The Franchise Law Review: Saudi Arabia

Introduction

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 33.7 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$21,540 per capita.2 According to Trading Economics, Saudi Arabia's gross domestic product in 2019 was over US$792 billion, which represents 0.66 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.

Market entry

i Restrictions

There are a few legal restrictions on local and foreign franchisors in Saudi Arabia. Under the Saudi Arabian Commercial Franchise Law (the Franchise Law – discussed further in Section IV), a franchisor cannot grant franchises, nor can a master franchisee grant sub-franchises, unless the franchise system has been in operation for a period of not less than one year, by two persons or in two outlets (one of whom may be the franchisor operating a corporate outlet).

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 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 riyals for entities of this kind.

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.

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.

iii Enforcement

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 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.6 The Anti-Cyber Crime Law protects 'information, commands, messages, voices and images' that are or can be 'saved, processed, transmitted or constructed by computers'.7 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.

Saudi Arabia recently approved the E-Commerce Law along with its implementing regulations.8 The E-Commerce Law establishes a regulatory regime applying to all e-commerce transactions in Saudi Arabia with a predominant focus on consumer protection. All sellers (referred to as 'service providers' in the E-Commerce Law), including those outside the country, are required to comply with the Law if they provide products or services within the Saudi Arabia.

Service providers (i.e., sellers) wishing to conduct e-commerce transactions in Saudi Arabia must have their online store (referred to as an 'E-shop' in the E-Commerce Law) authenticated by authentication agencies and thereafter be registered with the authorities. Broadly, the E-Commerce Law looks to regulate key issues such as privacy, data protection and consumer rights. Service providers must publish particular information online on their E-shop, including prescribed content to be included in the terms and conditions of sale and the invoices issued once a sale has been concluded.

Customers are also afforded further consumer protections including rights to terminate or amend an e-commerce transaction in certain scenarios. For data protection, the E-Commerce Law regulates how customer data is retained by the service provider and imposes obligations on the service provider to report any breach of customer data to the authorities. The use of online advertisements is also subject to regulation by the E-Commerce Law, including a requirement that consumers be permitted to opt out of direct electronic marketing. Breaches of the E-Commerce Law can result in fines not exceeding 1 million riyals, suspension or blocking of the E-Shop, or publication of details of the breach in media.

Franchise law

i Legislation

Saudi Arabia has now approved the Franchise Law along with its implementing regulations (the Franchise Law Regulations), which came into force in April 2020.9 The Franchise Law creates a regulatory framework for the relationship between the franchisor and the franchisee on a basis that promotes transparency. The Franchise Law shall apply to any franchise agreement implemented within Saudi Arabia.

ii Pre-contractual disclosure

The 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 include the content prescribed in the implementing regulations, broadly covering the main rights, obligations and material risks related to the proposed franchise. The disclosure document and franchise agreement must be translated into Arabic. If there are any material changes to the disclosure document after it has been issued to the prospective franchisee but prior to the signing of the franchise agreement, the franchisor is obliged to provide a revised disclosure document or a separate document outlining the material changes.

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 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.

A breach of the disclosure obligations under the Franchise Law may expose the franchisor to a claim by the franchisee for compensation or damages.

iii Registration

Both the franchise agreement and the disclosure document, translated into Arabic by a certified translator, must be registered with the competent authority within 90 days of signing the franchise agreement. The registration is valid for the duration of the franchise agreement; however, a further registration is required if the franchise agreement is amended by way of changes to any of its parties or its term. A breach of the registration requirements under the Franchise Law may expose the franchisor to a claim by the franchisee for compensation or damages.

It remains to be seen if any supporting documents will have to be submitted. Before the Franchise Law came into effect, the MOCI required the following documents to register an agreement as a commercial agency, which was required to obtain things such as signage approval:

  1. a standard application;
  2. a certified Arabic translation of the agreement, as well as all other foreign-language documentation;
  3. a copy of the franchisee's commercial registration and chamber of commerce certificate; and
  4. a declaration, in writing, that the franchisee's capital is Saudi-owned and its authorised representative is a Saudi national.

iv Mandatory clauses

Under the Franchise Law, a franchise agreement does not currently have to follow a specific template, but it must include the following elements (the majority of which also apply retrospectively to franchise agreements entered into prior to the entry into effect of the Franchise Law in April 2020):

  1. the name and a description of the franchise business;
  2. the term or period;
  3. the method of amendment;
  4. the geographical scope;
  5. the consideration payable to the franchisor by the franchisee and the method of calculation;
  6. both parties' obligations concerning the training of the franchisee's employees by the franchisor;
  7. the franchisor's obligation to provide technical, marketing and other types of experience required by the nature of the franchise;
  8. the franchisees obligation to adhere to the instructions, marketing method, display and maintenance of the franchise's identity;
  9. the franchisee's rights in relation to intellectual property;
  10. the mechanism of settlement of any dispute;
  11. the franchisee's rights relating to sub-franchising; and
  12. provisions relating to any change of owner of the franchise.

The Franchise Law Regulations set out the following further requirements for the franchise agreement:

  1. any restrictions on the franchisee in relation to assigning or transferring its rights to third parties;
  2. details about the trademark owner, the trade name or other intellectual property rights and, if the franchisor is not the owner of the intellectual property, details of the relationship between the franchisor and the intellectual property owner;
  3. both parties' rights and obligations in relation to termination of the franchise agreement;
  4. the franchisee's rights in relation to renewal or non-renewal of the franchise agreement;
  5. both parties' rights and obligations arising from the termination or expiry of the franchise agreement;
  6. any restrictions on either party in relation to the exercise of a competing business during or after the term of the franchise agreement;
  7. the franchisee's commitment not to harm the reputation of the franchisor and the franchise business;
  8. the franchisee's obligations in relation to the business site; and
  9. both parties' obligations in relation to confidentiality and data protection.

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.

Tax

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. With effect from 1 July 2020, the VAT rate was increased to 15 per cent.

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.

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 Franchise Law specifically provides that all parties shall undertake their obligations in good faith.

ii Agency distributor model

Following the implementation of the Franchise Law in April 2020, franchise agreements should be registered on the franchise register and not as commercial agencies. However, the Commercial Agencies Law and its implementing regulations (the Commercial Agencies Regulations), which govern the principal–agent relationship, also cover the relationship between a franchisor and a franchisee. While the Franchise Law provides that 'agreements or contracts subject to the Commercial Agencies Law in Saudi' are not considered a franchise agreement for the purposes of application of the Franchise Law, 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.

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, the Commercial Agencies 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 Franchise Law is concerned with the relationship between franchisor and franchisee and not consumers or customers.

v Competition law

Saudi Arabia introduced the Competition Law in 2004 to facilitate fair competition and stimulate the economy by preventing the formation of monopolies. The Competition Law and its regulations were further updated in 2019 with the aim of protecting fair competition and combating anticompetitive and monopolistic practices, which essentially gives the consumer more bargaining power. The Competition Law allows market principles and principles of free competition to determine the prices of goods and services. Furthermore, the Law regulates the conduct of those businesses with a 'dominant position' in the market place and places restrictions on businesses looking to undertake activities that constitute an 'economic concentration'.

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 implementing Franchise Law Regulations allow the parties to negotiate and contract into obligations regarding the exercise of any competing businesses during the term of the franchise agreement and after its termination or expiry.

vii Termination

The Franchise Law requires there to be a legitimate cause to terminate a franchise agreement before expiry. Although 'legitimate cause' is an undefined term, the Franchise Law provides examples of circumstances constituting legitimate cause, including voluntary abandonment, intellectual property infringement or an unremedied breach of the franchise agreement. There is also a catch-all provision that allows the franchisor to terminate for any other reason stated as a legitimate cause in the franchise agreement. Moreover, the franchisor may terminate the franchise agreement if the franchisee commences any liquidation procedures, dies or has a health impediment that impedes operation of the business. Where the franchisor has incorrectly terminated the franchise agreement before expiry without legitimate cause under the Franchise Law, the franchisor may be exposed to a claim by the franchisee for compensation or damages.

In the event of any disputes leading to or following termination where the agreement is governed by the laws of Saudi Arabia and within the jurisdiction of Saudi courts, Saudi courts will refer to the agreement and the intent of the parties and determine whether the clauses are compliant with the Franchise Law, shariah law and all other relevant regulations. If disputes arise, it is unclear at present whether the competent authority will prevent prospective franchisees from registering new franchise agreements with the franchisor concerned until the dispute is settled either by the parties or through the courts; however, the Franchise Law Regulations allow the franchisor to apply for the cancellation of the franchise registration within 90 days of termination or expiry of the franchise agreement or a court ruling declaring the agreement null and void. Similarly, the franchisor must also notify the Saudi Authority for Intellectual Property if the franchisee's right to use the trademarks associated with the franchise system has ceased because of the termination, expiry or non-renewal of the franchise agreement.

The courts may also award direct damages but are hesitant to award any indirect or consequential damages to either party. The Franchise Law contains a chapter consisting of three articles dealing with compensation in the event of a breach of the Franchise Law.

Both the franchisor and the franchisee have a statutory right to compensation in certain situations. Finally, a breach of the Franchise Law may also result in a fine not exceeding approximately 500,000 riyals and publication of the breach, adversely impacting on the franchisor, both financially and reputationally.

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

The Franchise Law specifically allows for alternate dispute resolution methods, such as arbitration, mediation and conciliation, and 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:

  1. 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;
  2. 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;
  3. 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;
  4. consistency: the judgment being enforced does not contravene a judgment issued by a Saudi court or other governing body on a similar matter;
  5. finality: the foreign court's decision is final and binding and not subject to further appeal; and
  6. public policy: the judgment does not violate Saudi law or public policy.

Current developments

Under the previous regime, franchise agreements were registered as commercial agency agreements and it is currently unclear whether those existing registrations will be migrated to the franchise register.

In other recent developments, the Saudi Food and Drug Authority has instructed food facilities in Saudi Arabia to display clearly both the ingredients and the number of calories in food and beverages.

Footnotes

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 2020), available at: http://www.doingbusiness.org/data/exploreeconomies/saudi-arabia/.

4 GCC member countries consist of: Saudi Arabia, Qatar, the United Arab Emirates, Bahrain, Kuwait and Oman.

5 SAGIA Business Center list of businesses prohibited for foreign investments, available at: http://www.sagia.gov.sa/Documents/Download%20center/Business_not_permitted.pdf.

6 Cabinet Decision No. (79) of 1428 H.

7 KSA Bureau of Experts at the Council of Ministers, Anti-Cyber Crime Law (August 2010), available at: https://www.saudiembassy.net/announcement/announcement03260701.aspx.

8 Cabinet Decision No. (628) of 1440 H and Ministerial Decision No. (200) of 1441 H.

9 Cabinet Decision No. (122) of 1441 H and Ministerial Decision No. (591) of 1441 H.

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