the Commercial Agencies Law Regulations. The New Franchise Law specifically excludes 'agreements or contracts' subject to the Commercial Agencies Law and it remains to be seen whether an amendment will be made to the Commercial Agencies Law Regulations to exclude franchise agreements.
ii Pre-contractual disclosure
The New Franchise Law requires franchisors to provide the franchisee with a disclosure document at least 14 days prior to the execution of the franchise agreement or before the franchisee pays any funds relating to the franchise (i.e., a deposit). The disclosure document must disclose the main rights, obligations and material risks related to the proposed franchise. The disclosure document and franchise agreement must be translated into Arabic.
Under shariah law, parties must deal in good faith and fully disclose all material facts to each other. This good-faith obligation is now specifically set out in Article 10 of the New Franchise Law. Parties may seek judicial remedies if a party is alleged to have failed to disclose or fraudulently disclosed any pertinent facts and the other party sustained damage from the disclosure or non-disclosure.
The franchise agreement, along with the disclosure document, must be registered with the the MOCI. It is not yet clear what supporting documents will also have to be submitted. Under the previous franchise regime, the MOCI required the following documents to register an agreement as a commercial agency, which was required to obtain things such as signage approval:
- a standard application;
- a certified Arabic translation of the agreement, as well as all other foreign-language documentation;
- a copy of the franchisee's commercial registration and chamber of commerce certificate; and
- a declaration, in writing, that the franchisee's capital is Saudi-owned and its authorised representative is a Saudi national.
We expect to receive further clarification as to the documents required once the implementing regulations have been issued.
iv Mandatory clauses
Under the New Franchise Law, while a franchise agreement does not currently have to follow a specific template, it must include the following elements:
- a franchise business description;
- the term or period;
- the method of amendment;
- the geographical scope;
- the consideration payable to the franchisor by the franchisee and the method of calculation;
- both parties' obligations concerning the training of the franchisee's employees by the franchisor;
- the franchisor's obligation to provide technical, marketing and other types of experience required by the nature of the franchise;
- the franchisees obligation to adhere to the instructions, marketing method, display and maintenance of the franchise's identity;
- the franchisee's rights in relation to intellectual property;
- the mechanism of settlement of any dispute;
- the franchisee's rights relating to sub-franchising; and
- provisions relating to any change of owner of the franchise.
The implementing regulations of the New Franchise Law may set out further requirements for the franchise agreement, including a set form for the agreement.
v Guarantees and protection
Franchise agreements generally include guarantees. Guarantees are enforceable depending on their level of conformity with the elements of shariah law. Guarantees may be enforceable against entities, and personal guarantees may be enforceable against individuals.
i Franchisor tax liabilities
Saudi and GCC national franchisors are exempt from corporate tax. Instead, they pay zakat at the rate of 2.5 per cent. Non-Saudi and non-GCC nationals must pay a flat corporate tax at the rate of 20 per cent. If a company has GCC national shareholders as well as non-GCC shareholders, the GCC nationals would be responsible for zakat at the rate of 2.5 per cent on their interest in the company and non-GCC shareholders would be responsible for a 2 per cent corporate tax on their interest. A franchisor who is a Saudi resident individual or company must declare and pay withholding tax on payments made outside Saudi Arabia. Payments to non-residents are subject to a withholding tax of 5–20 per cent, depending on how they are classified. For payments outside Saudi Arabia, franchisors will be subject to a 5 per cent withholding tax.
ii Franchisee tax liabilities
Individual franchisees are not subject to tax obligations while franchisee entities will be subject to corporate tax or zakat. As with franchisors, GCC national franchisees will be subject to a 2.5 per cent zakat, while non-GCC franchisees will be subject to a 20 per cent corporate tax. These same flat tax rates apply to companies with GCC national shareholder and non-GCC shareholders respectively.
Franchisees will be subject to a withholding tax of 5 to 20 per cent on payments made to non-residents. Payments to the foreign franchisor, the head office or an affiliated company located outside Saudi Arabia are subject to a 15 per cent withholding tax. The franchisee must declare and pay the withholding taxes.
Saudi Arabia has no personal income tax, so individual franchisees will have no personal tax liability. They will, however, be required to pay zakat at the rate of 2.5 per cent.
VAT was implemented in Saudi Arabia on 1 January 2018 at a rate of 5 per cent, with a limited number of exemptions for certain items related to education and healthcare, and basic food items.
iii Tax-efficient structures
The Saudi Arabian government provides tax incentives to companies that establish entities in designated economic areas. Additionally, Saudi Arabia has tax treaties with China, Japan, Russia and the United Kingdom, among others, that may be channelled for tax incentives for foreign franchisors and franchisees.
VI IMPACT OF GENERAL LAW
i Good faith and guarantees
Good faith dealings are deeply rooted in Saudi Arabia's moral code and practices. Saudi courts can hear cases where one or more parties did not behave in good faith. Courts will look to the intent of the party in question to amend or enforce agreements. To avoid allegations of having acted in bad faith, parties must set out their terms, rights and obligations explicitly, clearly and to a full extent. The New Franchise Law specifically provides that all parties shall undertake their obligations in good faith.
ii Agency distributor model
Because at the time of writing, under Saudi law, franchising in Saudi is governed by the Commercial Agencies Law Regulations, it is regarded as a commercial agency. The franchisor–franchisee relationship is treated as a principal agent relationship, with a key difference being that the franchisor is generally not vicariously liable for any torts that the franchisee commits unless the former is shown to have exercised direct control over the franchisee's everyday operations. This will change, however, once the New Franchise Law comes into force in April 2020.
iii Employment law
Saudi law generally does not view a franchisor–franchisee relationship as an employment relationship.
iv Consumer protection
The franchisee cannot claim any consumer protection rights as they are deemed to be the franchisor's agents.
In terms of protecting consumers, Saudi Arabia's Commercial Agencies Law Regulations place an obligation on the franchisee to maintain their products at a reasonable cost, and to ensure that spare parts are available at reasonable prices throughout the term of the franchise agreement and up to one year thereafter. Franchisees must keep stock of integral spare parts, while spare parts that are not in stock must be made available to the consumer within 30 days of the latter's request. The franchisee is held to the same warranty periods that the franchisor provides, therefore the franchisor has an obligation to provide spare parts and necessary support to franchisee for the term of their agreement and for one year thereafter.
The New Franchise Law is concerned with the relationship between franchisor and franchisee and not consumers or customers; however, when released, the implementing regulations of the New Franchise Law may contain some consumer protection provisions.
v Competition law
Saudi Arabia introduced a Competition Law in 2004 to facilitate fair competition and stimulate the economy by preventing the formation of monopolies. The Competition Law allows the market forces to decide prices of goods and services, which essentially gives the consumer more bargaining power.
vi Restrictive covenants
Saudi Arabia recognises restrictive covenants. Courts may enforce covenants, such as non-compete clauses, if they are provided for in the franchise agreement and so long as they represent the parties' intent and are in accordance with shariah law. Parties may restrict each other from conducting substantially the same business with third parties, and may also agree to geographic restrictions. The New Franchise Law does not discuss restrictive covenants therefore there is no express prohibition on the franchise agreement including such clauses.
Currently, in the event of any disputes leading to or following termination, Saudi courts will refer to the agreement, the intent of the parties and whether the clauses are compliant with shariah law and all other relevant regulations. If disputes arise, the MOCI will not permit a new franchisee to register a new franchise agreement with the franchisor until the dispute is settled either by the parties or through the courts. Courts may issue an order to deregister the franchisee from the Commercial Agency Register if they find in favour of the franchisor. The regulations of the New Franchise Law may contain similar provisions. The courts may also award direct damages but are hesitant to award any indirect or consequential damages to either party. The New Franchise Law contains a chapter consisting of three articles that deal with compensation. Both the franchisor and the franchisee have a statutory right to compensation in certain situations.
viii Anti-corruption and anti-terrorism regulation
Corruption, bribery, manipulation, embezzlement, unlawful enrichment and money laundering are criminal offences in Saudi Arabia. Saudi Arabia has elected Nazaha, the National Anti-corruption Commission, whose aim is to eliminate corrupt practices and bribery. Additionally, an Anti-Bribery Law was introduced to combat the making or receiving of bribes.
ix Dispute resolution
Parties are free to select their means of dispute resolution. They can opt for their choice of governing law and jurisdiction. Currently, the Board of Grievances in Saudi has jurisdiction over franchising disputes for those disputes not referred to international or local arbitration.
Traditionally, parties have selected the Board as their redress, but arbitration clauses have become more common given that local arbitration regulations were enacted in 2012. Franchisors may prefer arbitration as an alternative to the Board, as the latter has been known to enforce its subjective interpretation of shariah law. Furthermore, the Board rarely, if ever, cites precedent cases, meaning the parties lack foresight as to the outcome of a hearing. Another worry for franchisors is that the Board may also exercise protectionism towards Saudi-national franchisees. An issue with arbitration is how or whether the Board will enforce awards. Despite the fact that Saudi Arabia is a party to the New York Convention and the Washington Convention, the Board has broad authority to dismiss arbitral awards. Foreign awards are subject to the same enforcement issues. In general, foreign judgment and arbitral awards may be enforced if the following conditions are met:
- jurisdiction: the Saudi courts do not have jurisdiction to hear the original matter decided by the foreign court, and the foreign court has the jurisdiction to adjudicate the matter and issue judgment;
- due process: the parties to the litigation are afforded their due process and (1) issue a summons and complaint; (2) are adequately represented; and (3) are able to defend themselves;
- reciprocity: there is reciprocity between the foreign jurisdiction that issued the judgment and Saudi Arabia to enforce each other's judgments. This is typically done through a treaty. The absence of such a treaty may not bar an enforcement action;
- consistency: the judgment being enforced does not contravene a judgment issued by a Saudi court or other governing body on a similar matter;
- finality: the foreign court's decision is final and binding and not subject to further appeal; and
- public policy: the judgment does not violate Saudi law or public policy.
The New Franchise Law specifically allows arbitration, mediation and conciliation.
VII CURRENT DEVELOPMENTS
Despite the New Franchise Law being released, until such time as the implementing regulations have been issued, it will be difficult for franchisors to fully understand how to comply with the Law. Under the current regime, franchise agreements are registered as commercial agency agreements and the MOCI registers most commercial agency and distribution agreements as 'non-exclusive', regardless of whether they contain any exclusivity provisions. This is probably because of the the pending implementation of the New Franchise Law and uncertainty as to its application in practice.
There have been recent developments in which the Saudi Food and Drug Authority instructed food facilities in Saudi Arabia to clearly display both the ingredients and the number of calories in food and beverages.
1 Melissa Murray is a partner at Bird & Bird (MEA) LLP.
2 World Bank Group, 'Doing Business: Ease of Doing Business in Saudi Arabia' (revised in 2018), available at: https://www.doingbusiness.org/data/exploreeconomies/saudi-arabia/.
4 GCC member countries consist of: Saudi Arabia, Qatar, the United Arab Emirates, Bahrain and Oman.
5 SAGIA Business Center list of businesses prohibited for foreign investments, available at: https://www.sagia.gov.sa/Documents/Download%20center/Business_not_permitted.pdf.
6 KSA Bureau of Experts at the Council of Ministers, Anti-Cyber Crime Law (August 2010), available at: https://www.saudiembassy.net/announcement/announcement03260701.aspx.
7 Cabinet Decision No. (122) of 1441 H.