Recent Trends in Franchise Relationship Laws

7.8 Quality Control Rights of the Franchisor

Relationship laws in some jurisdictions contain quality control rights in favour of the franchisor.  These laws are aimed at protecting a franchisor’s trade-mark and other intellectual property rights, such as goodwill and reputation in the community but do not necessarily rely on trade-mark protection or other intellectual property rights.  Rather, they create a baseline standard for franchisee conduct which can be read into every franchise agreement.  In general, quality control standards require a franchisee to ensure the proper quality in operating the franchise business, selling products, providing services, and in all marketing and advertising.  Under the Russian Civil Code these rights are referred to as the user’s obligations, and require a franchisee to ensure compliance with the quality of goods on the basis of the contract and similar works of the right holder.  The Lithuanian approach is to require franchisees to ensure proper quality of goods manufactured, work performed, or services rendered.  In Estonia, the Law of Obligations Act requires a franchisee to maintain the quality of goods and services and provide appropriate additional services required or expected by local customers.  The Fair Franchise Transactions Act in South Korea similarly requires franchisees to maintain the uniformity of the franchise and good reputation of the franchisor.  Lastly, Article 142 of the Industrial Property Law[37] in Mexico allows a franchisor to interfere in a franchised outlet to ensure that the image and standards of the franchise are respected.

7.9 The Duty of Confidentiality

Confidentiality covenants are an integral part of any franchise agreement and, unlike non-compete clauses, typically last for an indefinite period.  Simply put, such covenants compel the franchisee, and in some instances, his or her principals, associates, and employees, to keep trade secrets, commercial information, and know-how confidential both during and after the franchise relationship.  Countries such as China, Malaysia, Russia, Lithuania, Ukraine, Belarus, Moldova, Georgia, and Italy all impose a duty of confidentiality on a franchisee.  Russia, Lithuania, Ukraine, Belarus, Moldova, Georgia, China, and Italy all impose a general obligation on the franchisee to keep commercial secrets confidential.  The duty is somewhat more onerous in Malaysia requiring a franchisee to provide the franchisor with a written guarantee that the franchisee and his employees will not disclose confidential information.

7.10 The Right to Associate

A franchisee’s right to form an association is a popular concept in North America.  In the United States, for example, Arkansas, California, Hawaii, Illinois, Iowa, Michigan, Minnesota, Nebraska, New Jersey, and Washington all prohibit a franchisor from restricting the right of free association among franchisees for any lawful purpose.  In Canada, all five of the franchise statutes prescribe the right to freedom of association among franchisees.  The Australian Franchising Code of Conduct has similarly followed suit and contains a provision explicitly prohibiting a franchisor from inducing franchisees or prospective franchisees not to form an association or associate with other franchisees or prospective franchisees for a lawful purpose.  A similar right is also found in Moldova.

Simply put, the right to associate allows franchisees to come together and collectively express, promote, and pursue common interests.  The right is grounded in the need to level the contractual playing field between franchisor and franchisee during the term of the agreement when the franchisor reserves extensive powers to change unilaterally the economic basis of the business.  If franchisees have the right to associate they could obtain sophisticated advice and stand in a more balanced position in keeping ill conceived or opportunistic initiatives in check.  In Ontario, a recent decision out of the Court of Appeal found that the franchisees’ statutory right to associate includes the right to engage in a class proceeding to enforce their rights under the legislation or otherwise.[38]  In reaching its decision the Court highlighted the importance and purpose of franchise legislation and endorsed the holding of a trial court finding that it “would be inexplicable if it [the right to associate] was not intended to permit franchisees to associate for the purpose of protecting their interests and enforcing their rights through collective action.”[39] That said, franchise associations are not indomitable unions and while franchisors cannot prohibit associations, there is nothing in the legislation requiring a franchisor to recognize or deal with an association.

7.11 Reasonable Restraints on Competition

The franchise model involves fundamentally the grant of a right by the franchisor to the franchisee to carry on business under its trade-mark and business system in exchange for financial consideration.  By its very nature, the franchise model requires the franchisor to share its confidential information and know-how with the franchisee.   This transfer of confidential information can often leave the franchisor vulnerable should the franchisee choose to use the franchisor’s know-how in the pursuit of a similar competing business system.  For this reason, some jurisdictions have enacted relationship laws explicitly restraining post-term competition.  For example, in Albania, Moldova, Georgia, and Malaysia, once the relationship has ended the franchisee is prohibited from competing with the franchisor in the local market.  The period of restraint ranges from one year in Albania, Moldova, and Georgia to two in Malaysia.  Similarly, the Russian, Ukrainian, and Belarusian Civil Codes expressly prohibit a franchisee from competing with the franchisor on the territory.  The Codes, however, are silent with respect to whether the prohibition applies during or post term.  In most jurisdictions non-compete clauses must be reasonable, while others prohibit them all together.  Further, under the common law in Canada non-compete clauses cannot offend public policy and must be described with sufficient particulars, duration, and geographical scope.