Cross-border franchising: the legalities around growing internationally

Once a franchise network is firmly established in the UK, many franchisors look to export the system overseas. This can open a whole new market but does raise a number of legal, regulatory and practical considerations.

The first and most important thing is to consider whether the business system will work in the new location. There is no guarantee a model which works well in one country will translate into a successful franchise in another with different culture, customs and local market conditions. It’s therefore always worth testing the system with a pilot operation in the target country before incurring the costs and time of a full launch. The pilot should run for at least a year. This will give an opportunity to identify and solve any problems, understand local legal and regulatory requirements, local labour market conditions and other areas where the system can be tailored to better reflect the local conditions in the overseas territory.

Having decided to proceed, there are several ways a franchise can expand cross-border.

Direct franchising

The first option is for the franchisor to issue franchise agreements directly to franchisees in the new country in the same way they would issue agreements directly to its home franchisees. This will usually only be appropriate where the home territory and target country are geographically close to each other and have very similar cultures, customs and regulatory requirements. For example, that would work well for expansions from Germany to Austria, USA to Canada or UK to Ireland.

This is because a key feature of the franchise system is that the franchisor is able to support its franchisees and police the network. This will be more difficult if franchisees are spread across a wide area in multiple countries. Equally, the franchisor may not have enough local knowledge about the target country to be able to properly advise and support franchisees. For example, the franchisor may not be familiar with local employment practices or legal requirements.

This arrangement may also cause tax difficulties where franchise and other fees are paid by a franchisee in one country to a franchisor in another.

Master franchise or joint venture

In view of the difficulties of direct franchising overseas, many franchisors will seek the involvement of a partner from the target country. This allows the franchisor to benefit from both the partner’s local knowledge and have boots on the ground to provide support to franchisees and control the system.

This is typically achieved by entering into a joint venture and/or master franchise agreement. In a joint venture, both the franchisor and the local partner will take a stake in the business. In the case of a master franchise, the franchisor will grant the local partner a franchise for the whole of the target country. The master franchisee will then recruit local franchisees and be responsible for supporting and policing them.

Franchise fees are shared between the franchisor and master franchisee. A variation to the master franchise agreement is a franchise development agreement. This is similar to a master franchise agreement except the franchise developer will be required to open and operate its own outlets rather than recruiting franchisees to do so.

The main disadvantage with these approaches is that the franchisor hands over control to the master franchisee or franchise developer and is wholly dependent on them for the success of the business in the new territory. The franchisor retains more control in a joint venture arrangement but the extent of its power will depend on the terms of the specific agreement.

Local branch or subsidiary

Another option would be for the franchisor to open a local branch or subsidiary in the target country. This has the advantage that the franchisor retains full control over the new market and doesn’t have to share their fees with a third party. However, this method requires the franchisor to commit substantial time and resources to setting up a new branch. Also, the lack of local knowledge may still be an issue.

Protecting the brand

However a franchisor chooses to expand overseas, protecting the brand in the local area will remain a priority. Typically, this involves exploiting a number of rights including protecting the brand name and logo with trademarks.

There are several options available for international trademark protection, including applying for local protection in each individual state, making a single application for a community trademark for protection across the EU or seeking protection under various international agreements in which countries agree to reciprocal arrangements to respect each other’s national trademark protections.

Similarly, local regimes for protecting the manual, knowhow and system, which in the UK are typically protected by copyright and confidentiality, vary from country to country.

There may also be novel requirements in specific states that the franchisor ought to be aware of. For example, it’s common practice for UK franchise agreements to state that the goodwill in the brand belongs to the franchisor. However, in Germany franchisors can be required to compensate the franchisee for loss of goodwill when the franchise agreement terminates.

Regulation

There can be big differences in the extent to which the franchise industry is regulated across different countries. For example, in the UK, franchising is largely unregulated compared to the US where extensive rules and obligations apply.” In some territories – noteably France, Spain, Italy and parts of the US – franchisors are required to comply with formal pre-contract disclosure requirements which don’t apply elsewhere. The franchise agreement will be subject to local contract law which will differ from one jurisdiction to another.

Brexit

No article on international franchising would be complete without a word or two on Brexit. At the time of writing, the position is that a two-year transition period will run from 30 March 2019 to 31 December 2020. During that time, most EU law will continue to apply in the UK. It’s unlikely that Brexit will have much of an impact on UK regulation of franchise agreements but it’s still too early to tell what the wider implications – whether good or bad – might be.