“The first step before entering any new jurisdiction is to undertake broad legal due diligence of the laws and regulations applying to the franchise relationship you are about to enter,” according to Scott Antel, partner at the international law firm, Berwin Leighton Paisner LLP. Here are 10 key issues regional franchisors must take account of when considering franchising their businesses to the US or to Europe
1. Legal status of the franchise relationship
Many countries (the US, most EU counties and China) have specific franchise laws, whereas other countries variously treat the franchise relationship under their civil codes as a commercial agency, a license of rights or a personal services contract. Knowing the contractual status will significantly impact how you draft your franchise agreement to protect your rights and limit your exposure.
2. Disclosure and registration requirements
Many countries have disclosure obligations, which the franchisor must provide to the hotel owner seeking to franchise the brand and system. Penalties for failure to comply can be severe. Other countries require that the franchise contract is registered to make it valid. This can be in addition to the obligation to register the brand marks and name with the local trademark authority. These registrations can be time-consuming, so addressing this early will prevent delays in implementing your franchise.
3. Secondary liability of franchisor
In some jurisdictions, a franchisor can be held secondarily liable for the wrongful third-party actions of the franchisee under the agency doctrine of ‘respondeat superior’. Franchisors need to structure their franchise agreement (FA) relationships to minimize their business exposure in such cases as well as ensuring that the franchisee is adequately insured for such events and provides indemnity guaranties to the franchisor in the event of a secondary liability claim.
4. Termination rights/rights of renewal
In many jurisdictions, a franchisee will have automatic rights of renewal of the FA unless the franchisor can establish ‘justifiable grounds’ for early termination or non-renewal. This can often be difficult to prove. Franchisors need to have clear standards and measures to establish whether a franchisee is in violation of the FA and they need to document and notify the franchisee of violations in order to support any later claim for termination.
5. Territorial and exclusivity limits
Franchisees will frequently seek to have certain territorial exclusivity for use of the franchised brand and system. These can often conflict with local competition laws and need to be checked and modified so as to be enforceable.
Most MENA countries have relatively limited double-tax treaty relationships with other countries, given the historical absence – or limited application of – profits taxation in the region. However, franchise fees payable from most countries to a MENA-based franchisor will be subject to a withholding tax which can range from 10 to 30 percent. Make sure you either structure the relationship in a way that can avail of an applicable tax treaty or provide language in the FA (e.g., ‘gross up’ provisions) as to who bears any withholding tax on the franchise fees.
7. Approval of operator
A hotel franchise will only be successful if the hotel is operated by someone with experience in running a property to the level of an international hotel and to the brand’s standards. Make sure the FA allows for the franchisor to have approval over the hotel operator, if third party, for example, at least over the appointed general manager and other executive personnel.
8. Choice of law and arbitration
Given the varied legal status of franchise relationships noted above and the fact that the franchisor will be the ‘foreign invader party’ in the relationship, select a governing law that you are comfortable with and which protect your rights to the brand and system. Although local mandatory legal provisions may override certain FA provisions under a foreign law contract, at least you will have greater control over the relationship. The use of a neutral foreign arbitration venue can protect against any local court bias where local law is used.
9. Key money structure
It is increasingly common for the franchisor to pay the franchisee a certain amount of ‘key money’ as an inducement to enter into the FA. Often, this is applied to convert the hotel to the brand standards. Make sure that any key money advanced has specific restrictions on what it is used for. Review how such payments are structured as they can have potentially negative profits, tax and VAT consequences for the franchisee.
10. Owner guaranty
In a foreign market, the franchisor is likely to have less knowledge about the business reputation and soundness of the counterparty. Apart from undertaking the obvious counterparty commercial and reputational due diligence, make sure that any personal or parent company guaranties offered are structured in a way that means they can be enforceable and collected. This is particularly important when dealing with new or individual franchisee counterparties as opposed to larger institutional parties.