International development of a franchise network: legal aspects

The international development of a franchise network can result from opportunities, such as being a strategic growth driver, or even a necessity, for networks that have matured in their domestic market

This article aims to summarize the main possible legal modalities for the expansion of an international franchise network, before presenting the fundamental legal aspects that must be anticipated to secure such an expansion.

The Legal Terms and Conditions for the International Development of your network

The choice of the most appropriate legal modalities to approach a foreign market is a strategic decision that depends in particular on the objectives of the franchisor, its financial and human capacities, its desire for control and local regulatory constraints. Several options, involving varying levels of investment and control, can be considered.
Own

Development: Subsidiaries and Branches

The creation of a subsidiary (separate legal entity) or a branch (simple establishment of the franchisor without its own legal personality) in the target country represents the highest level of integration.

• Advantages: This approach offers full control over operations, development strategy and branding. It also allows the franchisor to capture all the profits generated locally.
• Cons: This is the most expensive and risky method. It requires significant financial investments, in-depth knowledge of the local market and the mobilization of significant human resources. In addition, the franchisor must comply with all local laws, including corporate, labour and tax laws, and may encounter foreign investment regulations.

The International Franchise Agreement

In this model, the franchisor, from its home country, enters into franchise agreements directly with franchisees located in the foreign country.

• Advantages: The franchisor retains a direct link and control over each franchisee, which ensures a better homogeneity of the network. Revenues per unit are also higher than in a master-franchise system sincethey are not shared.
• Cons: Managing a network remotely can be complex and costly, including support, training, and quality control. This option is often viable for geographically and culturally close countries. The proliferation of these contracts may also lead to the need to manage a large number of franchisees, in different markets.

The Master-Franchise

Master franchise is one of the most widespread methods for rapid international expansion. The Franchisor (the “Master Franchisor”) grants to a local entity (the “Master Franchisee”) the exclusive right to develop the Network in a defined territory (which may range from a region to one or more countries). The master-franchisee then acts as a sub-franchisor: he recruits, trains and assists his own sub-franchisees with whom he contracts directly.

• Advantages: This formula limits the investment and risk for the lead franchisor. It makes it possible to rely on the expertise of the master-franchisee, his knowledge of the market, culture, local regulations and his relational network. The adaptation of the concept to local specificities is also facilitated.
• Disadvantages: The franchisor’s control over the network is indirect and therefore weaker, which can pose a risk to the brand image. Revenues are also shared, with the franchisor receiving only a fraction of the royalties paid by the sub-franchisees. Finally, the end of the contractual relationship is a critical point that must be meticulously prepared to determine the fate of the sub-franchisee network.

The Joint Venture

The franchisor can partner with a local partner to create a joint venture. This new entity will be responsible for developing the network in the country, either on its own or through the use of the franchise.

• Benefits: Risks, investments and skills are shared. This structure combines the strength of the franchisor’s concept with the local anchorage and expertise of the partner.
• Cons: Success is based on the alignment of interests and the quality of the relationship between partners. The governance, distribution of powers, financing strategies and exit clauses in case of conflict or blockage must be precisely defined in a shareholders’ agreement to avoid inextricable situations.

The Master Development Agreement combined with a Franchise Agreement

This contract is concluded with a “developer” franchisee who undertakes to open a certain number of own points of sale in a given territory and according to a defined schedule. Unlike the master-franchisee, the franchisee does not have the right to sub-franchise; he is a multi-franchisee.

• Advantages: The franchisor retains direct control over network standards and receives higher revenues.
• Cons: Financial risk is focused on a single partner. The end of the contract can be problematic if the franchisor does not have the means to buy back the units or does not find a buyer, to maintain its presence in the territory.

The Area Developer

The Area Developer, often a franchisee who has proven his loyalty to the brand, his mastery of the concept and know-how, is responsible by the franchisor for recruiting franchisees on behalf of the franchisor. Either as a broker (it connects candidates with the franchisor) or as an agent (it acts in the name and on behalf of the franchisor). Franchise agreements are signed directly with the franchisor, but the Area Developer can also be involved in the facilitation and assistance of the network, for example by taking charge of training or visits. This arrangement raises tax issues, including the risk of constituting a “permanent establishment” for the franchisor in the country concerned.

Combination of these Solutions

In practice, it is not unusual for these solutions to be combined or to follow one another. For example, a master franchise agreement may be concluded with a Joint Venture, so as to provide it with the brand, know-how and assistance of the franchisor to enable it to conclude the franchise networks itself, without surrendering its strategic assets to it. Over time, the franchisor may have to leave this Joint Venture, or on the contrary take sole control of it. It is also possible to conclude a first international franchise contract to make a first test, the franchisee then becoming an area developer or master franchisee.

The Fundamental Legal Aspects to Anticipate

Regardless of the model chosen, successful internationalization relies on anticipating several critical legal issues.

Protection of Intellectual Property

The brand is the cornerstone of the franchise system. Its protection is an absolute and non-negotiable prerequisite.

• The Brand: Before taking any steps, it is imperative to check the availability of the brand and to register it in the target countries. Several systems coexist: national trademarks, European Union trademark (EUIPO), or the Madrid system for an international registration (WIPO). This process may take a long time to obtain confirmation of trademark registration and should be anticipated.
• Know-How: The confidentiality of know-how must be ensured by robust contractual clauses. Its adaptation to the local market may be an issue.

Domain

• Names:It is also essential to register the corresponding domain names, including national extensions (.fr, .de, .co.uk, etc.) to master the online presence of the brand.

International Contract Law

Drafting the contract is a crucial step that determines the balance and security of the relationship.

• The Choice of Applicable Law (Lex Contractus): The European regulation “Rome I” enshrines the principle of autonomy of will: the parties are free to choose the law that will govern their contract, provided that this does not constitute fraud against the rights of one of the parties.
• The Impact of Police Laws: The choice of a law does not rule out the “police laws” (or mandatory provisions) of the foreign country. These are rules deemed so essential for the protection of the public interests of a State (social, political or economic) that they imperatively apply to any situation falling within their scope, regardless of the law designated in the contract. It is also necessary to take into account the rules applicable locally to the exercise of the activity but not directly concerning the relations between co-contractors. The contract must take this into account so as not to impose non-compliant obligations preventing proper performance of the contract or presenting a risk of sanctions. The pre-contractual information obligation, such as the Doubin law in France, can thus be a police law. As well as rules applicable to the sector of activity, competition law, rules on personal data or foreign exchange regulations. Therefore, a franchisor must often comply with both the law chosen in the contract and the police laws of its partner’s country of location. A review by a local colleague is therefore essential to ensure the effectiveness of the contract.

Dispute

Resolution

Anticipating conflict management is essential in an international context.

State
• Jurisdictions: The parties may insert a jurisdiction clause to designate the courts of a country. Within the EU, the “Brussels Ia” regulation regulates this matter. It is crucial to draft the clause broadly (“any dispute arising out of or in connection with the contract”) to cover disputes of a contractual as well as tort nature (e.g. unfair competition).

International

• Arbitration: Arbitration is often preferred in international contracts. It offers significant benefits:
• • Neutrality: It prevents one of the parties from being judged by the “national” courts of the other.
  • Confidentiality: The procedure remains private.
  • Enforcement: Arbitral awards are more easily enforceable abroad than state judgments, thanks to the 1958 New York Convention. The arbitration clause must be drafted carefully, specifying the seat of the arbitration, the language, the number of arbitrators and the applicable arbitration rules (e.g. ICC, LCIA) if applicable.

Specific Contractual Clauses

In addition to the classic clauses of a franchise agreement and its adaptation, the international context requires particular attention to certain points. The operation of the franchise should be adapted to international aspects. Among the aspects that can be impacted may include the organization of training and participation in network events (due to distance and costs), procurement methods (to allow cheaper, faster local procurement, etc.), software (for language issues or compliance with local rules in force), or brand communication (the franchisor having less control of the local market). Also, the language of the exchanges must be defined as well as the language of the contract.

Beyond these topics, the following clauses require special attention:

Development
• Plan: In master franchise or development contracts, this clause is central. It must precisely define the territory, the number of openings, the number of cumulative open establishments, a timetable and the sanctions in case of non-compliance (penalties, loss of exclusivity, termination).
• Adaptation of the Concept: The contract must provide for the modalities of adaptation of the concept to the local market (products, marketing, consumer habits, regulations, etc.), defining who is responsible for it (generally the local partner) and under what control of the franchisor so that it retains control. In the same vein, it may be necessary to define the terms of translation of the documents that will be submitted by the franchisor: in which language are they submitted, who takes care of any translations?

Financial

• aspects: Provision should be made for the currency of payment, payment guarantee clauses, and foreign exchange risk. “Gross-up” clauses may be inserted so that the net royalties collected by the franchisor are not affected by any local withholding taxes. In some countries, it is also necessary to anticipate foreign exchange regulations, as certain payments may be subject to specific authorizations. Suitable drafting to avoid questions of interpretation of the classification of payments under tax treaties may also be required.

Supply

• clauses: when the contract involves questions of supply by the franchisor or a company in its group (whether exclusive or not) particular questions arise with regard to international trade law: application or not of the Vienna Convention on the sale of goods, choice of an INCOTERM in connection with international sales, payment guarantees, etc. Topics of product conformity may arise involving the definition of the respective obligations of the parties: who performs the required formalities, what information must be provided by the other party to allow these formalities.
• End of Contract: This is a hotspot, especially in master-franchise. The contract must organize the fate of the network of sub-franchisees: providing a replacement mechanism allowing the franchisor (or a new master-franchisee) to take over the contracts in progress is essential to ensure the sustainability of the network in the territory.

Conclusion

The international development of a franchise network is an ambitious undertaking that cannot be improvised. Success depends on a prior strategic analysis to choose the most suitable implementation modality and rigorous legal engineering to secure the operation. The protection of intellectual property, the careful drafting of contracts taking into account local police laws, and the anticipation of dispute resolution mechanisms constitute the fundamental triptych on which a sustainable and profitable international expansion is based. The assistance of specialized legal advice, both in the country of origin and in the target country, is therefore essential to successfully navigate the complexity of international trade law.