The Franchise Law Review: Resolving International Franchise Disputes
I LIKELY CAUSES OF DISPUTE
The majority of disputes that arise fall into the following categories.
i A mismatch of expectations
This is one of the most common forms of dispute and will usually come to light within six to 18 months of the commencement of the agreement when the franchisee is not as successful as either party thought it would be and any failings in relation to how the franchise opportunity was presented by the franchisor are likely to come to light. A mismatch of expectations will range from a general disappointment, which falls short of giving the disappointed party any legal basis for claim, through to giving the innocent party the right to treat the agreement as effectively void and claim damages.
The concept of misrepresentation exists in many jurisdictions. The key elements that will need to be proved for an innocent party to succeed in a misrepresentation claim will vary between jurisdictions but are likely to include evidence that the franchisor (and misrepresentation is normally a claim against the franchisor) made an untrue statement of fact or law to the franchisee that induced the franchisee to enter into the agreement thereby causing the franchisee loss. The remedies available to the franchisee who is able to successfully prove a misrepresentation has been made will also vary from jurisdiction to jurisdiction but could include the right to set aside the agreement, recoup all monies paid under the agreement (minus an allowance for any profit made) and claim damages for loss of opportunity.
The risk of misrepresentation can be minimised by ensuring that all recruitment literature and any financials (in those jurisdictions where a franchisor is permitted to provide financial information) that are given are accurate and up to date; the parties carry out proper due diligence in relation to the other; both parties take proper professional advice; the franchise agreement is carefully drafted to ensure that the franchisor's liability for misrepresentation claims is limited or excluded (subject to local laws in relation to exclusion or limitation of liability); a carefully drafted and up-to-date disclosure document is given by the franchisor (the provision and content of which is mandatory in some jurisdictions); and the parties communicate openly and frankly with each other both before and after the agreement is signed to ensure that any mismatch of expectations is dealt with promptly to avoid escalation of issues.
ii Inappropriate choice of franchise partner
When a franchisor decides to expand overseas, they often make the mistake of entering into an agreement with the first partner who shows an interest in their brand. It is vital that proper due diligence is completed and that the franchisor is confident that the choice of partner has experience of the local market (ideally in the particular industry sector in which the franchisor is operating); is properly funded; has experienced and capable staff who speak both the local language and that of the franchisor to ensure open and clear communication; and ideally a proven track record of growing other franchise brands.
In recent years, a number of large organisations have grown and been highly successful from buying up the master franchise rights to brands particularly in the Middle East and East Asia. Often these master franchisees are extremely experienced local operators and very well funded and own a whole stable of Western brands commonly in the food and beverage and retail sectors. The growth of such organisations has shifted the balance of power in the international franchisor–franchisee relationship and it is no longer necessarily the case that the franchisor is the larger or more experienced organisation. The growth of the large master franchisee organisations has resulted in much more sophisticated franchise partners who can make a phenomenal success in their local markets. However, these partners are also more likely to negotiate hard over the wording of the agreements with the result that agreements are a lot more balanced than they have been historically.
iii Failure to reach minimum performance requirements
It is common for agreements to have some sort of minimum performance requirements (MPRs) whether in relation to the number of stores opened, turnover achieved or products purchased. The covid-19 pandemic has had a devastating impact on the global economy during 2020 and the lockdowns and other social interaction restrictions imposed by many governments has caused sales in bricks-and-mortar retail outlets, dining in brand-name restaurants, and business in hotel and leisure facilities to plummet. These sectors are the most commonly franchised internationally and many franchise partners will have been unable to meet MPRs during 2020 and it is likely that the first half of 2021 will be similarly impacted, even with the positive news that vaccines are being rapidly developed and immunisation programmes planned in many countries. Failure to reach MPRs often entitles the franchisor to terminate the agreement, remove exclusivity or reduce the size of the franchisee's territory, but it is likely that the majority of franchisors will be prepared to forgive any failings during 2020 and renegotiate MPRs to allow franchise relationships to continue in the long term. It is important though that, once the world does start to emerge from covid-19 and return to some semblance of normality, franchisees do not continue to use the coronavirus as a convenient excuse not to pay royalty fees or meet their MPRs, and it is quite possible that more formal disputes will be seen over the next few years even if the parties have managed to remain on good terms during the height of the pandemic itself.
iv Lack of franchisor support
Lack of support is a common complaint by franchisees. In domestic franchise systems, the express obligations on the franchisor in terms of support levels may be very limited. However, in an international context, they are likely to be more detailed and extensive. Lack of support allegations are often closely aligned with a mismatch of expectations as it may be that the franchisee is not contractually entitled to high levels of support but is not receiving what they expected or had been told they would receive. A number of franchisees have turned to their franchisors for support during the covid-19 pandemic. Most well-resourced franchisors have been supportive, suspending royalty fees and agreeing longer payment terms, but for many franchisees the support offered may be seen to be inadequate and this could result in more formal disputes over the next 12 to 18 months.
v Failure to maintain brand standards
It is a common complaint by franchisors that master franchisees are failing to maintain the brand standards that the franchisor has set in its home country. This may be for genuine reasons such as a requirement for the brand and operating methods to be adapted to be successful in the franchise territory. There is sometimes a fine line between acceptable modifications to the system and undermining the valuable brand reputation that the franchisor has built up.
II FORMS OF DISPUTE RESOLUTION
In the event of a dispute between a franchisor and franchisee the main options open to the parties are (1) discussion, (2) mediation, (3) termination, (4) arbitration, and (5) litigation. Each of these options is considered in turn below.
Most international franchise agreements are long-term and complex arrangements. It is likely that neither of the parties will want the relationship to break down and the agreement to be terminated unless there really is no other option. The legal and commercial implications of termination are considered later in this chapter. Therefore, before taking any enforcement action or considering termination, the franchisor should contact the franchisee and try to discuss the issues involved to see whether an amicable settlement can be reached. There are often practical difficulties to overcome in arranging discussions as the franchisor and franchisee will inevitably be in different countries and potentially different continents but, if possible, a face-to-face meeting should be arranged as it is more likely to be conducive to settlement.
Many franchise agreements will contain a dispute escalation clause, which sets out how the parties must deal with any dispute that arises between them, or a reference to the operations manual, which sets out a detailed dispute escalation procedure. The first step in a dispute escalation clause is likely to be a face-to-face meeting between certain representatives of both parties. Some clauses will set out in detail the procedure and timings for such a meeting, including how much notice must be given, where the meeting will be held, who must be in attendance, what language will be used and the information that must be exchanged prior to the meeting. While such detail may, at the outset of a relationship, seem unnecessary, it can help when both parties are embroiled in a dispute for there to be a clear contractual mechanism for seeking to resolve it. While the legal enforceability of a dispute resolution clause will depend on the law of the agreement, the courts and arbitrators in many jurisdictions are increasingly likely to hold the parties to a contractually agreed dispute escalation process.
If initial discussions do not prove fruitful, the parties may wish to arrange for discussions to take place between their legal representatives, who will be able to assess the relative merits of each parties' case and may be able to negotiate a compromise. The involvement of legal representatives will not necessarily lead to litigation although it does inevitably have an impact on the relationship and can be taken negatively by a franchisee. However, the early involvement of legal representatives can often lead to a speedy settlement thereby avoiding the costs of the litigation and a complete breakdown in relations between the parties.
Discussions are more likely to be successful if the cause of the dispute is issues such as failure to reach MPRs, failure to maintain standards or allegations of lack of support as the parties should hopefully be able to work together to agree a process going forward that is mutually acceptable. In some circumstances, discussions may be entirely inappropriate and the franchisor may need to move straight to litigation or arbitration. Such circumstances would include where there have been breaches of confidentiality or contractual provisions in relation to non-competition or misuse of the franchisor's trademarks or other intellectual property rights.
If the parties agree to mediation, the dispute is submitted to a single impartial individual who will act as a referee in relatively informal settlement discussions. It is preferable, and nowadays fairly common, for there to be a contractual obligation for the parties to try to resolve their differences via mediation prior to resorting to litigation or arbitration, which will be an enforceable obligation in many jurisdictions. Mediation is a recognised form of alternative dispute resolution in almost all jurisdictions and is becoming increasingly popular because of the fact that the success rates are relatively high and it is a way for the parties to continue the relationship on agreed terms, which is ultimately what most parties wish to do.
As stated above in relation to informal discussions, it is preferable for the mediation clause in the agreement to set out precisely the mechanism for a mediation to avoid satellite arguments holding up the resolution of the main dispute. The clause should set out the mediation body (if any) that will be appointed or an arrangement for the parties to mutually agree the nomination of a mediator; the notice period that must be given; the location and language of the mediation; the length of the meeting (e.g., if it is limited to an eight-hour day or a two-day period); the representatives who must be in attendance (e.g., the CEO or managing director of each company); and how the costs of the mediator will be divided between the parties. In the absence of a mediation clause in the agreement the parties will not have a contractual obligation to mediate but instead must voluntarily and mutually agree to go to mediation.
Mediation is conducted in confidence and, as in arbitration, it should be possible for the parties to avoid any publicity, which can be a major advantage to the franchisor as the brand owner. The main advantages of mediation are as follows:
- it is private and flexible;
- a mutually acceptable trained professional is selected by the parties who acts as a referee;
- mediation is relatively low cost and, if litigation is avoided, is a cost-effective way of dealing with a dispute;
- an effective mediator should be able to dissuade a party from pursuing an unreasonable claim or an excessive amount of money;
- if there has been poor communication between the franchisor and the franchisee, mediation can bring the parties together to save the relationship;
- the parties are able to explore more innovative settlement options that are available to a judge or arbitrator;
- subject to practicalities, a mediation meeting can be set up very quickly thereby saving costs and ultimately the relationship; and
- as a result of the travel restrictions due to the covid-19 pandemic, many mediation meetings have been taking place virtually. Parties to virtual mediation report that it has been successful and still effective in resolving disputes and this option could continue post the pandemic, making mediation an even easier and more cost-effective option for resolving international franchise disputes.
The main disadvantages of mediation include the following:
- the mediators available may have little experience of franchising and may not understand the key issues;
- quick and effective action may be needed to remedy the breach such as applying for an interim injunction (particularly if there has been a breach of confidentiality or intellectual property rights);
- mediation does not necessarily produce an enforceable and binding decision. The parties must mutually agree a settlement and time and effort could be wasted while the breach remains unremedied; and
- mediating too early in the lifespan of a dispute may mean that the parties are not ready to settle, which can render the mediation unsuccessful.
Mediation is becoming increasingly popular, particularly as a means of resolving international disputes, which can be incredibly expensive to litigate and potentially very damaging to a franchisor's brand reputation and may have an impact on the rest of the franchise network.
The increase in international trade in recent decades has led to a huge upsurge in the use of arbitration as a method of resolving international commercial disputes. Arbitration is essentially a private form of litigation and all parties must agree to the use of arbitration as a means of resolving their dispute. The rights and obligations of the parties to arbitrate their disputes arise from the arbitration agreement that they have agreed. It is common to see an arbitration clause in an international franchise agreement that will form the basis of the agreement to arbitrate. An arbitration clause is a self-contained contract between the parties that is collateral to or ancillary to the main contract, which means that an agreement to arbitrate will not be regarded as invalid, non-existent or ineffective even if the main agreement is defective.
Arbitration has many advantages over litigation in an international franchise context as set out below:
- In many jurisdictions, arbitration proceedings are private and confidential, which means that the decision of the arbitrator will not be reported in the same way as a court judgment and the parties should therefore be able to avoid any adverse publicity that often follows litigation. However, this does not apply in all jurisdictions, so local law advice should be taken.
- The parties have the power to agree flexible procedures to ensure that the dispute is dealt with efficiently and cost-effectively.
- The parties can choose a neutral location for the arbitration hearing as opposed to opting for one of the parties' national courts. Jurisdictions such as Hong Kong, Singapore and Geneva have become very popular neutral locations for arbitrating international disputes. Arbitration can also take place virtually, cutting down on cost and travel time.
- Parties can choose an arbitrator with expertise that is relevant to the franchise industry or to the particular issue in dispute. They can also ensure that the arbitrator is neutral and unbiased, which may be an issue in relation to the judges in some local courts.
- An arbitration award is generally final and binding and the options for challenging an award are very limited, whereas a court judgment is usually subject to rights of appeal to high appeal courts. The process should therefore give more certainty and finality for the parties.
- It is generally easier to enforce an arbitral award in another jurisdiction than it is a court judgment.
Because of the increase in the popularity of international arbitration and the fact that it encourages trade between continents, national legislators have responded by establishing improved and streamlined arbitration laws and procedures and the national courts of most jurisdictions demonstrate a willingness to provide a hospitable climate for arbitration and to require parties to comply with contractual obligations to resolve disputes by arbitration. In general, national courts will interpret arbitration clauses widely so that they cover all nature of disputes arising out of all in connection with the franchise relationship and will usually make it more difficult for parties to challenge arbitration awards in the courts.
Arbitration can be 'institutional' whereby the parties agree to use the laws of a particular established institution specialising in arbitration proceedings who will also have a list of recommended and approved arbitrators. Alternatively, the parties can choose ad hoc arbitration whereby the parties either set out their own rules for the conduct of the arbitration or rely on the rules of the law that govern the procedure of the arbitration. It is normally preferable to choose institutional arbitration to rely on the well-drafted rules administered by one of the international arbitral bodies and also benefit from the administrative assistance that they provide. In addition, institutional arbitration tends to be less expensive as, although the arbitral body will charge a fee, the body will fix the fees of the arbitrator or negotiate hourly rates for the parties, whereas there is no control of this type with ad hoc arbitration. Among the more well-known arbitral institutions are the CIETAC, the ICC, the ICDR, the HKIAC, the LCIA, the SIAC and the Arbitration Institute of the SCC.2 The choice of arbitral body will usually be swayed by the location of each of the parties and the choice of the seat of arbitration.
The institutional rules usually contain the basic provisions for commencing arbitration, choosing the arbitrators and the procedures to be followed after the award has been given. In drafting an arbitration clause, parties should state where the arbitration is going to take place (the 'seat' of the arbitration); whether it will be administered by a particular arbitral body or be ad hoc; the language that will be used; the number of arbitrators (one or three); and the procedural and governing law.
An arbitration award is equivalent to a judgment in litigation in that it is final and binding. Enforcement of arbitration awards in countries other than the location of the arbitration hearing should, in theory, be relatively straightforward in view of the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards (the New York Convention). As parties to arbitration normally choose a neutral forum for the hearing, it is unlikely that an arbitration award will be made in the defendant's place of residence or business and therefore it is very common for arbitration awards to be enforced in another jurisdiction in which the property and assets of the losing party are located.
The New York Convention requires the courts of contracting countries to give effect to an arbitration agreement and to recognise and enforce awards made in other member countries subject to only very limited exceptions. Countries that are signatories to the New York Convention are able to limit the applicability to awards made in other contracting countries only. Therefore, when seeking to enforce an award, it is important to check whether both the country where the award was made and the country where enforcement is intended are contracting countries. It is also open to countries to limit the applicability of the New York Convention to awards relating to commercial matters only but that should not present a hurdle in franchise relationships.
Despite being signatories to the New York Convention, the courts of some jurisdictions have remained resistant to enforcing foreign arbitral awards, instead choosing to look at the reasoning behind the award and effectively forcing the parties to relitigate the dispute. It is therefore always advisable to consider where the assets of the counterparty may be held, which will not necessarily be the same jurisdiction as its registered office address, and to take local law advice on the enforceability of foreign arbitral awards before deciding on the location of the arbitration.
The New York Convention provides for very limited grounds on which the enforcement of a convention award can be refused. These grounds include incapacity of the parties, invalidity of the arbitration agreement, denial of a fair hearing, lack of jurisdiction, invalid award, procedural irregularities and public policies. The party seeking to enforce an award should apply to the court of the country in which it seeks enforcement and present the award and the agreement under which it was made. The court is then generally bound by local laws to enforce the award unless one of the grounds for refusal is satisfied. If a party is seeking to enforce an award that was made in a country that is not a signatory to the New York Convention, it will need to establish whether the country where enforcement is sought has entered into any other international treaty.
The agreement will usually include either a binding arbitration clause or a jurisdiction clause that determines the jurisdiction of the courts that will deal with any litigation between the parties. The two main factors that parties normally take into account when deciding whether to opt for litigation or arbitration are whether there are any reciprocal arrangements between the countries in which both parties are based in relation to enforcement of court judgments and how important it will be to keep the dispute private.
One of the major disadvantages of litigation is that it may be reported and can lead to adverse publicity for the franchisor. As explained above, arbitration proceedings are private and therefore are not reported although if there is satellite litigation surrounding an arbitration case that may be reported and it is often very difficult for a franchisee to keep the fact that it is in a dispute with one of its franchisees completely confidential from the rest of the network.
Location of the parties
If both parties are based within the EU, for example, the parties may opt for litigation in either party's home country as it is relatively straightforward to enforce a court judgment obtained in one EU Member State in another EU Member State by virtue of the Brussels Regulation No. 1215/2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (recast), which replaced the 2001 Brussels Regulation (Council Regulation (EC) No. 44/2001) for all legal proceedings instigated after 10 January 2015; and the 2011 Lugano Convention (the Lugano Convention on Jurisdiction and the Recognition and Enforcement of Judgments in Civil and Commercial Matters), which allow a party who has obtained a judgment from any EU Member State to enforce that judgment in all other Member States without issuing separate proceedings there. However, if one party is, for example, based in the EU and the other is based in the United States, enforcement of a court judgment is far more complicated as there are no reciprocal enforcement arrangements between the United States and the EU. In those circumstances, the parties may be better advised to opt for arbitration and seek enforcement under the New York Convention. The position in relation to English law and jurisdiction agreements has been complicated by the current threat of a 'no deal' Brexit, with the question of jurisdiction and the enforcement of English court judgments still uncertain at the time of writing.
v Dubai International Financial Centre
The United Arab Emirates (UAE) remains a desirable location for Western franchisors because of its wealth, the continued thirst within the region for Western brands and the barriers for entry resulting from the local shareholding restrictions for certain types of businesses (outside the free trade zones).
The Dubai International Financial Centre (DIFC) is a federal financial free zone, established in 2004 to promote growth and economic opportunities in the region. The DIFC has its own court system, separate from the local Dubai courts, which is a common law system based on English law and all proceedings are conducted in the English language. The judges are highly respected and experienced judges from not only within the UAE, but also the United Kingdom, Singapore, Australia and Malaysia. While the DIFC courts were originally restricted to cases relating to the DIFC, their success and reputation for quality decisions has led to an extension of their jurisdiction to any civil or commercial case where the parties opt for DIFC jurisdiction in a commercial contract or after the dispute has arisen.
The DIFC courts have become a popular choice of jurisdiction in international franchise agreements where one of the parties (most commonly the franchisee) is based in the UAE, as the courts are preferable to the local Dubai courts, and there have been cases where non-UAE entities have encountered difficulties enforcing an arbitral award obtained outside the UAE in the local courts, despite the fact that the UAE is a signatory to the New York Convention.
The DIFC also has an international arbitration and mediation centre that is run in partnership with the LCIA, the rules of which are closely modelled on those of the LCIA.
III CHOICE OF LAW AND JURISDICTION
In an international context it is preferable to choose the jurisdiction and the governing law (to the extent that the choice will be upheld by local laws) under which any disputes will be resolved to avoid time-consuming and expensive satellite litigation. While many jurisdictions will allow the parties to an agreement to choose a governing law and jurisdiction that is not that of the country in which the franchisee trades, some will not and will impose mandatory local law. The natural tendency is for franchisors to choose the jurisdiction and laws of their home country. However, it is imperative to check local laws in the country in which the franchisee is based and will be trading to determine whether these choices will be upheld. It is also important to check that there is a reciprocal enforcement of judgments structure in place between the relevant jurisdictions otherwise the franchisor could risk litigating in its home country and then effectively having to litigate the case again in the franchisee's home country where it could achieve a completely different result. The individual country chapters will deal with these issues in relation to each featured jurisdiction.
Choice of jurisdiction clauses can be exclusive or non-exclusive. The main advantage of an exclusive clause is that it gives certainty to the parties. The existence or otherwise of a reciprocal arrangement for enforcement of judgments is an important factor when deciding whether to choose an exclusive or non-exclusive jurisdiction clause. For example, if the franchisee is based in a country that has reciprocal arrangements with the franchisor's country, the franchisor should be able to enforce a judgment obtained in its home state in the franchisee's jurisdiction and an exclusive clause may be preferable. However, if there is no such reciprocal arrangement, a non-exclusive clause may be preferable so that the franchisor has the option of suing the franchisee in the country in which the franchisee's assets are situated rather than attempting to enforce a foreign judgment in that country with all the difficulty that involves.
While a non-exclusive clause does provide flexibility, it also potentially exposes the franchisor to litigation in more than one country. While it may be possible to apply for a stay of proceedings, this will undoubtedly lead to increased costs and uncertainty for all parties. A non-exclusive jurisdiction clause or an exclusive foreign jurisdiction clause has the obvious disadvantage to the franchisor in that it has the cost and inconvenience of instructing foreign lawyers and the uncertainty of litigating abroad.
Even if the parties have opted for arbitration, it is relatively common for the franchisor to carve out a right to apply to the local courts where the franchisee is based or trading to apply for emergency injunctive or other relief (if such relief is available in that jurisdiction) to protect the franchisor's intellectual property rights, know-how and confidential information.
Termination of an international franchise is one of the most difficult issues for a franchisor to face as it can be messy, expensive and commercially disastrous. Not only does the franchisor face often complex legal provisions and potentially risk being sued by the franchisee for compensation, it also faces the daunting task of deciding what should happen to the franchise in the territory following the termination. It is, of course, far preferable to avoid being presented with this problem by taking heed of the common causes of dispute discussed at the outset of this chapter. However, unexpected issues do arise and if a franchisor finds itself in a situation where it is seriously considering terminating an agreement, it is vital to ensure that it carefully considers the ramifications of such a termination, to carefully plan the legal and commercial procedures necessary and take good local legal advice before making a decision.
V COMMERCIAL ISSUES
The main decision facing the franchisor will be how to deal with the territory following termination. The answer will inevitably depend on the value of the market and the potential impact on the franchisor's brand reputation. If the territory already has a number of outlets up and running, the franchisor will usually want to allow them to continue. One way to achieve this is to terminate only the rights to open new outlets thereby allowing the franchisee to continue to operate any existing outlets and allowing the franchisor either itself or via a third party to exploit the rest of the territory (if the agreement permits the franchisor to do so); however, this can cause complications in that the franchisor and the franchisee are still in a relationship and it may be difficult to refranchise the territory given that existing relationship. It may be that the franchisee's breaches are so serious that the franchisor does not want to continue the relationship at all and therefore the only option is for termination of the entire agreement. In this situation the franchisor has three options: (1) appoint a new franchisee for the territory, (2) take over the franchisee's business and run it itself, or (3) discontinue trade in the territory.
i Appointing a new franchisee
This is likely to be the most attractive option for many franchisors, but it may be difficult to recruit a new franchisee if the former franchisee's actions have damaged the brand's reputation in the territory. Timing is also a big issue – unless the franchisor plans the process carefully, there may be a gap between termination of the old franchise and appointment of a new one. This can of course cause huge logistical problems in an international context. It is therefore more common for a franchisor to seek to appoint a new franchisee prior to terminating an agreement; however, the franchisor in that situation needs to take advice on the legal implications of being in discussions with a new franchisee while the old one is still trading, and of delaying a decision to terminate, which could lead to accusations that the franchisor has affirmed the contract and lost its right to terminate.
ii Taking over the franchisee's business and running it
If a franchisor needs to terminate immediately or is having difficulties finding a new franchisee, the franchisor may have no option but to step into the shoes of the former franchisee. It is highly likely that the franchisor will not have any staff on the ground in the territory and this can cause huge logistical problems and be highly time-consuming and very expensive – it is not a decision to be taken likely. The franchisor also needs to take local advice in relation to the enforceability of any 'step-in' rights that it may have in the agreement and the legal implications of effectively taking over the franchisee's business, which could entail the franchisor also taking responsibility for certain debts, leases, employees, etc.
iii Discontinuing trade in the territory
This may be the most unattractive option but may be necessary to protect goodwill. This will also need to be carefully planned in relation to the sale of any assets and the sale of any existing stock. A well-managed winding down of the operations in the territory may give the franchisor an opportunity to reconsider its strategy for the territory and refranchise at a later stage when trading conditions are more favourable.
The situation may be complicated if the franchisor has granted master franchisee rights as opposed to developer rights. If there is a developer, then it is easier and cleaner for the developer's corporate outlets to be closed down or brought back with relative ease. It is, however, far more difficult to deal with the sub-franchisees left by a terminated master franchisee, with whom the franchisor is unlikely to have any contractual relationship. It can be very difficult for the franchisor to have any control over such sub-franchisees and could also result in negative publicity for the franchisor.
VI LEGAL ISSUES
Many countries have quite prescriptive legislation or regulations in relation to the parties' rights to terminate franchise agreements. If a franchisor terminates incorrectly, it could be faced with a substantial damages claim and, just as importantly, may face real issues in relation to controlling its intellectual property rights, in particular trademark rights in the territory. If the trademarks have been properly registered in the franchisor's name, the franchisor should be able to protect them following termination. However, in some jurisdictions, if the franchise agreement was registered with the relevant local agency, it can be more complicated to stop the franchisee from continuing to use the trademarks following termination. These issues are addressed in more detail in the intellectual property rights chapter and the individual country chapters.
If a franchisor terminates for underperformance, it is quite likely that the franchisee will owe the franchisor money for management fees or for stock. If the franchisee company is a vehicle that has been set up specifically to run the franchise, then there is a real risk that it will have little or no assets against which the franchisor may obtain enforcement. Unless unpaid debts are fairly substantial and undisputed, the time, cost and effort involved in enforcing against the franchisee in a foreign jurisdiction may outweigh the benefits of doing so. While it is difficult to completely prevent this type of problem arising, the franchisor should try as far as possible to ensure that payments are carefully monitored on a regular basis and that any under payment or non-payment is dealt with swiftly. Particularly in the current climate, it is not uncommon for franchisors to agree payment plans and extended payment terms with franchisees to avoid the difficult question of termination; however, this can be a 'slippery slope' and when the franchisor does make a final decision to terminate, the franchisee may be in a situation where it owes the franchisor substantial sums that are going to be difficult to recover.
Another issue that the franchisor needs to consider is the question of existing stock and whether it should be returned to the franchisor or whether the franchisee can be permitted to sell it through other networks. The question is really a commercial one and will depend on which option the franchisor prefers. It may be that it is not commercially worthwhile for the franchisor to ship the goods back to its home country and it would prefer the stock to be sold on by the franchisee perhaps by way of an agreed method and within an agreed timescale. These types of issue should ideally be dealt with in the franchisor's standard terms and conditions of supply agreed at the outset of the relationship and annexed to the franchise agreement.
Any real estate or leases owned by the franchisee can also cause logistical problems. It may not be possible for the franchisor to take over any leases for local law reasons or the landlord may not wish to contract with a foreign franchisor.
VII NON-COMPETITION COVENANTS
Franchisors will commonly ask their franchisees to give certain contractual undertakings not to be involved in a competing business both during the term of the agreement and for a certain time period after termination. The enforceability of these in-term and post-term obligations will vary greatly depending on the jurisdiction and will be subject to the competition and antitrust laws of the franchisee's jurisdiction.
i In-term obligations
As a general rule, in-term non-compete obligations are more likely to be enforceable as local courts may agree that the franchisee should have an obligation not to compete with its franchisor during the term of the agreement. The franchisee will be party to a great deal of valuable confidential information that belongs to the franchisor during the term of the agreement, particularly in relation to pricing, costs of products and marketing strategy, and it is therefore unreasonable for the franchisee to be involved in a competing business while it is party to such information from the franchisor. In addition, it is also quite common for there to be a provision in the agreement entitling the franchisor to terminate if the franchisee is involved in a competing business in the territory during the term of the agreement. If the franchisee is an existing operator, then it is quite likely that the parties will agree a carve-out for the franchisee's existing business interests when the agreement is negotiated.
ii Post-term obligations
These restrictions are more complicated both from a legal and commercial perspective. While the franchisee may be prepared to agree to an in-term restriction, many master franchisees are not prepared to agree to any post-termination restrictions, particularly if they are an existing operator in their jurisdiction. It is more common for post-termination restrictions to be widely used in the franchisor's domestic market in the event that it wants to ensure that a unit franchise operator does not go on to compete in its territory following expiration or termination of an agreement. With a more sophisticated international partner, it will be more difficult for the franchisor to impose post-termination restrictions and obligations. In addition, post-termination restrictions are more difficult to enforce as they are more likely to be anticompetitive and these issues are dealt with in more detail in each country chapter.
VIII CONFIDENTIAL INFORMATION
As mentioned above, a franchisee will be party to a considerable amount of confidential information that belongs to the franchisor during the term of the agreement. The agreement should contain an obligation to keep that information confidential, even following termination or expiration, for as long as the information remains truly confidential.
Therefore, even if the franchisee has not agreed to a post-termination restrictive covenant, it may be possible to prevent the franchisee from continuing to trade in the same line of business if it can only do so by using the franchisor's confidential information. In many franchise systems, however, while the franchisor does have valuable information in relation to operating procedures and systems, in most cases this information is not truly confidential and it will be very difficult for a franchisor to prevent a former franchisee from using fairly general operating methods and procedures. The information being misused must be genuinely secret and that information must be properly safeguarded and protected by the franchisor to benefit in turn from legal protection.
While international franchising can be a very successful way for a brand owner to expand its network with less costs and exposure than corporate expansion, it is not something to be entered into lightly and it is vital that the franchisor takes proper local law advice so that it can anticipate and prepare for potential problems and issues before granting the franchise rights. The country in which the franchisee is located is going to be a deciding factor in whether to use arbitration or litigation, and what the franchisor's rights and remedies will be if and when disputes do arise. Resolving international disputes can be expensive and therefore should ideally be avoided if at all possible. Franchisors should therefore consider the likely causes of disputes set out above before entering into the agreement and thereafter conduct the relationship in an open and transparent way to deal with issues before they escalate.
1 Victoria Hobbs is a partner at Bird & Bird LLP.
2 China International Economic and Trade Arbitration Commission, International Chamber of Commerce, International Centre for Dispute Resolution, Hong Kong International Arbitration Centre, London Court of International Arbitration, Singapore International Arbitration Centre, and Stockholm Chamber of Commerce.