Using International Franchising to Expand a Business


Following the domestic "franchise boom" in the United States in the 1960s and 1970s, and the dramatic increase in international franchise activity in the 1980s, franchising has become one of the premier vehicles for international business expansion. Franchised businesses can now be found throughout the world: across Europe and the states of the former Soviet Union; in Middle Eastern countries such as Bahrain, Kuwait, and the United Arab Emirates; throughout Asia; in Brazil and other Latin American nations, and in such developing countries as Brunei, Macau, Mauritius, and Swaziland.

Franchising now exists in more than 160 countries and is successfully utilized in more than 70 different business sectors. By one count, franchise sales are averaging a staggering $18.3 billion.

Need for Skilled Franchise Counsel
This dramatic increase in activity has brought with it a concomitant increase in the need of U.S. franchisors for skilled franchise counsel. As more and more domestic franchisors look to expand into foreign markets, an increasing number of opportunities are created for well-positioned law firms with qualified franchise attorneys, and other commercial and intellectual property attorneys.

From a marketing standpoint, the threshold consideration in positioning a law firm to take advantage of these opportunities is an assessment of the abilities and experience of the firm's lawyers. As one might expect, the legal environment for international franchising has grown in complexity as the business environment for franchising has matured. A wide range of laws affects international franchise transactions, the most important of which relate to trademark, antitrust, contract, tax, and technology transfer issues, currency control, foreign investment, import and export restrictions, and dispute resolution. These laws stem from numerous sources, including U.S. federal and state statutes and regulations, laws of the foreign nation in question, and various bilateral or multilateral treaties.

FTC Rule on Franchising
To best assist a U.S. franchisor contemplating expansion overseas, franchise counsel should have some experience with the U.S. Federal Trade Commission's Trade Regulation Rule on Franchising (FTC Rule), which applies to all "continuing commercial relationships" that are either "package and product franchises" or "business opportunity ventures."

Under the FTC Rule, a franchisor must provide to a "prospective franchisee" a disclosure document containing information in twenty required categories, along with financial statements and a copy of the franchise contract. Section 5 of the Federal Trade Commission Act (FTC Act) states that "unfair or deceptive acts or practices in or affecting commerce, are declared unlawful." The FTC Act defines "commerce" very broadly. As a result, the FTC Rule would appear to apply to international transactions, as the FTC has repeatedly asserted. One federal appeals court, in Nieman v. Dryclean U.S.A. Franchise Co., has recently held that the FTC Rule did not apply to a transaction between a U.S. franchisor and an Argentine citizen.

Knowledge of State Laws Important
State franchise laws in the Unites States may also apply to an international franchise transaction. Fifteen states have franchise sales laws that, like the FTC Rule, require that a franchisor provide extensive disclosure to a prospective franchisee at the time a franchise is offered or sold. Fourteen of these states also require registration of the franchise offering and the disclosure document. Generally speaking, these laws apply in the event of an "offer" or "sale" of franchise rights in the state and, therefore, may apply to the offer of international franchise rights, if the offer originates in the state, is accepted in the state, or is made to a domiciliary of the state.

Foreign franchise sales laws must also be considered. Since 1987, the number of countries in which franchising is specifically regulated has jumped from three to 24, and voluntary disclosure regimes have been initiated in four additional countries. In 1988, for example, franchisors in 12 countries were significantly effected when the European Commission of the European Community adopted the so-called "Block Exemption on Franchising," which prohibits certain provisions from being included in a franchise agreement. The current Block Exemption is set to expire this year, and will likely be replaced with a new exemption on expiration. Laws requiring pre-sale disclosure by a franchisor now exist in Australia, Brazil, Canada (Alberta only), China, France, Indonesia, Japan, Malaysia, Mexico, Romania, South Korea, and Spain. In general, these laws require a franchisor to provide to a prospective franchisee, prior to sale, a disclosure document containing certain required information and, in some cases, require that the disclosure document be filed with a specific government agency. Russia has enacted franchise legislation, as well, which contains certain pro-franchisee provisions that are likely to hinder the development of franchising in Russia.

Know Foreign Regulatory Barriers
In addition to franchise-specific laws, counsel for a U.S. franchisor considering an international transaction should be aware of possible regulatory barriers in the foreign country in question. Technology transfer laws, for example, regulate the sale or licensing of foreign technology (including franchises) within any country enacting such laws. While many countries have repealed their technology transfer laws since the end of the Cold War in the late 1980s, franchise counsel must be aware of any such laws still in force in the particular foreign country being considered by the client. Currency control restrictions are another example of a regulatory barrier to franchising that many nations have eased or eliminated over the past decade.

Protection of the franchisor's trademarks and other intellectual property continues to be of paramount importance. While there is no foolproof way to protect a franchisor's intellectual property, franchise counsel should certainly recommend to the client that several basic steps be taken prior to international expansion. Tax and dispute resolution concerns must also be considered. Franchise counsel should have some familiarity with any bilateral tax treaties between the United States and the foreign country being targeted and with the multilateral treaties concerning dispute resolution, including the New York Convention of the Recognition and Enforcement of Foreign Arbitral Awards.

Understand Typical International Franchise Arrangements
Experienced franchise counsel will also have an understanding of the advantages and disadvantages of the typical international franchising arrangements. The most common method employed by domestic U.S. franchisors expanding overseas is "master franchising," wherein the franchisor grants a foreign party the right to itself establish and operate franchised outlets and to license others to do so as well. Direct franchising, wherein the franchisor directly grants to a franchisee the right to operate a franchised outlet, is also used, but is typically limited to cases where the franchisee is located in a country geographically close to the United States and where the culture and legal system of the country is similar to that of the United States. Joint ventures are also used, as are various types of licensing and distribution arrangements.

As can be seen, numerous legal and business issues present themselves during the course of a franchisor's overseas expansion. Experienced franchise counsel can provide valuable assistance at each stage of the process by helping to structure the transaction, by preparing letters of intent and draft agreements that are sensitive to the specific legal concerns involved, and by assisting the franchisor in negotiating the final agreement. Marketing professionals can help to place their firms in a position to capture some of this franchise work by employing basic marketing tools, practice group and individual practice development plans, and well-focused seminars. To begin such a process and to become more familiar with current events and trends in international franchising, contact the International Franchise Association (www.franchise.org) or the American Bar Association's Forum on Franchising (www.abanet.org/forums/franchising).

Editor's note - Mr. Loewinger heads the Franchise and Distribution Group of the Washington, D.C., office of Buchanan Ingersoll. Mr. Steinbrecher is an associate with the group.