Recent Trends in Franchise Relationship Laws

2. Franchise Relationship Laws

As noted above, franchise relationship laws govern explicitly the franchise relationship after the franchise agreement has been signed, providing extra-contractual protection to franchisees.  They seek to level the playing field between franchisors and franchisees, who are often presented with a standard form franchise agreement on a take-it-or-leave-it basis.  Relationship laws provide minimum relationship standards, override certain provisions contained in franchise agreements, or require an overriding duty of good faith.

Why are relationship laws important? The success of every business format franchise network depends on each franchised unit at all time presenting an image to the public of being but one of a large chain of identical units, all offering the same quality goods or services and customer experience.  To maintain this vital image the franchise contracts must necessarily include a great many significant controls on the franchisee’s method of operation, and as a corollary most franchisors will also offer significant assistance in that method of operation.  As mentioned above, a franchisor is thus highly motivated to use standard-form contracts, so that the same terms will govern all of its franchise relationships of the same type, and for the same reason these contracts are usually presented to prospective franchisees on a take-it-or-leave-it basis.  Thus franchise agreements are both relational contracts that confer discretion on a party, that is, the franchisor, to deal appropriately with certain unpredictable future events, and contracts of adhesion that are drafted for the franchisor’s benefit.  While these features are necessitated by the business reality and the franchisor’s need to control its brand image and system uniformity, as a practical result, these agreements require a fair amount of trust between parties and are rarely freely negotiated, conferring little, if any, discretion on the franchisee.  By their very nature, franchise agreements are characterized by a disparity in bargaining power that could give a self-seeking franchisor opportunities to abuse its discretionary power to the detriment of the franchisee.  Franchise relationship laws, then, are designed to restrict the power franchisors exude over franchisees.  Generally, the areas at which relationship laws are aimed to address include: unjust termination; no renewal rights; no right to assign; restricting free association among franchisees; discriminating between franchisees; and bad faith.

It should be noted that while the franchise relationship laws in North America predominately deal with restrictions on franchisors and protection of franchisees, franchise relationship laws in other parts of the world often impose obligations on franchisees as well.  For example, Article 18 of China’s Regulation on the Administration of Commercial Franchises provides that the franchisee must not transfer the franchise without the franchisor’s approval, and must not disclose or allow others to use the franchisor’s trade secrets.[4]  Malaysia’s Franchise Act 1998 stipulates that the franchisee and its employees must not carry on any business similar to the franchised business both during the franchise agreement term and for two years after expiration or termination of the franchise agreement.[5]  These provisions may be of limited value to international franchisors, as their franchise agreements typically include such restrictions on the part of the franchisees, but they are reflective of the regulators’ acceptance that franchising is a distinct method of doing business, which, as discussed above, makes certain restrictions on the part of franchisees appropriate and necessary.

3. Other Laws Affecting the Franchise Relationship

In addition to these franchise relationship laws, a number of countries have enacted commercial agency or distributorship laws that are not specifically targeted at franchise relationships but that under a variety of circumstances may apply to franchises. While a discussion of these laws is important for understanding the complete picture of relationship regulation, such a discussion is regrettably outside the scope of this paper.  Interested readers should refer to How Commercial Agency Laws Impact Franchise Relationships.[6]

Outside of specific franchise laws and agency/distributorship laws, there are also a number of other bodies of laws that will affect the franchise relationship, including, for example, general contract laws[7], competition laws[8], intellectual property laws (particularly those dealing with trademark license and technology transfer)[9], and foreign exchange control regulations[10].  In some countries, cases decided by courts have also impacted the franchise relationship.[11]  These are also outside the scope of this paper and will not be addressed here.

4. Impact on International Franchise Transactions

The franchise relationship laws are primarily designed and adopted to apply to domestic franchise agreements, where both the franchisor and franchisee are within the country, but they also affect “cross-border” franchise agreements, where a foreign franchisor enters into an agreement with a domestic franchisee, in a number of important ways.

More often than not, cross-border franchise agreements are governed by the law of the franchisor’s jurisdiction.  Sometimes, the law of a “neutral” jurisdiction (England and Wales, and State of New York being the most common choices) is chosen.  However, some franchise relationship laws require that the law of the franchisee’s jurisdiction will apply.  In the case of Indonesia, the entire franchise agreement must be governed by Indonesian law.[12]  In the case of the U.S. states with franchise laws, these laws will apply to matters they regulate regardless of the parties’ choice of law.  Franchisors that enter into cross-border franchise agreements with franchisees from these jurisdictions will need to adjust their franchise agreements accordingly.

Even if a jurisdiction’s franchise relationship law does not mandate a specific governing law, it would be prudent for international franchisors to assume that such law would apply to their cross-border franchise agreements regardless of the choice of law provision.  Therefore, international franchisors should proactively adjust their franchise agreements to try to comply with the franchisee country’s franchise relationship law requirements.  Otherwise, the franchisor might risk the entire franchise agreement, or entire provision of significant importance, being found unenforceable due to some aspect of the franchise agreement not being compliant with certain relationship law requirements.  Such revisions, however, should not be “blindly” added into the franchise agreement.  A better approach would be to add language to override certain provisions in the franchise agreement, but clarify that such overriding is only applicable to the extent required by applicable law.  Otherwise, the franchisor might find itself being bound by contractual requirements that are no longer required by law due to legislative changes.  Recent changes to South Korea’s Fair Franchise Transactions Act serve as an excellent example in this regard.[13]  The prior law’s onerous requirements with regard to termination procedure were deleted, but franchisors who directly built the termination procedural requirements into their franchise agreements would not be able to enjoy the benefit of such revisions.