Understanding Top Legal Issues in International Franchising
March 2009 Franchising World
By John L. Rogers, Michael S. Richards and Susan Friedman
Dealing with international franchising legal considerations for numerous countries would require a large book rather than an article, and an article cannot do justice to more than a few of the concepts involved. The focus of this article will be legal advice to a corporate franchisor wanting to expand its franchise system to another country in three key areas: structuring considerations, employment law aspects and dispute resolution mechanisms.
Structuring Considerations (John L. Rogers)
An important first consideration for a franchisor seeking to expand to a foreign country is application for registration of intellectual properties––one or more trademarks, copyrights and perhaps domain names––in the foreign country. Where possible, applications for registration should be made as soon as the decision is made to proceed with an expansion. As laws concerning intellectual property are generally enacted on a nation-by-nation basis, the expanding franchisor will need to “re-register” its intel lectual properties in the foreign jurisdiction. Further, the franchisor may need to license its intellectual property to a foreign subsidiary it may establish.
A second consideration is whether to franchise directly into the foreign territory or through a subsidiary to be incorporated there. A subsidiary is often used because it can insulate the franchisor from liability for start-up losses and other liabilities that might be incurred in the foreign territory. Such liabilities would be the sole responsibility of the subsidiary unless the parent franchisor provides a guarantee or indemnity of them. A foreign subsidiary could be used as a vehicle for a joint venture to be established with one or more foreign persons or entities who are knowledgeable about franchising and familiar with the culture, business customs and sometimes different language of the foreign country. If a foreign subsidiary is used to establish a joint venture, the franchisor must ensure that a detailed shareholders agreement covering such things as governance, shareholder loans and potential transfer of interests of the joint venturers down the road is established at the outset. A foreign corporation may be used to establish a foreign name and provide a “local presence.”
A foreign franchise lawyer may advise the franchisor to establish a master franchise agreement, license agreement or area development agreement whereby its new subsidiary or an arm’s length third party in the foreign country would be granted the right to use the franchisor’s intellectual property to grant unit franchises to foreign franchisees.
A further structuring consideration is the form of franchise agreement to be used. The franchisor’s existing franchise agreement (and supplementary documents) should be delivered to an experienced franchise attorney in the foreign country for review and recommendations for changes. Such changes should include compliance with local laws, customs and perhaps a different language. As the franchise agreement will be the primary means of controlling use of the franchisor’s system and intellectual property, all changes to it must be considered carefully.
If the foreign country has franchise legislation, disclosure requirements will likely apply. The foreign legal consultant will want to review the franchisor’s domestic disclosure document so that it may be adapted to comply with local laws.
Another consideration is the operations manual, which, like the franchise agreement, must be adapted to suit local laws and customs and perhaps a different language. A strong initial and ongoing training program for new foreign franchisees will be vital. The franchisor will need to be flexible in allowing creation of a hybrid of its existing training program to suit the needs of new franchisees in the foreign country. When will the training be provided and who will provide it? How will the direct and indirect costs of training be paid? Should training be provided by a combination of personnel from the franchisor’s “head office” and persons hired as employees or consultants in the foreign country?
There are numerous other structuring considerations which will need to be taken into account in a foreign expansion. These may include currency exchange risks, potential currency export restrictions (on payment of royalties, for example), any restrictions on importation of goods essential to operation of the franchise system, any specialized laws governing the franchised business, taxation laws (dealing with income, value added, sales and withholding taxes and maybe other taxes), establishment and maintenance of a foreign advertising program (and its relationship to the franchisor’s domestic advertising program), enforceability of confidentiality and non-competition covenants against foreign franchisees and their guarantors, enforceability of guarantees, potential legal restrictions on transfer or cancellation of franchise units, privacy laws, and competition laws.
Finally, if the franchisor plans to have one or more of its executives work in the foreign country, at least for a time, then compliance with visa and other immigration concerns will be important.
Employment Law Aspects (Michael S. Richards)
Employment law considerations are often overlooked by franchisors seeking to expand into new countries. Many franchisors conclude that, since they do not intend to employ individuals in the new countries, they need not worry about applicable employment and labor standards legislation and regulations.
There are, however, several key issues of which franchisors should be aware. First is whether the franchisees themselves could be deemed to be employees of the franchisor under the laws of the relevant jurisdiction. In a number of countries, the line between employee and franchisee is becoming increasingly blurred. Courts have, in some cases, concluded that the franchisor was in fact the employer of the franchisee.
This factor becomes particularly important when a franchisor seeks to terminate a franchisee. A number of common law jurisdictions, including Canada, imply a term into employment agreements that termination can only occur upon provision of reasonable notice. (This is the opposite of the “at will” employment concept which exists in some U.S. jurisdictions.) What constitutes reasonable notice depends on a number of factors, most significantly, the length of the relationship. In Canada, for example, reasonable notice for a terminated employee can range anywhere from two weeks to two years. Franchisors should give significant thought to the termination provisions of their franchise agreements when adapting them for use in other countries to ensure that a foreign court will not view the termination provisions as unduly oppressive or unfair, and then strike out such provisions and replace them with a guarantee of reasonable notice.
In addition, a foreign franchisor may be declared a “common employer” with a franchisee for the purposes of unionization. Here, a union may not only seek to gain collective bargaining rights with the franchisee, but may also seek to extend its representation rights to include the franchisor. As a result, franchisors expanding into foreign countries should consider both the level and methods of unionization which exist there. In the United States, a significant amount of press has recently been given to the Employee Free Choice Act or “card check” legislation. The EFCA allows unions to gain representation rights by having employees sign membership cards rather than requiring a secret ballot to take place.
Similar card-check legislation existed in Canada in the past. The Canadian experience was an increase in unionization. Employers had little or no warning that a union was attempting to organize their employees until it was too late. As a result, individual employers had virtually no ability to communicate to its employees the employer’s position regarding unionization.
Franchisors should also have regard to the “permanency” of unionization in different jurisdictions. Again, using Canada as an example, if a franchisee became unionized in a certain location, a different franchisee taking a transfer of the business of a unionized franchisee would likely be bound to the union. To go one step further, if a franchisee of a different franchise system operating a similar business (e.g. two fastfood franchises) was to open in the same location, the new franchisee could inherit the union.
In addition to unionization, there are several other employment aspects franchisors should consider. This is particularly the case where a franchisor has a detailed operations manual which dictates employment policies and how individual employees are to be treated by the employer franchisee. Hours of work legislation, with the potential for overtime class-action lawsuits, is one such consideration.
Further considerations arise with respect to health and safety obligations. If a franchisor has standardized methods of operation or specialized equipment, it needs to consider what health and safety obligations exist in different jurisdictions. Such obligations may require the franchisor to make modifications to its equipment or processes to comply with applicable legislation.
A final consideration is any postrelationship restrictions that the franchisor intends to impose regarding competition, confidentiality and use of its intellectual property. Whether such post-relationship restrictions will be valid and enforceable may vary from jurisdiction to jurisdiction.
Given the foregoing considerations, it is wise for a franchisor expanding to a foreign country to obtain advice on the foreign country’s labor and employment laws at an early stage.
Dispute Resolution Mechanisms (Susan Friedman)
Franchise agreements often call for resolution of disputes through the use of mediation, arbitration or litigation, or a combination of all three. What are the factors to be considered in selecting a dispute resolution method for an international franchise agreement?
First, there are conflict-of-law issues. The franchisor will want to obtain advice from an attorney in the jurisdiction in which an order is to be enforced, as to whether that jurisdiction’s courts will enforce an order from the jurisdiction stipulated in the franchise agreement as the place where disputes are to be resolved. The answer may depend on whether the order at issue is an order of a court of competent jurisdiction, or an order of an arbitrator and that, in turn, may affect the choice of dispute resolution mechanism. Similarly, if the agreement is to contain a choice-of-law provision that selects the law of a jurisdiction other than that of the jurisdiction of enforcement, the franchisor will want to ensure that the enforcing jurisdiction does not require that its own law be used to determine a franchisor-franchisee dispute. Other issues can arise with respect to enforcement of an order in a jurisdiction other than the one that granted it, including considerations of public policy, due process, local competition law, local intellectual property law and a host of others. Should the agreement require mediation as a pre-condition to arbitration or litigation? The vast majority of disputes end with a negotiated settlement. This result is particularly desirable if the parties’ relationship is to continue after the dispute. Even where the dispute ends the relationship, considerations of privacy, timing and costs suggest that a quick settlement may be in everyone’s best interests. Accordingly, it is sensible for a franchise agreement to require that the parties mediate before they proceed either to litigation or to arbitration. The agreement should contain an exclusion from this requirement, however, in situations where it is necessary to obtain an injunction quickly, to prevent harm that would result if the conduct at issue is allowed to continue while the parties proceed first to mediation.. The agreement should also provide guidelines for selection of the mediator and a procedure which promotes efficiency and effectiveness.
If the mediation does not lead to settlement, should the parties proceed to litigate or arbitrate their dispute? Arbitration, like mediation, is a consensual process and both parties must agree that this process is the one to be used to reach resolution. Since reaching agreement is not likely after the dispute has arisen, the agreement to arbitrate will be contained in the franchise agreement. It will also be the franchise agreement that defines which issues are the ones that can be arbitrated, as opposed to litigated, and sets or adopts rules for conduct of the arbitration.
Arbitration presents the advantage of being a private exercise, resulting in a decision that is not available publicly. Accordingly, the decision will not set a precedent, binding on another arbitrator in determining any subsequent dispute between the franchisor and another franchisee. The parties will agree in the franchise agreement on a method to select the arbitrator, which can result in the decision-maker being a person who possesses franchising expertise. This may make the decision more acceptable, even to the losing side. There is also finality to the result of arbitration, since many jurisdictions limit the basis on which an arbitrator’s decision can be appealed. Arbitration can be less costly and result in a more timely decision than litigation. This is particularly so where the parties have agreed on rules respecting conduct of the arbitration that streamline the discovery process, since discovery tends to be a costly aspect of litigation.
Of course, the limits on appeal rights may be seen as a detrimental aspect of arbitration by the losing side. There are other negative aspects of arbitration, not present in litigation. For example, if the franchise agreement does not contain an exclusion that allows resort to litigation in particular situations where an injunction is required, a party’s interests may be irrevocably compromised by the time taken to initiate arbitration. There are also procedural aspects of an arbitration that may render it less effective at uncovering the facts. For example, it may be difficult in an arbitration to obtain an opponent’s documentary evidence. Rules respecting admissibility of evidence are generally more lax, allowing parties to introduce hearsay evidence that cannot be properly tested on cross-examination. There may also be circumstances in which the desired speed of arbitration is illusory. For example, a disagreement may exist as to whether a particular dispute is one that is capable of being arbitrated. In many jurisdictions, courts will permit the arbitrator to determine, in the first instance, whether the issue is one that is within the scope of the arbitration provision. After that determination has been made, the losing party may resort to litigation, to argue that the arbitrator was mistaken as to his jurisdiction. There may be a right of appeal from that judicial decision. Somewhere during this process, the speed and cost-efficiency benefits of arbitration may well have been lost. In selecting the mode of dispute resolution in their international franchise agreements, franchisors should consider the factors set out above, as well as the particular nature of the franchise business and disputes that might typically arise in that business. Since it is not possible at the outset of a relationship to foresee all possible disagreements, the dispute resolution provisions of an international franchise agreement should provide as much flexibility as possible. |
There are many legal considerations which a franchisor wishing to expand into a foreign territory will need to consider including those described above. Wellrounded legal advice from a knowledgeable foreign franchise lawyer will be an absolute necessity.
John L. Rogers and Michael S. Richards are partners and Susan Friedman is a litigation partner at the Canadian law firm of Davis LLP. Rogers, who also acts as general counsel to the Canadian Franchise Association can be reached at email@example.com , Richards can be reached at firstname.lastname@example.org and Friedman can be reached at email@example.com .