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I am delighted that Thomson Reuters decided again to include Franchising in its excellent collection of Practical Law Global Guides, and very proud that they have again asked me to be the General Editor.
The practice of law is changing dramatically, driven forward both by globalisation and new technologies, and Thomson Reuters are at the forefront of the delivery of new services in the legal area to support businesses and their advisers.
I am very pleased indeed that so many specialist country chapter contributors have made this publication such a valuable resource for those embarking on international expansion projects around the world, and I am most grateful to all these authors for participating.
For the benefit particularly of non-franchising specialists who are not immersed in the techniques, there are myriad business, network relationship and particular legal issues with which successful franchisors and their legal counsel will be familiar. Accordingly, this introductory chapter is aimed more at the business people, general counsel and non-specialist lawyers, to better familiarise them with these issues, and with the impact business format franchising can have when effectively deployed, both to re-engineer a company owned and operated business, and as an expansion technique, in the domestic market as well as internationally. Given its applicability to most commercial and many not-for-profit sectors, franchising is an important strategic option to have on the board's agenda.
It is important to remember that when franchisees are referred to, this can mean either a small individual, most usually in the context of domestic franchising, or the largest of companies, which sometimes make excellent franchisee business partners for brands, either in particular domestic markets to which they have particular access or presence, or as the country franchisee responsible for developing a new international market.
The impact of franchising internationally: US brands leading the way
For more than 30 years, I have focused on the expansion of businesses using franchising structures. I had started out on my legal career after university in the late 1970s as the first ever "articled clerk" (now, more meaningfully, called trainees) Simmons & Simmons had in its tax department. Simmons was then the only UK law firm to have a branch office in Brussels, and as a linguist at school I liked the sound of that and indeed got the opportunity to finish my training in Brussels before returning to international tax planning back in London. Later, at the age of 30, I decided again to leave the UK, this time reckoning that it would be interesting to spend a few years in Frankfurt, which would give me the opportunity to experience yet another culture, and polish up my rapidly rusting German language skills. Little did I know that the 20-man McDonald's Europe office I was about to join as their first in-house General Counsel, located all of 4km from Frankfurt airport at the centre of Europe, was essentially English speaking, given the presence of various expatriate US nationals, highly experienced in their individual disciplines, which had taken them to this trailblazing EMEA headquarters office, along with a smattering of other Europeans.
The company then had less than 200 restaurants (stores) in Europe, and by coincidence was then in 30 countries globally – a number I still remember not just because of the plaque of 30 "country flag pins" I was presented with at some point back then, but because it coincided with my own age. It was also the year in which Jack Greenberg, former head of US tax at Ernst & Young, also joined McDonald's Corporation as its CFO, a fact which stuck in my mind, both because of my own international tax structuring background, and in due course because, very shortly, I met him and the rest of the Finance and Treasury team. I was of course very impressed during my two-month induction training at the company's headquarters campus in Oak Brook, a western suburb of Chicago at which the famous Hamburger University (HU) is located, nestling on the banks of some carefully landscaped lakes, opposite the equally beautifully designed in-house hotel, then managed by Hyatt for the company, at which HU students and visitors to the corporation would typically stay. When I arrived in Frankfurt, I knew nothing about hamburgers, nor frankly much about McDonald's, and certainly nothing about franchising. With hindsight, the fact that the company had outsourced the management of its rather lovely hotel facility to a highly experienced industry operator spoke volumes about its understanding of the need for focus to deliver "top-notch" operations. That observation escaped me at the time, but it has been reinforced by a lifetime working with franchisors and their franchisees ever since.
Ten years later, when I left McDonald's to return to the private practice lawyering world at Eversheds, recruited by the 60-year-old European franchising guru Martin Mendelsohn to work as his right-hand man, we had by then opened up many more countries in Europe and were dipping our toes into North Africa and the Middle East, and stores in the region has risen from 200 to more than 2,000.
I had observed and concluded that, at that time in the mid-1990s, there was very little understanding, in the UK at least, of how effectively to expand retail business operations internationally on a multi-country basis, as McDonald's had done. I saw how, at the time, Marks & Spencer was retreating from France after disastrous company-owned operations had put red ink all over their map. I had meanwhile worked in a highly effective, multidisciplinary team with both a line function to open restaurants in new country markets, and a consultancy function to nurture and build up the local country teams in our patch, laying the solid foundations for future growth in their domestic markets. So, I was tempted back into private practice to use my skills to help others do the same. I had by then observed the effectiveness of franchising, both at the domestic country market level, and as a driver for what McDonald's had proved to be extremely effective international expansion.
The McDonald's network now boasts more than 36,000 stores internationally, in 120 countries. It is no longer the leader in absolute store numbers in the international restaurant sector, having been overtaken by Subway, but given their predominantly "real estate-based franchising" model, which means that the group has invested in and become the largest holder of retail real estate interests in the world (which is a much more demanding expansion model), they still remain head and shoulders above most other globally internationally expanding brands.
Although I did not realise it at the time, and as I learned as I later started to attend international and US legal and franchising conferences, McDonald's is held in considerable awe in US franchising circles for its professionalism and that was certainly something I experienced in the teams I worked with. Using almost all of the techniques discussed in this Guide has been one of the key secrets of its success and longevity.
For various reasons, the US is certainly the cradle of franchising, and remains so. Franchising has made an enormous contribution to the US economy. Regular studies over the years have tracked the sector's growth, with a 2016 PwC study (Economic Impact of Franchised Businesses, Vol 11, September 2016) reporting:
732,842 outlets.
Direct employment in the sector (ignoring peripheral employment with suppliers and so on) of 7.6 million.
Sales of US$674 billion, representing fully 5.8% of US GDP.
There are many US domestic networks with thousands of franchised outlets in the country. There are many quoted franchisors, many of them among the world's best-known brands, such as KFC, Marriot and Holiday Inn (IHG). There are even quoted franchisees, such has been the impact of this entrepreneurial phenomenon in perhaps the most entrepreneurial of countries. And of course the technique has been propagated around the world since its origins in the mid-1950s US, with many developed countries now home to hundreds of locally established franchising brands. Each of the country chapters in the Guide starts with a short description of the impact of franchising in its market.
Depending on the country and the brands in question, it can be fashionable in some quarters to denigrate the march of franchising and the brands the technique carries around the world as "cultural imperialism". What is forgotten is that when the technique is used in good hands to effectively develop outlets in new country markets, the key reason for the success (besides the appeal of the brand and business concept itself) is the small business building and management techniques and skills which franchising imparts and trains into the people who become involved locally. This assists, by this transfer of business operating know-how and the creation of successful entrepreneurial role models, with the development of emerging economies themselves into which franchising carried the brands. It is no accident that "social franchising" techniques, as well as small business franchising, accompanied at the top end by "big-ticket" hotel franchising, are developing similar skill sets and are playing a major role in transforming Africa today. I observed this phenomenon, with some amazement and perhaps some self-congratulatory pride, when in the mid-1980s in the former communist Yugoslavia, then with no concept of profit in the system, the McDonald's Europe team trained up a highly intelligent young economist – teaching him and the rest of the new local team western accountancy and business skills from scratch. He became the first controller of the small, start-up joint venture business we had created together with a local US$2 billion "Organisation of Associated Labour" as McDonald's' 50/50 joint venture partner to open the first stores in Belgrade.
Still a relatively little understood expansion and re-engineering technique
As I wrote in the introductory chapter to the first version of this Guide, then published by the European Lawyer which was subsequently acquired by Thomson Reuters, and which was entitled "Alternative Corporate Re-engineering" (rather deliberately to attract the attention of those who are responsible for considering businesses' expansion and restructuring options), franchising is not often put forward as an expansion technique by leading corporate finance advisers. It is not, in the UK at least, typically focused on as a re-engineering and expansion technique by big businesses. Its usefulness is perhaps therefore not articulated well because it is not generally understood. There are various reasons for this, but I have concluded that a major reason, at least among the professional advisers who counsel big companies, is quite simply that, once the franchise contracting and business model has been developed in the first place, there are simply not the professional fees to attract city lawyers, accountants and private equity players, who live off corporate expansion and the significant M&A fees which this generates, to advocate franchising as an important option to be put on the expansion or re-engineering board's agenda. In the franchising world, the majority of the investment is made by the franchisees, not by the franchisor, as decentralised and not corporate investment. It is the accountants and lawyers of the franchisees who cumulatively make most of the professional fees as a network expands organically, not the City or Wall Street corporate finance advisers.
But from the perspective of the brand-owning company and its owners, failing to put franchising on the agenda of potential expansion and re-engineering techniques is a serious omission. Over the years, several US studies in the restaurant sector have demonstrated that overall return to shareholders is enhanced by using a franchised model, when compared with a company-owned model. Private equity in the US understands this and there are US private equity funds that particularly specialise in the franchising sector. In the UK, in recent years, some of the private equity funds that acquire the bigger casual dining restaurant chains have learnt that using franchising overseas can demonstrate, having planted a few successful flags in the map overseas, that there is a potentially huge multi-country international market still to be exploited, and can add significant value to the price the next buyer is prepared to pay as part of their planned exit strategy.
Re-engineering company-owned operations which have grown organically, by using franchising techniques, can frequently transform the financial performance of businesses. There are many examples of where this has been done, such as the well-known programmes of assets disposals by the major hotel corporations, resulting in them essentially providing service and support functions to the hotel assets which were spun off into the hands of independent investors. IHT (Holiday Inn and other brands) is a good example, as are the disposal programmes of some of the coffee shop brands. The combination of franchise fee income and fees paid under management contracts is considerable, and the profitability and return on investment ratios of companies that have adopted these spin-off techniques have been significantly enhanced. Similarly, there have been programmes of disposals of company-owned restaurants, real estate brokers or coffee shops to franchisees, and examples where important in-house functions have been spun off (for example, by the white goods manufacturer Whirlpool when it disposed of its servicing function, disposing of its stock of spare parts, service engineers and vans to independent, regional franchisee businesses around the country). Re-engineering international expansion using franchising can also enhance corporate performance. Mothercare, a well-known quoted UK retailer of baby equipment, clothing and toys, with 134 shops in the UK, has had serious difficulties over recent years in its domestic trading (from which it hopes it is now emerging), while its international business (wholesaling products to entirely independent international franchisees) has expanded steadily over many years of international franchising to now in excess of 1,100 overseas stores. Its international business has consistently produced strong returns without the constraints, including rent costs, coming from the UK real estate and company-owned operations.
The business logic in these cases is not, however, restricted to the immediate results of the financial re-engineering exercise in the company itself. Frequently, a big company is also seeking to inject cultural change and entrepreneurship into the way its business is done. In the case of Whirlpool, for example, it was expected that service engineers deployed in small, locally-owned, customer-focussed businesses, would be more effective at cross-selling other products and services to customers when in their homes.
In truth, the appropriate domestic expansion model or models (franchising is often used in parallel with company-owned operations in different domestic markets) will always depend on the nature of the particular business, and the varying market potential around the country. Critical to this evaluation, which will be different for each business, will be the overall size of the country market and its geography.
In a relatively small geography, it is much easier to conceive that company-owned operations will, over time, gradually penetrate the entire domestic market. And of course in recent years, online sales have added another dimension to the strategic planning exercise, particularly in the retail sector. However, experience has shown that company-owned branches have their own investment/return criteria in any business. There are places "company owned" will never go because of those numbers, quite apart from the difficulty of monitoring service quality in the operations and providing the necessary support to a far-flung outlet. One of the advantages of franchising is that, with a very different overheads model, and with the hands-on local focus, expertise and ownership incentive of a local operator, a brand or business concept can be taken into markets, perhaps with a slightly different model, which would never be penetrated by company-owned operations. As a result, consumers in smaller, remote markets can get to see branded outlets in their own areas even where, as in the UK, the predominant expansion model has been for company-owned operations on the high streets of more major towns.
This contrasts with the position in enormous geographies, such as the US. The relatively rapid roll-out of new concepts throughout these giant markets has been made possible by the use of franchising models described below.
The same logic is at play when businesses consider international expansion, but the barriers to successful company owned expansion are multiplied.
The key drivers of successful franchising
At this point, it is worth reminding the non-specialist reader briefly of the key requirements and drivers that are behind successful franchised expansion, remembering that these issues are almost always required across the broad range of commercial and even non-profit sectors (such as education and healthcare), in which the techniques can be used too:
A successful business model, which is relatively easily replicable, initially piloted to prove the concept by those behind it, perhaps in different market contexts (often a novel approach to the provision of services that have been delivered in different ways before).
A business model and fee structure that works for, and incentivises, both sides (not as relevant in the non-profit sectors).
A well-branded concept that can be delivered consistently, the marketing of which is designed and developed centrally, partly funded by franchisee contributions, the plans for which are often contributed by, and always subject to the scrutiny of the network of self-interested franchisees. This is a very important dynamic and check that delivers high-quality, effective marketing and promotion.
Investment by the franchisee business owner. This ownership incentive (skin in the game) allows the franchisee to strive for and keep the profits of its own business, less the fees paid to the franchisor, which produces a different behavioural dynamic and incentive from that of typical managers and employees of company-owned outlets. This also means that the mother company/franchisor is not constrained by funding requirements. It will not need to raise the capital to expand, which is inherent in corporate expansion models.
Similarly, because the investment in, and management of, outlets is outsourced to the franchisees, human resources are not a constraint on growth. There is no need to build up cohorts of in-house accountants and employees to run and supervise operations in which the company's shareholders have invested. Rather, the most experienced operations people in any business will become "field consultants" to, rather than "managers" of, the franchisees in their area. Franchisees become successful independent business owners, "partners" in the overall network. The ready sharing and development of new ideas which can bubble up from such a vibrant, self-interested environment can in effect become a highly effective, unpaid, research and development department. The franchisor, as owner and guardian of the brand and business system, controls, filters and refines for the benefit of the network good ideas and initiatives collected in this way.
The relatively small head office functions that these structures typically permit result in lean decision-making, which is relatively lacking in bureaucracy and is entrepreneurially focused. The franchisor's success, and those of its employees, depends on the success of its franchisees, and on appropriately involving them in planning for the future of the business.
These factors mean that expansion using a franchising model can take place significantly more rapidly than using corporate operations.
Of course, many successful franchisors run some parallel, company-owned outlets for a variety of reasons, including testing and proving new ideas, and as a training ground for new field consultants.
The local ownership incentive of the franchisee, who is constrained to operate within the "System" and according to brand standards, reporting requirements and so on, means that the franchisee will "work" and exploit the local market more effectively than would company-managed operations. One only has to shop a High Street late on a Saturday afternoon to observe the contrast between the company-owned outlets whose managers are closing the door promptly at 5pm to get home, with the franchisee owner-operators whose opening hours will flex as long as there are customers on the street. In the services sector, the techniques developed over years by a franchisor and its network enable franchisees who are granted the rights to exploit a designated territory to find and provide service to customers with great focus and drive. They are often supported by bespoke software packages and other centrally provided services, which have been developed as support tools to the business, and always driven by the intense focus on optimising all aspects of the business to support their franchisees, which successful franchisors make their key preoccupation.
The head office becomes the franchisee recruitment, training and support services hub, monitoring and contributing to performance, a centre of excellence in all areas (for example, in the area of new operational techniques, marketing and public relations, product supply and sourcing, shop fitting, equipment and merchandising).
It is the "business format" that is franchised or cloned, and it is the consistent and successful deployment of that format, under the brand, which over time generates customer recognition and repeat business.
The key foundations to every successful franchise network are:
The business concept itself.
The network of trained and motivated franchisees.
A franchisor staff that is effective at supporting the network.
A model that is successful for all participants.
A well-written franchise agreement and ancillary documents, which is the foundation of the relationships, and which ensure that the franchisor can ultimately control and develop the network, the underlying business concept and its brand over time.
Franchising: the basis for multi-country global business expansion
Turning to the topic of this Guide, international expansion on a multi-country basis is rendered possible for many brands and businesses only by using "business format franchising" techniques.
There are very few major corporations that operate on a genuinely multi-country global basis using a company-owned expansion model outside the manufacturing and pure product distribution sectors, for example, pharmaceuticals and motor and oil companies. Even the latter use networks of dealers and an approach which, in many cases, even adopts the term "franchise" to describe the relationship.
Over the years, there have been many examples of ill-fated company-owned expansion by major corporates (perhaps because this is the only model they know and have been encouraged to adopt) that have misunderstood the overseas market, overpaid for real estate, acquisitions and other costs, and have ended up divesting, selling-up and retrenching after a few difficult years. This is sad to see, particularly if the market opportunity was there to be developed in a more intelligent way.
The key logic behind international expansion using franchising is to identify and make use of an enthusiastic and well-capitalised local operator who wants to develop the business locally, who understands the culture and realities of the local market, how to do business in his country, and who will avoid the myriad mistakes which the incoming foreign business will inevitably make at its considerable cost.
At the heart of every successful international expansion programme, whichever particular franchising technique is used, is a properly designed international franchising model and business, which is financially attractive to both sides. This franchising model will therefore encourage the country franchisee to develop the potential of the market to its maximum, and will crucially involve very careful and prudent selection of overseas country franchisees and master-franchisees, with appropriate support systems in place provided by the franchisor.
For those with limited international expansion experience, getting this right will inevitably involve bringing into the business, either as employees or outside consultants, those with a track record of success in establishing these international operations, including legal advisers.
Each chapter in the Guide consists of a series of questions that are specifically designed to elicit relatively short responses to most of the key questions which a business considering using franchising as a technique with which to penetrate the overseas market would need to ask of a local lawyer. Word limits in the formats mean that answers have sometimes been truncated, and although reliance on the Guide is therefore no substitute for specific follow-up with local advisers in a specific case, the answers are designed to provide the basis of a good initial legal audit of key franchising-related legal issues in relation to the target market/jurisdiction.
Several basic contractual models and techniques are typically used, depending principally on the nature of the business, the experience of the franchisor, the size and potential of the overseas market, and the ideal profile of the franchisee, all of which experience has shown the particular franchisor is likely to deliver the optimum approach to developing a successful overseas market.
Joint ventures
All of these techniques lend themselves to being combined, at the level of the local operator, into a joint venture operation with the home country franchisor. In other words, the franchisee itself becomes a joint venture entity.
There are certain techniques that enable a franchisor to avoid initially being drawn into the commitments that joint ventures typically involve, and so potentially setting up a mechanism from the outset which will enable a classic joint venture to be created in the future, enabling the brand owner to participate in locally-generated operating profit and, over time, in the value of the local enterprise.
However, joint ventures that involve the commitment of home country shareholders' capital to the overseas start-up, and to its future development, are essentially almost as costly to support in terms of risk and involvement and monitoring requirements, as would be wholly-owned overseas corporate operations. The selection of the "right" local joint venture partner is expected to relieve this burden substantially. If the overseas partner were to be completely aligned with the perspectives of the home country investor, without its own agenda, perhaps competing and distracting investment objectives, demands of its own shareholders and of prioritising its other businesses, with the risk that key management staff are moved to other divisions, and could be expected to be entirely trustworthy and transparent, then the monitoring of the home company's investment, with the inherent risks and demands and liabilities attaching to local directorship responsibilities, would mean that it would only be capital and funding constraints which would limit the number of markets to which the business using these joint venture techniques could think of expanding into over time. That in itself would severely limit, for the vast majority of businesses, the number of international markets into which they could consider expanding with such a model. Unfortunately, the realities are of course very different. Academic studies have consistently shown that overseas joint ventures carry with them statistically high percentage rates of failure and dissolution. Experience of the realities of operating joint ventures is that significantly higher demands are made on the time and attention of the home country franchisor than would be the case if the relationship was entirely at arm's length, without company and shareholder capital at risk. Management resource constraints, let alone funding issues, mean that these joint venture arrangements can only be operated in a limited number of international markets, for all but the very largest multinational corporations.
Corporate lawyers must remember that it is essential to have in place a proper business format franchise agreement to accompany the inevitable shareholders' agreement/joint venture agreement. Not only does this provide the brand owner with another level of contractual rights and controls, as it would over any other franchisee operator, but it must be in place at the outset. It will simply be too late to think of negotiating a proper franchise agreement on arm's length terms when the joint venture has broken down and the local shareholder, with the blessing of the home country brand owner, proposes to continue to operate the outlets.
The key franchising techniques
International franchising techniques are described below. Careful consideration and business planning, with appropriate expert input, will help each business think through the technique that makes most sense in a particular market context. Some internationally expanding franchisors use different techniques in different market situations.
Master and sub-franchising. This technique is typically used in the services sector, where local sub-franchisees are allocated territories and operate in the national language environment, approaching and providing services to local customers. This requires the piloting of the business by a country master franchisee, who will then proceed to develop the business of recruiting and supporting sub-franchisees in the local business and language environment. In recent years, franchisors have become more concerned about the inability to monitor and control brand performance at the sub-franchisee level if the master franchisee fails to do so properly, and this will always be a concern given the lack of direct supervision by the franchisor over the operations of the sub-franchisees. Techniques can sometimes be introduced to enable the home country franchisor to intervene without exposing itself to the risk of liabilities to support sub-franchisees. The master franchisee's business is the business of being a good franchisor, recruiting and supporting its sub-franchisees, and the skill sets required to do so are entirely different from the skills required to operate the business format successfully at outlet level. This technique is also sometimes used in the quick service restaurant category.
Direct franchising. In direct franchising, the home country franchisor enters into a direct franchise agreement with the outlet operator franchisee for a particular location in the overseas market. Essentially, this is the same approach as if the franchisor was recruiting and supporting a domestic franchisee in its home market. It will be readily appreciated that this technique cannot realistically be used on any significant multi-country scale, simply because of the number of relationships that must be monitored, supported and managed. Instead, for most businesses, it will become imperative to develop a country office to service and support a network of local franchisees. The significance of having an independent master franchisee responsible for developing the country network, or using a wholly-owned local subsidiary of the franchisor to perform the same function, must be considered. Inserting such an additional layer clearly carries with it additional costs that must be shared between the various participants, still enabling each to make an adequate return, and which is ultimately paid for by the price the customer will be prepared to pay for the products or services in the local market.
The number and size of the outlets in the particular business will have an impact on whether or not direct franchising can be used. For example, it may be possible to do so where the outlet will be a "unique destination" in each country's capital city, for example Hard Rock Café, or in the luxury hotel and resort segment.
Development agreement franchising. This technique is typically used in the retail and casual dining restaurant sectors. The franchisor is looking for a well-resourced local operator, already operating successfully in its country, with the capital, people resources and experience to successfully embark on a country-wide roll-out of the concept country-wide, or with the right to do so in a significant region in a very large country (such as India).
An alternative to this technique can be thought of as "cluster franchising", where a regional development agreement is entered into with an experienced local area operator who commits to open and operate a number of outlets in its regional market, for example, where an existing multi-unit fast food franchisee of another brand in, say, Birmingham, enters into a development agreement to invest in and develop 15 new outlets in the same market over a five-year period. In some segments, non-compete restrictions can prevent such an operator from taking on another brand. This must be carefully checked at the outset to avoid potential problems, including claims of inducing breach of contract.
Under these structures, all outlets are operated by the franchisee entity itself. Sub-franchising is not permitted.
Area development agreement franchising (US-style). Under an area development arrangement, a third party, the area developer, will be granted the right to find and recruit franchisees to operate inside the allocated area. The franchise agreement will be entered into directly between the franchisor and the franchisees recruited by the developer, and not with the developer. The area developer will typically participate in a "cut" of the initial fee payable by the franchisee, and potentially a share of ongoing royalty payable to the franchisor. Sometimes, these agreements also require the area developer to provide certain support services to the franchisees in its area.
This technique is not often adopted in a domestic country market where the franchisor is capable of recruiting and providing service and support to its franchisees itself. Most franchisors strongly prefer to do this themselves, and with good reason. The intervention of an intermediary can produce conflicts of interest in the recruitment of prospective franchisees, and other problems.
Regulatory and legal environment: general concerns for the non-specialist
Franchising is a technique that can be used across almost all commercial sectors. The impact of laws and regulations relevant to the particular sector and operations must always be carefully considered. It is rare for patents to form part of the bundle of rights which the franchisee is granted the right to use, although this occurs occasionally. Patent-related issues are not considered in detail in this Guide.
The franchise agreement is a hybrid contract, essentially granting the right to use a branded business format (which is why, properly described, franchising is referred to as "business format franchising") comprising various elements, including:
Various intellectual property rights, almost invariably one or more trade marks and copyrighted materials.
The "System" know-how developed as a package by the franchisor.
The know-how will consist of confidential and secret information which is specific to the business, generally blended together with management techniques and procedures which are to some extent generic and in the public domain.
A key element in business format franchising, which distinguishes it from other forms of licences (which may grant the right to exploit certain rights, but are not prescriptive of the entire format and presentation of the business) is the operations manual, sometimes developed over time into a series of manuals each dealing with distinct parts of the operation and management of the particular business. The operations manual or manuals essentially provide the blueprint for the operation of a successful business using the particular System. The contract will, crucially, require the franchisee to comply with the policies, procedures, standards and requirements of the franchisor as set out in the manuals, many of which are essential to ensure the high quality and consistent presentation of the brand. As the business concept must inevitably develop over time in the competitive environment, the franchisor must introduce changes to the manual, requiring its franchisees to adapt and change their business practices accordingly. It must retain the right to do so unilaterally. If changes to the operations manual were to be considered as amendments to the franchise agreement, the franchisor would need to obtain the consent of each and every franchisee in its network before doing so.
The franchisor backs up the provision of know-how in this way by providing initial and ongoing training programmes, by monitoring and inspecting the performance of its franchisees in the field, by receiving financial reports, and by providing consultancy services, usually in addition to at least an annual franchisee conference, often combined with new product presentations, training, and so on.
Particular businesses may package up, in addition to the franchise agreement itself, other important elements, such as:
A lease or a sublease for premises.
An equipment lease.
A software licence.
Other ancillary agreements.
It will be necessary to explore the impact of local laws on these arrangements.
Usually, the franchisor will require that a guarantor stands behind the franchisee limited liability operating entity, agreeing to be responsible for fees if the franchisee does not pay, and undertaking to ensure that the franchisee follows the requirements of the agreement.
Franchisors are, as they recruit prospective franchisees, essentially selling the business opportunity, often to relatively unsophisticated and inexperienced small business people who frequently invest their life savings into the business, perhaps taking a mortgage over their home to secure bank funding. Consequently, a growing number of countries, originally led by the US, have developed franchise-specific regulations, designed to protect potential unsophisticated franchisees from misrepresentation in the franchisee recruitment process. Every country's laws and procedures provide remedies for misrepresentation, but franchise-specific regulations can create a separate category of remedies and sanctions for breach. Some countries' general laws of contract require proper disclosure in good faith to a prospective franchisee of all material facts relevant to its decision to enter into the commitment. Others do not have such a general requirement, adopting a "buyer beware" approach.
The most frequent approach to franchising regulation is to require the franchisor to develop a formal "pre-contract disclosure document" containing specified facts and information about the franchisor, the business, the level and nature of the investment required, the contract, the existing network, the bankruptcy or disqualification history of the franchisor's directors and so on. Franchising regulations also require that the document be made available to the prospective franchisee sufficiently in advance of being bound by the agreement, providing them the opportunity to carefully review what is presented, and to potentially change their mind. The content and specific rules relating to these mandatory disclosure requirements vary from jurisdiction to jurisdiction.
Some regimes provide an exclusion from disclosure requirements where the prospective franchisee is a significant and sophisticated investor. This is a very practical and sensible regulatory approach for big deals where big companies or experienced business people are involved and agreements will be heavily negotiated.
Some jurisdictions require that the franchisor must register with a government authority before they can offer franchises in the state or country, and some require registration and approval of the disclosure document by these authorities, usually with an obligation to keep the registration up to date on a periodic, typically annual, basis.
International franchisors must establish whether, in countries where there are pre-contract disclosure requirements, and where sub-franchise contracts will be issued by a local master franchisee, they are also themselves obliged to participate in the disclosure process at that level, or whether the local master franchisee can be solely responsible for complying with the relevant regulations.
National franchise associations have been formed in most countries where franchising has developed. These are essentially trade associations representing the interests of franchisors and of franchising. Some associations have a category of membership for franchisees. Many associations have produced a code of ethical practice, which typically, of itself, does not have the force of law, nor would be incorporated as implied terms into members' franchise agreements, but is binding on its members under a regime of voluntary self-regulation.
Franchisors must also take care to understand whether a franchisee whose contract has come to an end is entitled as a matter of local law either to a renewal or to compensation. If so, franchisors must carefully consider the choice of law to govern their arrangements and factor this into its planning and modelling for the country. Fortunately, this is an issue in relatively few jurisdictions.
In addition, if a franchisor becomes involved in the real estate for the premises occupied by the franchisee for the purposes of the business, it will usually want to ensure that the franchisee does not acquire security of tenure entitling it to remain in the premises, so that, at the end of the term, or if the franchisee has been terminated, the franchisor can continue to operate the branded business from the premises or bring in a replacement franchisee to do so. Where franchisors do not become involved in the real estate, they will usually want to investigate what mechanisms are available to enable them, or a replacement franchisee, to exercise options to acquire the franchisee's premises on termination, and so not lose the presence of the brand in the local market.
Another very important area to address when conducting a legal audit of the issues that may interfere with the franchisor's business model in a target jurisdiction is the area of competition law. It is inherent in franchising that the market is shared or partitioned in some way, either by the grant of territorial rights to individual franchisees, an approach to sharing customers or by requiring franchisees to operate only from particular premises, or preventing them from engaging in e-commerce. A franchisee who has learnt from the franchisor all about the particular business to become a successful franchisee in its network, must be prevented from running a competing business under a different name, in parallel to the franchise and so potentially diverting what would otherwise be royalty-generating sales from customers loyal to the franchisor's brand. Similarly, a franchisor would expect that it can impose enforceable post-term restrictions on competition, at least for a reasonable period of time in a reasonable geographic area, again to protect the brand and the prospects of success for a replacement franchisee, in addition to post-term confidentiality restrictions. For some businesses, it is critical to their business model that they are legally free to tie their franchisees to buy a range of products or equipment from the franchisor or its designated suppliers, and prohibit competitive or brand-damaging products, therefore both ensuring quality to maintain the image of the brand, but also providing the franchisor with an income stream which is key to its business model. All these issues must be carefully investigated and considered together with experienced local counsel in the target market.