International Franchising

• Author: Mark A. Kirsch and John H. Pratt
• Pages: 279-327

279

International Franchising

CHAPTER 7

Mark A. Kirsch and John H. Pratt

Contents

Editor’s note: This chapter on International Franchising is new for the fourth

edition of this book. It is intended as a basic overview of international franchising

for the U.S. franchise practitioner who is taking some early, or baby, steps into the

arena of international franchising. Note that the ABA Forum on Franchising pub-

lished a book in 2013 titled Fundamentals of International Franchising, second

edition, which explores these issues, and many others, in much greater detail.

I. Going International . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281

A. Drivers of International Expansion . . . . . . . . . . . . . . . . . . . . . . 281

B. General Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 282

C. Franchisor Resources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 83

D. Due Diligence Regarding the Target Country . . . . . . . . . . . . . . 284

E. Hiring Local Counsel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 85

F. Identifying and Prospecting Countries . . . . . . . . . . . . . . . . . . . . 286

II. Trademarks and Intellectual Property . . . . . . . . . . . . . . . . . . . . . . . . 287

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287

B. Selection/Registration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 287

C. Registration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 88

D. Community Trademarks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289

E. The Madrid System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290

F. Licensing Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291

G. Domain Names and Social Networking . . . . . . . . . . . . . . . . . . . 292

H. Other Intellectual Property Rights, Including Copyright and

Trade Secrets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293

1. Trade Secrets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 293

2. Copyright . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294

3. Patents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 4

III. Structure of International Arrangements . . . . . . . . . . . . . . . . . . . . . . 295

A. Master Franchising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

B. Direct Single-Unit Franchise Sales . . . . . . . . . . . . . . . . . . . . . . . 2 97

C. Area Development/Multi-Unit Development . . . . . . . . . . . . . . . 297

D. Area Representative Agreements . . . . . . . . . . . . . . . . . . . . . . . . 2 98

E. Options and Rights of First Refusal . . . . . . . . . . . . . . . . . . . . . . 2 98

F. Joint Ventures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299

280 Fundamentals of Franchising

IV. Legal Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300

A. Franchise Disclosure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300

1. Disclosure Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 300

2. Code of Ethics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302

3. Civil Law Principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 2

4. Franchise Disclosure Document . . . . . . . . . . . . . . . . . . . . . . 303

B. Registration/Recording . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 03

1. Trademark filings and approval . . . . . . . . . . . . . . . . . . . . . . 3 03

2. Foreign Investment Approval . . . . . . . . . . . . . . . . . . . . . . . . 304

3. Franchisor Registration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304

C. Exchange Control/Central Bank Restrictions . . . . . . . . . . . . . . 304

D. International Tax Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 304

1. Withholding Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 305

E. Post-Termination Indemnification/Agency Laws . . . . . . . . . . . . 305

1. Local Ownership Requirement . . . . . . . . . . . . . . . . . . . . . . . 306

2. Competition Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 306

F. Data Privacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 07

G. Import/Export Control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 09

V. The Master Franchise Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 9

A. Commercial Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 10

1. Territory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 10

2. Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 311

3. Unit Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 313

4. Term and Renewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314

5. System Changes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 5

B. Legal Issues . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 315

1. Confidentiality and Covenant Against Competition . . . . . . . 315

2. Transfer Restrictions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316

3. Termination and Nonrenewal . . . . . . . . . . . . . . . . . . . . . . . . 3 17

4. Indemnification Obligations . . . . . . . . . . . . . . . . . . . . . . . . . 3 17

5. Guarantees/Letters of Credit . . . . . . . . . . . . . . . . . . . . . . . . . 3 18

6. Liquidated Damages/Penalty Clauses . . . . . . . . . . . . . . . . . . 319

7. The Subfranchise Agreement . . . . . . . . . . . . . . . . . . . . . . . . 320

VI. Dispute Resolution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 321

B. Choice of Law Governing the Relationship . . . . . . . . . . . . . . . . 321

C. Choice of Forum to Resolve Disputes . . . . . . . . . . . . . . . . . . . . 323

D. Mediation and Informal Dispute Resolution . . . . . . . . . . . . . . . 323

E. Arbitration of Disputes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324

F. Laws Governing International Arbitration . . . . . . . . . . . . . . . . . 325

G. Arbitration Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 326

H. Other Issues That Impact International Arbitration . . . . . . . . . . 32 7

Chapter 7 International Franchising 281

I. Going International

“International franchising,” from a U.S. perspective, is a U.S. franchisor “ex-

porting” its brand to a foreign country through some type of licensing, franchis-

ing, master franchise, or joint venture relationship. While international franchising

also includes U.S. operators or independent business owners becoming franchi-

sees or master franchisees of foreign-based brands, and other country-to-coun-

try franchising and licensing, anecdotally, many industry insiders (lawyers,

franchise development agents, IFA representatives, and others, consulted by the

authors) believe that the largest portion of international franchising (from a rev-

enue and unit growth perspective) is U.S. franchisors granting multiple-unit fran-

chise rights outside of the United States. International franchising has grown

steadily since the 1980s. This chapter addresses some of the key strategic, busi-

ness, and legal issues that franchisors and counsel face as they embark on an

international franchise program.

A. Drivers of International Expansion

A franchisor’s decision to “go international” may be shaped by different influ-

ences. Anecdotal experience indicates that many initial forays into foreign coun-

tries, particularly for younger systems, or those that have not developed nationally

or even multi-regionally, are opportunistic and not part of a strategic plan. An

existing franchisee, or developer, customer, or franchisee of another brand in

the same country, approaches the franchisor and asks to become the franchisee

in country “X.” In these situations, the driver for international expansion is often

based on the desire to receive a large up-front fee and a chance to travel to

exotic places as part of the franchise development, coupled with the recognition

that if the arrangement flops in a far-flung country, the failure will have little or

no impact on the brand in the U.S. For some companies, the lure of international

expansion is simply the cachet of having an international footprint, regardless

of whether the business adds to the bottom line.

Some franchisors approach international development more strategically.

For example, franchisors might research countries that may have a consumer

market that is receptive to the business or brand; the ease (or difficulty) of local

operators/franchisees to obtain inventory, ingredients, or equipment; the simi-

larity of language and culture; the ease and cost of supporting franchisees or a

master franchisee in the country; the regulatory and business environment; and

similar factors. For these reasons, Canada is often one of the first foreign coun-

tries where U.S. franchisors venture out.