The Franchise Law Review: The Impact of Covid-19 and Brexit on Franchising
The two phenomena that will have the most impact on franchising over the coming year are the covid-19 pandemic and Brexit. As such, they both deserve specific mention in this book.
The coronavirus (covid-19) pandemic is fundamentally a human crisis, but its impact upon business in general, and franchising in particular, cannot be ignored. Since 24 February 2020 –when for the first time there were more coronavirus cases outside China than in it, and Italy became a centre for the virus in Europe – it has been clear that franchisors cannot ignore it. As, despite the advent of numerous vaccines, the number of confirmed cases of covid-19 climbs day by day, and governments struggle to develop their strategy to deal with the pandemic, the franchising community has had to prepare itself for difficult times ahead. Donald Trump's introduction of a ban on flights into the United States from continental Europe in the summer is just one example of the challenges that lie ahead, despite the light that the vaccines are shining at the end of this long, dark tunnel.
Although there is a great deal about the virus that remains unknown, two things are clear: (1) the number of recorded cases continues to increase, (2) that increase, together with the steps being taken to deal with it, will have a significantly adverse impact upon the global economy and (3) while the roll-out of global vaccination programmes will push back the virus, it will take a good deal of time to get fully on top of it and we will have to live with a 'new normal'. Franchisors therefore have had to act immediately to put in place a coherent strategy for dealing with the coronavirus. The failure of businesses such as Flybe, Debenhams and Arcadia shows how serious the economic impact of the virus has been and will continue to be for some time to come.
Even the most optimistic predictions suggest that economic growth will fall markedly through the next two quarters of this year and that recovery will depend on a drop in the mortality rate of the virus and a slowing of its rate of onward transmission. That will most probably be due to 'seasonality', that is, a reduction in transmissions similar to that seen with influenza with the onset of summer. The more pessimistic predictions assume that the virus is not seasonal and rapid geographical spread in infection will lead to a global recession.
The likely impact will be on sales, the supply chain and potentially upon the integrity of franchise networks, with some franchisees using force majeure clauses to abandon their franchises.
It is clear that different sectors will be affected to different degrees. Some franchise chains, such as those in the aviation, tourism, food and beverage (F&B), and hospitality sectors, will see lost demand that will be largely irrecoverable. Other franchise networks in sectors such as retail will see delayed rather than lost demand. Customers are likely to delay their purchases because of fear of the pandemic, but in due course will probably buy the product when the pandemic is over or at least anxiety about it reduces. How long these difficult times will last is largely dependent upon how well governments around the world roll out a successful vaccination programme and otherwise manage to contain the virus, although some sectors, such as hotels and aviation, are likely to be most deeply affected.
In addition to facing a drop in consumer demand, franchisors will need to deal with significant supply-chain challenges. Many franchisors source a large amount of their products from China. Chinese manufacturers have warned that they will be unable to fulfil orders until at least late summer because of the epidemic. This late delivery will affect not only wholesale orders, but also individual customer orders, raising myriad issues. Franchisors with strong, centralised procurement teams and good relationships with suppliers in China may feel more confident about their understanding of the risks their suppliers face, but many are still grappling with their exposure in China. Despite the devastating impact that coronavirus has had on the Chinese economy to date, it seems as if the economic restart in China has been relatively quick in getting established. This may mean that franchisors with a Chinese supply chain are focusing on stabilising their supply chain rather than moving it out of China, while others bring forward changes to their supply chain that had been planned for the longer term.
There is no silver bullet, but there are a number of steps that many franchisors have taken and others should take to ensure that their network is as well prepared as possible for dealing with the pandemic.
i Establish a covid-19 task force
The first thing that many franchisors have done is establish a task force that includes some of their franchisees. This will be responsible for dealing with how they and their franchisees deal with the virus. This should be a multidisciplinary team and cover, among other things:
- its employees' and its franchisees' employees health, welfare and ability to continue carrying out their functions;
- supply-chain monitoring for the franchise network;
- financial contingency planning for the franchisor and its franchisees; and
- marketing and sales response.
ii Review the franchise supply chain and other third-party agreements
Franchisors need to work to understand the likely supply-chain exposure of the franchise network and develop appropriate contingency plans. Similarly for other third parties, such as the operators of shopping malls, train stations, etc., where their franchisees have outlets. This will inevitably involve reviewing contracts with suppliers and in particular the force majeure clause. Force majeure provisions typically excuse non-performance due to events outside a contracting party's reasonable control, but these boilerplate clauses vary significantly in their detail and there will be differences between the franchisor's various supply agreements. Many contracts may not specifically include epidemics as a force majeure event.
There will be many questions to be asked centring on what constitutes force majeure under the contracts. Closing of manufacturing facilities? Government restrictions on people gathering, including at work? Fear of being in crowds with people who may be infected? School closings that force parents, a significant portion of the workforce, to stay home from work to care for their children? Unwillingness of usual customers to visit restaurants or retail establishments because of fear of being infected?
Some suppliers may seek to invoke force majeure clauses to defer fulfilment requirements for franchisor networks. This leaves the franchisor with three options:
- agree that coronavirus is a force majeure event and accept the consequences;
- dispute that coronavirus is a force majeure event under the dispute resolution provisions of the supply contract, which will take time to resolve and, even if a judgment is awarded in the franchisor's favour, enforcing the judgment will be difficult; or
- negotiate a compromise. Such a compromise may include temporarily rerouting orders through other countries less affected by the outbreak, such as Bangladesh and Vietnam, negotiating to be the first retailer to receive orders once business resumes, or covering the cost of delay through the supplier's insurance.
Franchisors should also consider:
- taking advantage of applicable force majeure provisions to enable them to cancel current orders and source goods elsewhere;
- reviewing contracts with wholesalers to determine options for credit and payments for existing orders;
- making a claim on their business disruption insurance.
If franchisors find that the force majeure clauses in their agreements are suboptimal, they should consider redrafting them for future agreements.
iii Look after franchisees
Force majeure claims are not only an issue with third parties outside the franchise network. It is also possible that franchisors will find franchisees looking to invoke the force majeure clause in their franchise agreements to avoid the need to pay ongoing franchise fees or, depending upon how the clause is drafted, even walk away from the franchise altogether. Again, the franchisor can either accept this, contest it or seek to find a compromise. Franchisors should be very much alive to this possibility and develop a clear strategy for dealing with claims of this kind. Franchisors should also be aware of the risk that a number of their franchisees work together to justify a mass walk-out on the basis of force majeure. The best way to avoid these types of claim is not to look at taking legal action but to pre-empt the claims by taking appropriate proactive steps. Prudent franchisors should review the force majeure clause in their franchise agreements and plan how they will react to any claims made under it by franchisees.
iv Protect the franchisees' customer base
Franchisors must invest in their customers and try to anticipate their likely behaviours in reacting to covid-19. For example, it may be that while consumer demand is down, it does not disappear altogether and customers move to online shopping and home delivery. This would suggest that franchisors should support franchisees to build their omni-channel distribution capability. This could even be an opportunity for more creative franchisors and their franchisees.
v Ensure that franchisees take steps to maintain sufficient liquidity
Franchisors should be working with their franchisees to help them model the appropriate financial response to the impact of the virus, perhaps by helping to define input numbers and identify appropriate models, benchmarking key performance indicators and likely trigger points.
vi Ensure franchisees look after their employees
It is important not to underestimate the disruptive impact that the virus will have on existing ways of working and the emotional impact it will have on the workforce of both the franchisor and its franchisees. Franchisors should be working with their franchisees to draft and implement a plan that is based upon conservative predictions and government guidelines. They should benchmark themselves against their peers. Franchisors must show leadership so that franchisees and their employees have confidence in the franchisor and its coronavirus strategy. This will mean implementing a strong communication strategy.
As the coronavirus continues to wreak havoc globally, long-term business implications are likely for franchisors in terms of their supply chain, consumer demand and franchisees.
Franchise networks which operate in the F&B, leisure, hospitality and retail sectors are particularly at risk, with those selling goods manufactured in China probably being most impacted. Chinese suppliers' ability to perform under supply contracts, and hence the franchisor's ability to keep its franchisees fully stocked, is less of an issue as Chinese factories have reopened their doors, but a second or third wave of the pandemic may reverse this trend.
Consumer demand has also suffered badly and so creative consumer-facing strategies need to be developed by franchisors. It may even be that some franchise networks start to lose some franchisees through their taking advantage of force majeure clauses.
It is at times like this that franchisees really do look to their franchisors for strong leadership and ready-made solutions. To keep the confidence of their franchise network, franchisors must develop a strategy for dealing with the impact of coronavirus. Those that do may even find that they obtain an advantage in what will be a very volatile and competitive market.
International franchisors who operate across multiple countries are finding it difficult to keep track of local regulations as these adapt and change in response to the covid-19 pandemic. To make this monitoring easier, Bird & Bird has created the Covid Restart Tracker. This covers multiple jurisdictions and asks key questions regarding the lockdown status that inevitably impacts all sectors. The goal is to stimulate positive and strategic thinking on how and when businesses can plan their gradual return to business as usual.
The Covid Restart Tracker is constantly changing and adapting to try to best meet the needs of franchisors and franchisees around the world. Because of its constantly changing nature, providing details of the Tracker is beyond the scope of this book; however, readers can obtain further information about how franchising is impacting particular countries by googling [email protected]
The decision of the United Kingdom on 23 June 2016 to leave the European Union will have a very real, but at present not fully known, impact upon all those franchisors around the world that have a presence in the United Kingdom, and possibly upon many of those that have a presence in the rest of the EU. This will present challenges for franchise lawyers, who will need to understand the potential implications as these change and develop over the coming years, and consequently they will have to advise their franchise clients how best to deal with the developments.
Although the decision in the referendum was a close one, with 51.9 per cent of the voters in favour of leaving and 48.1 per cent in favour of remaining in the EU, then Prime Minister Theresa May made it clear that there would be no second referendum and that 'Brexit means Brexit'.
This unexpected result caught almost all franchisors on the hop and left them potentially exposed in respect of their business in the United Kingdom and, perhaps, in the rest of the EU.
There is still a body of sentiment in Scotland in favour of remaining in the EU and speculation that this could lead to another referendum on Scotland leaving the United Kingdom in favour of staying within the EU.
As from 31 January 2020 the United Kingdom exited the EU. As a result of the transition period in the Withdrawal Agreement, EU law continued to apply in relation to the United Kingdom until 31 December 2020. As from that date, the general principles of EU law ceased to apply in relation to the United Kingdom, and prior EU regulations only continue to apply in domestic law by virtue of the European Union (Withdrawal) Act 2018, insofar as they are not modified or revoked by regulations under that Act.
The Competition (Amendment etc.) (EU Exit) Regulations 2019 (the Competition SI),2 which were issued on 22 January 2019, came into force as from the end of the transition period. The Competition SI made legislative revisions adapting the EU competition regulations as a set of domestic competition regulations. The Competition SI revoked the EU procedural regulations and revised the substantive regulations, including block exemptions, by removing specific EU or inter-state references.
EU Article 101 of the Treaty on the Functioning of the European Union continues to apply post-Brexit to agreements or conduct of UK businesses that have an effect within the EU, in much the same way as agreements or conduct of US and Asian businesses are currently subject to EU competition law where their agreements or conduct affect EU markets.
Brexit's legal impact on franchising is mainly in relation to antitrust law. The substance of UK competition law is very similar to that of EU competition law, Section 60 of the Competition Act 1998 (which required UK competition rules to be interpreted in a manner consistent with competition case law of the European Court of Justice) was revoked and replaced by section 60A with effect from Brexit. Section 60A merely requires the Competition and Markets Authority and the courts to avoid inconsistency between their decisions and EU law and the decisions of the Court of Justice of the European Union (CJEU) before exit day.
As from the end of the transition period, the Withdrawal Act and the Competition SI retained the block exemptions with their then current expiry date in adapted form, removing specifically EU references. There are therefore 'retained exemptions' from domestic prohibitions so agreements that currently benefit from parallel exemption of this kind will continue to benefit from a retained exemption in the United Kingdom. Since the end of the transition period, there has been a greater chance of parallel investigations by UK and EU authorities. As the UK authorities are no longer required to apply EU law, the UK government could potentially decide to diverge more significantly.
It is likely that, despite Brexit, the decisions of the CJEU will continue to be persuasive in UK courts, particularly with respect to UK law derived from or harmonised with EU law. This influence will diminish over time as UK law diverges. Some UK statutes contain a requirement to interpret the legislation consistently with CJEU rulings: this requirement will continue to be effective after Brexit unless and until the UK statute is amended. Depending on the United Kingdom's new status in relation to the EU (which is to be negotiated), the United Kingdom may join the European Free Trade Association (EFTA) (and then also the Lugano Convention on Jurisdiction and Judgments) and possibly the European Economic Area (EEA).
If, as looks very unlikely now, the United Kingdom were to join EFTA, and through it join the EEA, the position in relation to many aspects of legal practice would remain unchanged. This remains a possibility and, if it were the outcome, there would probably be less upheaval from a legal point of view.
If, as looks most likely now, the more Eurosceptic view prevails, it is likely that the United Kingdom will most probably negotiate a looser arrangement with the EU via a series of bilateral and multilateral trade agreements, or through reliance on the rules of the World Trade Association, Organisation for Economic Co-operation and Development, and G20, of which it will remain a member.
One thing that is clear is that should the EU's Directorate-General for Internal Policies of the Union consider there to be a need for further franchise regulation, resulting in some form of new franchise regulation in the EU, this would most probably not take effect in the United Kingdom.
EU competition rules will continue to apply to franchising post-Brexit, although the Commission will have reduced powers. However, new block exemption measures will be needed at UK level, as the UK Competition Act currently relies on the EU block exemption regulations (which will no longer apply following Brexit).
Disputes where the franchisor or franchisee is based in the United Kingdom and the other party is based in an EU Member State are likely to be affected by Brexit. However, there may be an even wider impact. A dispute between a franchisor and franchisee, even if both are based outside the EU and the United Kingdom, may nevertheless be affected by Brexit if the subject matter of the dispute is in the United Kingdom.
The Brussels Regulation currently governs jurisdiction and the enforcement of judgments within the EU. The Lugano Convention sets out very similar rules, so if, post-Brexit, the United Kingdom becomes a signatory to this convention, little will change. Otherwise, the position will depend on negotiated bilateral and multilateral agreements with other countries, or the possible ratification by the United Kingdom, in its own right, of the Hague Convention on Choice of Court Agreements (which the EU has ratified).
It is likely that EU rights, such as registered and unregistered community designs and EU trademarks (EUTMs) (formerly referred to as Community trademarks or CTMs), will no longer have effect in the United Kingdom and there will be questions about what will happen to the 'UK portion' of such rights obtained before Brexit. If existing rights automatically reduce in geographical scope to exclude the United Kingdom, their value will diminish, which will have a commercial impact on the rights holder. This is something that US franchisors with EUTMs have to keep an eye on, as it may mean having to reapply for some of their trademarks in the United Kingdom at some point.
Furthermore, some US franchisors have EUTM registrations but only use their marks in the United Kingdom. Once the United Kingdom no longer forms part of the EU, these EUTM registrations could be vulnerable to attack for non-use. US franchisors in this situation would have to consider expanding their use in the EU to defend their EUTM registrations or consider filing independent national UK applications that would survive any possible future demise of their EUTM as a result of non-use.
Franchisors with a presence in the United Kingdom should audit the immigration status of their workforce, consider applications that could be made now (e.g., for permanent residency and communicate with concerned employees. In the longer term, if and when the government proposes that laws be amended or repealed, employers should also review employment contracts (with a view to addressing any enforceability risks that might arise), policies, procedures and benefit schemes, and check any European Works Council arrangements.
Changes to immigration laws in relation to EU citizens currently living and working in the United Kingdom could have a substantial impact on your franchisee's employees, particularly in the food and beverage and hospitality industries.
Various EU provisions have entered into force in the United Kingdom since the Brexit vote. These include the General Data Protection Regulation (GDPR), which entered into force on 25 May 2018, the Network and Information Security (NIS) Directive, enacted in UK law as the Network and Information Systems Regulations 2018 in May 2018 (and often referred to simply as the NIS Regulations) and, for the police and criminal justice sector, the Police Data Protection Directive, which had to be transposed by Member States by 6 May 2018.
Any US franchisor that processes or monitors EU citizens' personal data in connection with its offer of goods, services or monitoring activities, or has a group company or staff operating within the EU, will still have to comply with the GDPR. The extent to which the GDPR will be adopted in the United Kingdom will depend heavily on the type of relationship with the EU that the United Kingdom adopts. However, it seems likely that either the GDPR or a law that looks very like it will be required in the United Kingdom, given that the current UK law is in need of refreshment (it is nearly 20 years old) and given the way that EU data transfer laws operate.
The United Kingdom wishes to continue to trade with the EU post-Brexit, therefore closely comparable data protection and cybersecurity laws in many areas will be necessary to avoid barriers to trade.
US franchisors with franchisees in other EU Member States have to be very careful to ensure they comply with EU data protection and cybersecurity laws even after Brexit.
If they have not already done so, franchisors with a large number of commercial contracts, particularly with entities within the EU, should consider auditing these contracts in due course to determine the effect Brexit will have on rights and obligations under these agreements.
The commercial impact of the cost of increased trade barriers between the EU and the United Kingdom could have an adverse impact on franchisors with networks based in the United Kingdom and covering other EU Member States because of, for example, the impact of the restriction of free movement of persons and monitoring of currency fluctuations.