Franchising in the UK (England and Wales): overview
A Q&A guide to franchising in the UK (England and Wales).
The Q&A provides an overview of the main practical issues concerning franchising, including current market activity; regulation of franchising; contractual issues relating to franchising agreements (including pre-contract disclosure requirements, formalities, parties' rights and obligations, fees and payments, term of agreement and renewal, termination, and choice of law and jurisdiction); Operations Manual; liability issues; intellectual property; real estate; competition law; employment issues; dispute resolution; exchange control and withholding; and proposals for reform.
To compare answers across multiple jurisdictions, visit the Franchising: Country Q&A tool.
This Q&A is part of the global guide to franchising law. For a full list of jurisdictional Q&As visit www.practicallaw.com/franchising-guide.
The 2015 British Franchise Association/NatWest bank survey on the state of the franchising industry in the UK reported on the strong growth in the franchising sector of the UK economy, with:
More than 900 franchising brands in the UK (an increase from 718 ten years ago).
A total contribution to the UK economy estimated to be GB£15.1 billion.
44,200 franchisee businesses.
Total employment in franchising reaching 621,000.
97% of franchisee-owned businesses reporting profitability.
Failures representing only 0.2% of all franchised units.
There has been a considerable increase in the growth of multi-unit franchisees.
Of UK franchisors, 38% operate internationally:
30% in Europe.
8% in the US.
All the typical franchise models have their place in the UK. The choice of model will depend on various commercial factors, including the nature of the business, the investment level required and the ideal franchisee profile.
The models used for local franchising include:
Direct franchising to individual franchisee operators.
Area development agreements or "cluster franchises", where franchisees are granted the right/obligation to open a number of outlets in a defined geographic territory.
Development agreements (without sub-franchising) for the whole of the UK, or very large regions (such as Scotland).
Master franchising, where the master franchisee recruits and provides support services to its sub-franchisees
Joint venture franchising, where the franchisor or a related entity takes an interest in the franchisee.
Variants of almost all these structures occur (for example, joint venture franchising is common in the hair salon sector).
The flexibility of English common law enables the brand owner to establish hybrid structures combining other elements (for example, underlying principal/agency structures wrapped inside a business format franchise agreement where the brand must market and control fixed prices to customers nationally). There are few laws that interfere with this flexibility, except in relation to master/sub-franchising, as anti-pyramid selling scheme legislation can restrict its use to a single master franchisee for the entire country (see Question 5).
The techniques described above (that is, direct franchising, multi-unit franchising, national and regional development franchise agreements and master/sub-franchising) all have their place in international franchising whether outbound, or inbound into the UK.
In practice, direct franchising is not practical if expansion in a country market will take place on any significant scale, although it is used in the hotel sector, often coupled with a management agreement (sometimes referred to as "manchising"). Country development agreements are typically used by retailers and in bigger ticket restaurant franchising. Master/sub-franchising is particularly prevalent in the services sectors, although some restaurant franchises also use this technique.
Joint ventures have their place internationally, although not typically on any significant multi-country scale due to the additional management resources and investment required. Major brands are increasingly using this technique where the scale of the market opportunity is seen as increasing the potential return (for example, in China or India).
Local laws can influence the choice of structure, for example where there are:
Restrictions on foreign ownership.
Regulation of franchising
There is no official definition of the term franchise in the English common law system, given the absence of franchise-specific legislation or of a civil code. This is an advantage that enables flexible drafting and the use of hybrid structures including provisions typical in business format franchise agreements.
The British Franchise Association's Code of Ethical Conduct generally adopts the European Franchise Federation's definition in its own Code of Ethics for Franchising. Definitions used in other jurisdictions are sometimes referred to in litigation to educate the court about franchising principles.
Other than the general laws of England, Wales and Scotland, there are currently no franchise-specific laws.
Franchisors are subject to the laws relating to fraud and the Misrepresentation Act 1967 when selling franchises, but there is no obligation to issue a formal pre-contract disclosure document to potential franchisees.
There are no laws that confer compensation rights on expired or non-renewed franchising, distribution or agency agreements (except in the latter case under the Commercial Agents (Council Directive) Regulations 1993 (implementing Directive 86/653/EEC on self-employed commercial agents, and relating only to the sale of products by a commercial agent).
The Fair Trading Act 1973, the Trading Schemes Act 1996 and the Trading Schemes Regulations 1997 govern pyramid selling schemes. Their provisions are designed to prevent individuals from being caught in pyramid-selling schemes. These would make franchising impossible without the exemptions provided by the Trading Schemes (Exclusion) Regulations 1997, under which an agreement is exempt where either:
The franchise operates as a single-tier trading scheme (that is, the franchisor and a single level of franchisees below it).
All franchisees remain registered for VAT at all times.
Provisions dealing with these issues must be included in domestic franchise agreements to ensure that the exemption applies.
No laws specifically encourage franchising and no tax incentives are specifically directed at franchising.
Certain boilerplate provisions of contracts drafted overseas generally need to be adapted to be enforceable locally (for example, in relation to entire agreement and exclusion clauses). Additionally, formalities and local laws must be complied with when establishing guarantees and promissory notes.
The British Franchise Association (BFA) requires its members to comply with its Code of Ethical Conduct. The Code of Ethical Conduct expressly states that it does not form any part of the contractual agreement between the franchisor and the franchisee, unless expressly stated to do so by the franchisor. The BFA's Guide to the Code of Ethics provides guidance on its requirements for compliance with the Code. Prospective franchisor members are initially assessed by the BFA and must be periodically re-accredited with a view to ensuring compliance with the Code of Ethical Conduct. The sanction for non-compliance is exclusion from the BFA.
The Code of Ethical Conduct includes the following requirements (among others):
A prospective franchisor must pilot the concept before starting to franchise.
Requirements relating to the return of preliminary deposits.
Recruitment advertising must be free of ambiguity and misleading statements.
The parties must exercise fairness in all dealings with each other.
Pre-contract disclosure requirements
Under English law, there is no obligation to disclose fairly or in good faith all facts material to the franchise relationship. Prospective franchisees must adopt a "buyer beware" approach and conduct their own due diligence of the franchisor, the business opportunity and their chances of success.
There is no requirement that an IP owner that is not the franchisor must become party to a franchise agreement. However, the franchisee will need to ensure that its rights to use the relevant IP are properly secured. Under the British Franchise Association's Code of Ethical Conduct, the franchisee's rights to use the franchisor's IP must be:
Referred to in the franchise agreement.
Capable of verification.
There are no specific formal requirements to create an enforceable franchise agreement, provided basic elements to establish a contract exist, and in particular that contractual consideration is provided by both parties. The absence of consideration towards guarantors means that, typically, a deed (with particular execution formalities) will be used to bind a guarantor.
Parties' rights and obligations
English courts have over many years consistently taken the view that, on grounds of commercial certainty, obligations of good faith cannot generally be implied into contractual relationships governed by English law. This principle has been repeated most recently in the 2014 franchising case Carewatch Care Services Ltd v Focus Caring Services Ltd & Ors  EWHC 2313 (Ch). However, there have been a number of earlier recent decisions in non-franchise cases where, faced with clear dishonesty and egregious behaviour on the part of a contracting party, the courts have found in favour of the injured party. The courts advanced the theory that in long-term "relational" agreements, which require ongoing co-operation, honest communications and mutual trust, a standard of conduct that would be regarded as commercially unacceptable by reasonable and honest people in the particular context should be censured.
Given the conflict in authorities, care must be taken by franchisors to behave honestly and with integrity towards their franchisees, because it is clear that there are risks that dishonesty, combined with commercially unacceptable behaviour, may become the basis for claims. However, following the principles expressed in these recent cases, it is likely that at least in the absence of such circumstances (that is, where there is dishonesty and where reasonable and honest people would regard the conduct as commercially unacceptable), English judges will continue to take the view that, where the agreement does not expressly confer rights, benefits and protections, parties to commercial contracts should not be subject to an implied obligation to subordinate their own commercial interests to those of the other party.
These cases show how English judges continue to resist the general notion that an obligation of good faith expressed as such should be implied into commercial contractual relationships, on grounds of lack of certainty. They have rather tried in these judgments to clarify the definition of an implied term of commercially acceptable behaviour where the contract does not expressly deal with the issue in question.
The British Franchise Association's (BFA's) Code of Ethical Conduct, with which the members of the BFA must comply, requires the parties to exercise fairness in their dealings with each other, but its provisions must not be considered as contract terms unless expressly included by the franchisor.
The English courts have also clarified the implied obligations of a franchisor to provide services to its franchisee both:
With standards of reasonable skill and care where business efficacy requires it.
Where they are reasonably required or requested.
There are currently no legal requirements to include particular provisions in franchise agreements governed by English law, other than clarity as to the basic terms necessary to constitute a binding contract. Due to the common law and some statutory provisions that govern contractual relationships in the UK, it is prudent to have contracts governed by overseas laws reviewed by local lawyers. This typically results in some modification of standard provisions (for example, in relation to exclusion and entire agreement clauses).
In addition it is essential, given the risk of heavy fines for breaches of data privacy laws, that the franchise agreement carefully deals with both the franchisor's and franchisee's obligations and liabilities in relation to the protection of information and data (typically of customers and employees) under the Data Protection Act 1998 and other relevant EU legislation.
The terms of the contract govern the relationship between the parties, subject to general laws applying to commercial relationships. Under the Unfair Contract Terms Act 1977, some provisions typically included in franchise agreements must be reasonable to be enforceable. This applies to exclusion and entire agreement clauses under which a franchisor typically seeks to exclude its liability for pre-contractual statements and misrepresentations. In a number of cases, the courts have considered these clauses unenforceable. Particularly in financial misrepresentation claims, where the franchisor is unable to demonstrate through preserving its underlying factual records that statements made in the franchise sales process had a basis in fact, the courts may try to find in favour of the franchisee, considering it to have had a weak negotiating position when faced with a non-negotiable standard form contract, and when relying on the experience of the franchisor.
These clauses will not protect the franchisor where there has been fraud, and must be expressly drafted so as not to apply in cases of fraud.
Restrictions on purchasing and product tying
Under English common law, long-term product tying restrictions are considered unenforceable as a matter of public policy. This principle gave rise to the practice, where tied product supply is an essential component of the franchise arrangement, of granting an initial term of not more than five to seven years, with the franchisee's option to renew for a further term (therefore being freed from the tie if it did not wish to continue).
EU competition law, adopted in this respect by the UK Competition Act 1998 in relation to commercial arrangements that do not affect trade between EU member states, resulted in a similar approach to that of English common law, recognising the general economic benefit of focused distribution arrangements.
Any obligation on the franchisee to purchase from the franchisor, or from another supplier designated by the franchisor, more than 80% of the franchisee's total purchases of the contract goods or services for more than five years is considered to be an unenforceable "non-compete obligation" (Articles 1(d) and 5, Regulation (EU) 330/2010 on the application of Article 101(3) of the TFEU to categories of vertical agreements and concerted practices (Vertical Restraints Block Exemption)). Article 101 of the TFEU prohibits as incompatible with the common market agreements that both:
May affect trade between EU member states.
Have as their object or effect the prevention, restriction or distortion of competition within the common market.
This provision would potentially render product tying clauses unenforceable without the benefit of the Vertical Restraints Block Exemption. However, under the European Commission's Guidelines on Vertical Restraints (2010/C 130/01), following the leading Pronuptia decision of the European Court of Justice on this point (Pronuptia de Paris GmbH v Pronuptia de Paris Irmgard Schillgallis  EUECJ R-161/84), a non-compete obligation tying the goods or services purchased by the franchisee is not restricted where the obligation is necessary to maintain the common identity and reputation of the franchised network, provided that the duration of the non-compete obligation does not exceed the duration of the franchise agreement.
If the franchisor owns the premises from which the franchisee operates, or leases them from a person not connected with the franchisee, the permitted five-year period can be increased provided that it does not exceed the period of occupancy granted to the franchisee.
Non-compete obligations and transfer restrictions
In-term non-compete obligations. Provisions preventing involvement in a competing business or the sale of competing products or services during the term are usual and enforceable. However, non-competing obligations for a term of more than five years will not benefit from the exemption provided by the Vertical Restraints Block Exemption.
Transfer restrictions. There are no legal restrictions on a franchisor's ability to restrict the franchisee's right to assign the agreement, sell the franchised business or sell the shares or interests in the business. It is therefore usual to include provisions designed to enable the franchisor to ensure that control of the franchised business does not pass to a buyer unacceptable to it. These clauses typically contain a range of qualifying criteria for the buyer/transferee, and invariably give the franchisor or its nominee a right of first refusal.
Fees and payments
There are no legal restrictions on the range of fees and payments that can be contractually agreed, which typically include the following:
Initial franchise fee.
Outlet opening fees.
Periodic royalty (sometimes referred to as management services fees) based on gross sales.
Payments for various services (for example, IT contribution, payment for products, equipment and premises lease rentals).
A contribution to central marketing.
As a result of a recent Supreme Court decision, English contract law now permits contractual penalties, but these must not be unconscionable (Cavendish Square Holding BV v Talal El Makdessi; ParkingEye Limited v Beavis  UKSC 67). Default interest provisions for late payment will be unenforceable if set at a commercially unreasonable level.
Term of agreement and renewal
The terms of franchise agreements vary significantly depending on the nature of the business, the level of investment and the period required to recover the investment and make a return. There are no legal restrictions in this regard. However, restraint of trade laws and Regulation (EU) 330/2010 on the application of Article 101(3) of the TFEU to categories of vertical agreements and concerted practices (see Question 17) have given rise to the practice, whether or not product supplies are tied, of granting an initial five-year term with the option to one or more renewals, typically subject to conditions (including that the franchisee has not been in breach). Many franchisors grant longer terms, without multiple or any renewal rights if the term is long.
See Question 19.
It is not usual practice to charge a renewal fee on the exercise of renewal options, although most franchisors provide for the recovery of modest legal costs. The British Franchise Association's Code of Ethical Conduct provides that the franchise agreement must indicate clearly the basis of any right of renewal.
The law recognises contractual provisions regarding term and renewal, without interfering with them.
There is no legal right to renewal on the ultimate expiry of the contract term or any agreed renewal terms. There are no legal restrictions on the amount of renewal fees payable, although competition between franchised networks in recruiting potential franchisees, and commercial viability, tend to establish the level of both initial fees and any renewal fees payable.
Abusive non-renewal by the franchisor of a contractual renewal right in favour of the franchisee will give rise to a claim for damages and potentially for an injunction/order of specific performance.
Clear contractually specified grounds for termination (for example, for specified defaults, in the case of insolvency and so on) will govern this matter. Unjustified termination by the franchisor will give rise to claims for damages and potentially for an injunction or an order of specific performance.
The law does not generally provide for compensation to the franchisee in the event of legitimate termination by the franchisor, either on contractual expiry or on legitimate non-renewal of the agreement.
However, if the correct legal construction of the contractual relationship is one of commercial agency for the sale of products (not services) by the franchisee on behalf of the franchisor as its principal, the franchisee as agent is entitled to a minimum notice, and may be entitled to compensation unless the contract specifies an indemnity payment (Commercial Agents (Council Directive) Regulations 1993 (SI 1993/3053), as amended). The English courts will not, as has happened in several other European jurisdictions, extend this compensation requirement outside the context of agency for the sale of products.
The courts will enforce post-term non-compete covenants against the franchisee provided that they are limited to both a:
Reasonable geographic radius, the scope of which will vary depending on the:
location and market conditions of the franchised business; and
potential for the competing franchisee to take business away from the franchisor or a replacement franchisee.
Reasonable period of time (generally, 12 months is considered reasonable).
In addition, non-compete restrictive covenants can only benefit from an exemption from potential incompatibility with Article 101(1) of the Treaty on the Functioning of the European Union (TFEU) if the following conditions are satisfied (Article 5( 3), Regulation (EU) 330/2010 on the application of Article 101(3) of the TFEU to categories of vertical agreements and concerted practices):
The duration of the obligation is limited to one year after termination of the agreement.
The obligation relates to the contract goods or services.
The obligation is indispensable to protect know-how transferred to the franchisee.
The obligation is limited to the premises from which the franchisee operated during the term of the agreement.
The law does not require the franchisor to make any payment to the franchisee to have the right to enforce these restrictions.
Post-term confidentiality and non-disclosure provisions designed to protect the franchisor's confidential know-how can be of unlimited duration.
Unless the franchise agreement exceptionally provided for an "ownership of customers clause", both the franchisor and the former franchisee can deal with the former franchisee's customers. Usually, the post-term non-compete restrictions will prevent the franchisee from doing so.
The law does not provide for any compensation payable to the franchisee where the franchisor or a replacement franchisee continues to sell to the former franchisee's customers, except in cases of terminated product sales agency (see Question 21).
Choice of law and jurisdiction
The parties are free to choose the governing law of the franchise agreement, subject to the application of mandatory public policy provisions. In practice, sub-franchise agreements are governed by local law to enable sub-franchisees to engage local lawyers to advise them. Therefore, the relevant master franchise agreement is also frequently governed by local law so that it is legally co-ordinated with the sub-franchise agreements.
The franchisor will develop manuals that set out its policies, standards, procedures and requirements in relation to various aspects of the operation of the business. The franchise agreement itself will contain a clause requiring the franchisee to comply with the requirements set out in the manuals. The franchisor will typically train its franchisees on all relevant aspects of the system, and will monitor compliance by regular visits and inspections, consulting with the franchisee, and through requiring information reports, including sales reports and accounts.
A well-drafted franchise agreement will contain express provisions authorising the franchisor to unilaterally introduce changes, amend and modify its system and the manuals as, in its sole discretion, it determines that updates and changes are required from time to time.
Over time, every business must introduce changes. Franchisors consult with franchisees in advance of introducing major system changes, and many franchisors involve franchisees in the decision process in various aspects of the development of their business concepts.
Changes introduced by manual updates cannot, as a matter of contract law, override or change fundamental contract terms (such as contract term, territory, renewal provisions or fees payable).
The franchisee may have a claim for misrepresentation where it has been induced to enter into the franchise agreement, and suffered loss, in reliance on untrue statements of fact made by the franchisor. Under English law, misrepresentation can be innocent, negligent or fraudulent. Depending on the nature of the misrepresentation, the remedies can include either:
Rescission of the contract, with reimbursements of amounts paid under it.
The courts have shown themselves willing to circumvent or override exclusion clauses or limitation of liability provisions in appropriate cases, and to make substantial damages awards against franchisors. Therefore, it is essential that franchisors ensure both that:
These clauses are up to date.
Their franchise sales materials and practices are:
carefully developed with legal input and appropriate staff training; and
consistent with underlying records retained of the evidence of facts presented in the recruitment process.
Franchising has become so prevalent over recent decades, with a general understanding that franchised businesses are legally independent of the franchisor, that it is likely to be difficult, although not impossible, for a third party to bring a successful claim based on the argument that they thought they were dealing with the franchisor. Franchisees run their own businesses, and engage with their own customers (except in underlying legal principal/agency relationships). It would probably be necessary to base third-party claims on the control the franchisor exercised over the actions of its franchisee in relation to the acts that gave rise to the liability, therefore making the franchisor vicariously liable for the franchisee's acts, similarly to the employer/employee position. For example, if a franchisor required its franchisee to adopt particular security procedures that were defective and caused death or injury to a customer, it is conceivable that the franchisor would be held liable for having prescribed the systems that caused the damage. If, on the other hand, the liability arose because the franchisee had failed to run its business in compliance with proper procedures and standards, whether or not prescribed by the franchisor, and it is that failure or negligence which gave rise to the liability to the third party, it is unlikely that the franchisor will be held liable for the acts or omissions of its franchisee.
Franchisors usually include provisions in the franchise agreement requiring the franchisee and any guarantor to indemnify it if a third party brings claims against the franchisor based on the acts or omissions of the franchisee.
Limitations to the amount or scope of an indemnity are sometimes negotiated. The obligation to provide relevant insurance cover, protecting both the franchisee and the franchisor, is also an invariable requirement.
Well-drafted franchise agreements will:
Declare expressly that the franchisee is legally independent, and not an employee, partner, agent or joint venturer of the franchisor, and conducts the business as an independent contractor.
Require that third parties and customers are informed, by way of a prominent notice at the franchisee's premises and on letter paper, contract forms, till receipts and so on, of the name and independent status of the franchisee (this is in any event a statutory obligation under the Companies Act 2006 to inform customers of their independent, "locally owned business").
In addition, franchisors should take great care if considering the assumption of day-to-day control of a franchisee's business.
A franchise agreement will contain most of the provisions typically seen in IPR licences, including:
Provisions granting rights to use the IPRs.
Reservations and limits on use of the IPRs.
Non-disclosure and confidentiality provisions.
Grant-back of improvements or ancillary IPRs developed by the franchisee to the franchisor for use in its network.
The franchisee's obligation to return the manuals and other confidential materials on termination.
A provision that the franchisor, and not the franchisee, will have the right to take legal action against infringers, with the co-operation of the franchisee.
The relevant IPRs, particularly the details of the trade marks and whether they are owned or licensed to the franchisor, should be made clear, typically with registration or application dates specified in a schedule to the agreement.
Provision should be made for the franchisor to require that new and substitute IPRs should be used by the franchisee when necessary, for example as part of a network rebranding exercise.
Know-how is typically communicated to the franchisee both by way of the manuals, updates and through training programmes (frequently made available through an extranet). Contract provisions will require that security measures are implemented to keep the know-how confidential, including requirements that limited third parties that use or have access to the information must also assume an obligation of confidentiality.
The right to use the IPRs, including know-how, will be expressly prohibited after termination of the relationship.
To be effective, a trade mark licence must be in writing and signed by the grantor. The Trade Marks Act 1994 dispensed with the previous system for recording registered user agreements, although it is still possible to do so. In practice, this is not done and the licence provisions dealing with all IPRs and matters are typically included in the body of the franchise agreement.
All leases (except very short leases) will usually permit the tenant to transfer its interest in the lease to a third party. The landlord will impose various controls on the transfer process, which are designed to ensure that the incoming tenant has sufficient funding to meet its obligations under the lease. It is usual that the exiting tenant will be asked to guarantee the obligations of the incoming tenant throughout the period of the incoming tenant's lease.
A landlord cannot charge a fee for granting consent to the transfer of a lease (or to sublet) unless transfer (or subletting) is absolutely prohibited under the lease. However, the landlord will usually be entitled to reimbursement of its reasonable expenses incurred in approving the transfer.
The right to sublet is typically found in leases of five years or more. For shorter terms, landlords prefer only to permit transfers. Where a landlord is particularly sensitive about who will occupy its premises, subletting may be prohibited (typically in shopping centres where centre owners are keen to have well-known brands as tenants).
Landlords sometimes also require a right of pre-emption, so that they can take the premises back if the tenant wants to transfer or sublet.
Most leases only permit subletting of the entire premises, and are invariably subject to the landlord's consent and protected by conditions designed to protect the landlord's position, including requirements that the:
Subletting is on similar terms to the head lease.
Rent charged is at least at the current open market level.
The most common form of commercial occupation agreement in England and Wales is known as the "1954 Act excluded lease". Exclusion of the Landlord and Tenant Act 1954 (1954 Act) means that, at the end of the initial contractual term of the lease, the tenant will not have a right to take a new lease of the premises. Otherwise, the 1954 Act provides security of tenure to tenants. At the end of the contractual term, the tenant will be required to exit the premises unless terms for a new lease are agreed (unless there is security of tenure under the 1954 Act, which a franchisor or a related company that is the landlord will seek to exclude).
It is essential for a franchisor that leases its premises to its franchisee to be able to remove the franchisee at the end of the term of the franchise agreement, so that it can make the premises available for a new franchisee, or for company-owned operations.
The 1954 Act establishes a procedure for the landlord and tenant to agree to contract out of the security of tenure provisions conferred by the 1954 Act. A simple series of formalities must be followed, starting with the landlord serving a formal warning notice and the tenant then formally confirming that it is aware that it is waiving its 1954 Act rights. Any guarantor of the tenant's obligations must also agree to the contracting out.
The process must be completed before the tenant is contractually committed to take the lease. Careful compliance with the formalities required in the process is essential as, if the required procedures are not followed, the tenant's security of tenure rights under the 1954 Act will not be excluded.
Where the franchisee is taking the lease directly, its landlord is likely to have the same concern. Large landlords, for example in shopping centres, are typically unwilling to permit a franchisee to have the right to remain in the premises if it can no longer operate under the brand, and are also likely to require that a lease to a franchisee is contracted out of the 1954 Act.
In addition to the contracting out procedures described in Question 33, a franchisor that wishes to step in on termination, so that it can operate the outlet itself or put in a replacement franchisee, will have to intervene in the leasing process with a view to establishing step-in rights at the outset. Appropriate provisions will need to be included in the franchise agreement. Additionally, it will be necessary to agree on contingent assignment documentation, if the landlord will agree. Whether the landlord agrees will, in part, depend on its view of the franchisor's financial status. Alternatively, the franchisor can try to protect step-in option rights by registering options at the Land Registry.
Rent based on a percentage of retail sales, known as "turnover rent" in the UK, is permissible and is usually combined with a guaranteed minimum base rent, plus additional turnover rent once agreed sales thresholds have been reached. Rents charged on this basis are typically found in large shopping centres. Some franchisors, typically where they substantially develop the premises before leasing or subletting the premises to their franchisees, also charge turnover rents, in addition to the royalty and fees payable under the franchise agreement. In these circumstances, property-related costs (such as service charges, maintenance and repair costs, and insurance elements) can be passed on to franchisees under the contract.
The relevant competition laws affecting franchising stem from Article 101 of the Treaty on the Functioning of the European Union (TFEU), which applies to, and prohibits as incompatible with the internal common market, agreements, decisions and concerted practices between undertakings which both:
May affect trade between EU member states.
Have as their object or effect the prevention, restriction or distortion of competition within the internal market.
In particular, this applies to fixing prices or other trading conditions (for example product tying and market sharing, including territorial protection). The European Commission has passed a number of block exemption regulations, which exempt certain agreements from the Article 101 prohibition.
The main national anti-trust law is the Competition Act 1998, which is based on EU competition rules. It prohibits agreements and concerted practices between undertakings whose object or effect is the prevention, restriction or distortion of competition within the UK.
Section 60 of the Competition Act 1998 provides that, as far as possible, these aspects of UK competition law must be applied with a view to ensuring consistency with the relevant principles of EU law. The key difference is that the UK competition laws apply whether or not the agreement or practice affects trade between member states.
An agreement that breaches the Competition Act 1998 is automatically invalid, but is exempt from the prohibition if it satisfies certain criteria. Essentially, an agreement may be lawful if it both:
Contributes to improving production or distribution, or promoting technical or economic progress while allowing consumers a fair share of the resulting benefits.
Does not contain restrictions going beyond what is necessary to achieve the benefits.
The parties must "self-assess" whether the agreement merits exemption. Exemption is unlikely if the parties cannot demonstrate that there will continue to be effective competition in the market for the goods and services concerned despite the restrictions. An agreement that satisfies the exemption criteria is not prohibited and is valid and enforceable for as long as that continues to be the case. It is not possible to notify an agreement for exemption.
The Competition and Markets Authority (CMA) is primarily responsible for the enforcement of these prohibitions, a breach of which can give rise to fines of up to 10% of the parties' worldwide sales. Infringement can also be used as either a:
Defence to an action by the franchisor to enforce contractual restrictions.
Basis for a claim for damages to recover loss suffered as a result of an infringement of competition law.
The most significant exemptions available are outlined below.
Self-assessed exemption under the Competition Act 1998. See above, Competition law.
Exemptions under Regulation (EU) 330/2010 on the application of Article 101(3) of the TFEU to categories of vertical agreements and concerted practices (Vertical Restraints Block Exemption) and the Commission's Guidelines on Vertical Restraints (2010/C 130/01). These provide a safe harbour for franchise agreements and other vertical agreements that fall within the scope and definitions of the Vertical Restraints Block Exemption where both:
Neither of the parties to the agreement has a market share in excess of 30%.
The agreement does not contain any hard-core restrictions of competition, the inclusion of which can invalidate the entire agreement. Hard-core restrictions include:
prohibition of cross-deliveries between members of a dealer network; and
restrictions on "passive" selling into the territory of another franchisee.
Territorial carving-up of markets is generally regarded as a hard-core restriction. However, the Vertical Restraints Block Exemption recognises the pro-consumer benefits of generating focused local and regional inter-brand competition where exclusive territories are granted to franchisees, enabling them to maximise their attention on the territories to which they have been granted rights. The Vertical Restraints Block Exemption therefore permits clauses restricting franchisees from actively selling into each other's exclusive territories. This is subject to the important proviso that measures restricting franchisees from "passively selling" to potential customers from other franchisees' territories who approach them from outside their own territory are considered prohibited hard-core restrictions, which prevent the entire agreement from benefiting from exemption.
A franchisor can recommend prices or restrict maximum prices charged by its franchisees, but direct or indirect pressure to maintain minimum prices (resale price maintenance) is a prohibited hard-core restriction. However, the Guidelines on Vertical Restraints recognise that resale price maintenance can be pro-competitive in limited circumstances, for example to:
Promote the launch of new products or services by franchisees.
Support a co-ordinated short-term low price campaign (for example, a sales period of two to six weeks) across a network where uniform presentation is important.
Agreements that benefit from an EU block exemption regulation, including the Vertical Restraints Block Exemption, are exempted from prohibition under the Competition Act 1998.
See Question 17 for details on exemptions relating to non-compete obligations and product tying.
Appreciability and agreements of minor importance. Agreements can also fall outside Article 101(1) of the TFEU because they are not considered capable of appreciably affecting trade between member states the (Notice providing guidelines on the effect on trade concept for Articles 101 and 102 of the TFEU (formerly Articles 81 and 82 of the EC Treaty) (OJ 2004 C101/81)) where both the:
Aggregate market share of both parties on any relevant market within the EU affected by the agreement does not exceed 5%.
Supplier's aggregate annual EU turnover of the products covered by the agreement does not exceed EUR40 million.
The CMA will not normally enforce sanctions where an agreement does not have an appreciable effect on competition or trade. The CMA will also have regard to the European Commission's approach to assessing appreciability set out in its Notice on agreements of minor importance (OJ 2014 C291/1) (De Minimis Notice). The De Minimis Notice provides that an agreement will not be regarded as having an appreciable effect on competition in the following circumstances:
Where the parties to the agreement are considered to be actual or potential competitors on any of the relevant markets affected by the agreement, if their aggregate market share does not exceed 10%.
Where the parties are not actual or potential competitors, if their aggregate market share does not exceed 15% on any of the relevant markets affected by the agreement.
These thresholds are reduced to 5% were parallel networks of similar agreements can together result in foreclosing the relevant market. The De Minimis Notice does not apply where the:
Object of the agreement is to prevent, restrict or distort competition within the internal market.
Agreement contains hard-core restrictions.
The European Commission generally regards internet marketing and sales through websites as "passive selling" for the purpose of the Vertical Restraints Block Exemption. In other words, customers from outside a franchisee's exclusive territory who place an order with the franchisee as the operator of the website cannot be prevented from making a purchase from the franchisee, and must be free to make purchases over the internet in general. Prohibition of franchisee websites or web-based sales is therefore not permitted and is considered a hard-core restriction.
Therefore, for example, the following will be considered hard-core restrictions:
Obligations or mechanisms established to automatically re-route from the franchisee's website customers located outside the franchisee's territory.
Obligation not to process customer internet transactions if a customer's credit card data shows an address outside its territory.
For the same reason, obligations that could deter a franchisee from using the internet (such as an obligation to pay a higher wholesale purchase price for products sold to customers over the internet, or to limit the percentage of overall sales made online) will also be considered hard-core restrictions.
However, the Guidelines on Vertical Restraints recognise that franchisors can impose quality standards in relation to the use of the brand, and the appearance and content of the franchisee website. Given the significance of this issue, franchisors must take great care in relation to how they handle this matter both in the drafting of their agreements and as a matter of policy, procedure and communications with their franchisees.
There is no statutory recognition of the legal and financial independence of the franchisor entity from its franchisee entities. However, it will be very difficult under English or Scots law to maintain that a deemed employer/employee relationship has overridden the invariable express provisions in the franchise agreement that the relationship is one of legal and commercial independence and does not give rise to one of employment or partnership. This is particularly true where there is a normal and clear distinction between the franchisor and the franchisee. This will usually be the case, as most franchisees use separate limited liability companies as their trading vehicles, independently maintaining their own accounts for the franchised business. This will also be the case in the absence of interference in, or control over, the conduct of the day-to-day business of the franchisee or the franchised business, particularly in relation to its employees, both of which activities would increase the risks of deemed employment being construed if claims arose.
Most formal claims for breach of contract are resolved by litigation rather than arbitration in the context of domestic franchise agreements. Franchisors will invariably wish to reserve the right to seek injunctions from the court in appropriate cases, for example, for breach of non-compete covenants. Damages claims by franchisees against franchisors, typically based on misrepresentation, are also usually the subject of litigation. Arbitrators cannot award injunctions. A major advantage of arbitration is the confidentiality of the proceedings.
Mediation is not mandatory, although some franchise agreements include mediation provisions and mediation is a recognised method of resolving disputes that is encouraged by the Civil Procedures Rules.
Major international agreements for significant territory or country rights are often subject to international arbitration. The London Court of International Arbitration is frequently chosen as the forum, given its international reputation for neutrality.
The British Franchise Association has schemes for both mediation and arbitration, which are sometimes used in a domestic context, but experienced arbitration bodies are typically preferred by sophisticated franchisors given the significance of disputes.
Generally, the losing party will be liable to pay the legal costs of the successful party to the litigation, although awards of costs are discretionary. If the successful party behaved unreasonably in its conduct of the dispute, this can result in a partial award of costs, or even an order to contribute to the losing party's costs. The court will also consider the reasonableness of the legal costs incurred.
The UK is a signatory to the UN Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958. Therefore, UK courts will readily enforce arbitral awards issued in other contracting states, subject to the usual limited defences.
Judgments of foreign courts can also be enforced in the UK in several ways, depending on the country. Judgments from the courts of EU member states can be enforced under either the:
Regulation (EU) 1215/2012 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters (Recast Brussels Regulation).
Lugano Convention on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters 2007 (including judgments from Iceland, Switzerland and Norway).
A judgment from the court of another EU member state can also be enforced in the UK courts under the European Enforcement Order (EEO) procedure. The judgment creditor must apply to the court issuing the judgment for an EEO certificate. With that certification, the judgment will be enforceable in the UK as if it had been issued by the UK court.
The UK also entered into bilateral treaties under which judgments from courts in the relevant countries can be registered in the UK courts and then enforced. In addition, judgments issued in several other countries, including Commonwealth countries, (such as India, Australia and Canada) are enforceable under the Foreign Judgments (Reciprocal Enforcement) Act 1933.
Judgments from countries that are not covered by the above arrangements (including the US, China and the Russian Federation) must be enforced by bringing new legal proceedings in the UK. The foreign judgment is sued upon as if it was a debt, with summary judgment typically requested. For a foreign judgment to be recognised in this way, the following conditions must be met:
The judgment is final and conclusive.
The judgment was issued by a court regarded under English law as a competent forum.
The judgment does not conflict with UK public policy.
Exchange control and withholding
An overseas franchisor will be exempt from UK tax unless it carries on a trade or business through a permanent establishment in the UK, in which case it will be subject to UK corporation tax on its profits. Accordingly, an overseas franchisor should take care to ensure that the provision of support and services to its UK franchisees does not give rise to a permanent establishment in the UK under UK tax law.
Royalties payable to an overseas franchisor that is not trading in the UK and which relate to the IP rights granted to its UK franchisees are likely to be subject to withholding tax, subject to available reliefs under any relevant double tax treaty.
The following reforms/reform proposals may affect franchising in the UK:
A study on the regulation of franchising has been initiated by a committee of the European Parliament, stimulated by moves emanating principally from The Netherlands to address unfair practices in franchising. At a July 2016 workshop meeting in Brussels, senior representatives of the Commission indicated a reluctance to act, but this issue is unlikely to go away and franchisors must continue to monitor developments.
The European Franchise Federation has revised its European Code of Ethics for Franchising, which will have an impact on national franchise associations in Europe. Franchisors and their lawyers will need to remain vigilant to ensure that the implementation of these revisions by national associations does not risk creating additional liabilities for franchisors and problems for franchising in their jurisdictions (whether or not obligations of good faith and reasonableness are recognised as implied contractual terms in their national legal systems).
The UK has decided to leave the EU, although the completion of Brexit negotiations is likely to take at least two years from the moment the UK government formally triggers the exit negotiation process. EU competition laws, as well as other relevant EU trading and other laws will continue to apply to franchisors and their networks which trade in the EU. The UK will need to clarify whether it intends to continue to shadow EU laws where it will no longer be obliged to do so, and may need to refine domestic laws and regulations where gaps arise. It will therefore need to be clarified whether domestic competition laws, governing purely domestic businesses, will continue to reflect the EU competition laws (see Question 36). Other significant international legal regimes emanating from the EU (for example, in the areas of data privacy and cybersecurity) must also continue to be taken into account. Existing franchise agreements governed by English law generally do not immediately need attention, except where the underlying business may be adversely affected by changes in the regulatory regime relevant to the particular business. Going forward, franchising in the UK will benefit from not being obliged to adopt future EU regulations that may have a harmful effect on franchising or on the ability of franchisors to control their networks. For this reason, the choice of English law to govern international agreements becomes even more advantageous for franchisors.
Description. This website provides access to EU law.
Competition Act 1998
Description. This website provides access to the text of the Competition Act 1998.
Chris Wormald, Partner, Co-head of franchising
Professional qualifications. 1979, Solicitor, England and Wales
Areas of practice. Franchising and related domestic and international structuring, distribution and hybrid structures, including joint venture and management agreements, including relevant competition, commercial, IP and corporate issues, and relationship management/disputes; former international tax specialisation.
Non-professional qualifications. MA in law, Cambridge University (Sidney Sussex College); former ten-year VP and General Counsel McDonald's EMEA (provides Board Level consultancy on non-legal aspects of franchised development and expansion)
Advising various developers and master franchisees wishing to acquire rights to overseas franchise systems, in both UK and overseas markets.
Advising international investment fund on US$100m plus investment in multi-country JV/master franchise and development structure for major quoted US restaurant brand.
Advising prominent media company on commercialisation of several brands into customer-facing retail, restaurant and resort operations internationally.
Advising major global quoted food services company with company-owned operations on the implications of converting part of its network into franchised operations (non-legal consultancy project followed by legal implementation when approved).
Assisting owners of small UK bakeries with domestic and international expansion transactions.
Languages. English, French and German
Professional associations/memberships. Economic Research Council; EuroFranchise Lawyers; American Bar Association; International Bar Association; British Franchise Association; International Franchise Association.