As many of our clients expand beyond the territorial confines of the United States, we provide advice concerning overseas expansion and protection of intellectual property rights abroad. We have relationships with various attorneys in other countries who assist us in providing the local perspective on expansion within a particular country.
What is International Franchising?
Many countries, and several Canadian provinces, have adopted specific franchise laws and regulations. In addition, franchising is also subject to laws of general applicability that can have a large impact on the sale and operation of a franchise system in a particular country, including duties of good faith and laws governing the licensing of intellectual property, remittance of payments, competition and fair business practices.
The laws of each specific nation will then necessarily impact how a franchise is sold and operated in that country and what if any pre-sale disclosure is required. One of the major differences between the laws of nations is whether the judicial system is based on common law or civil law. Generally, countries that were at some time governed by the British have legal systems based on English common law, which is not based on legislation, but rather on past judicial decisions (precedent) as it is developed through the court system. Civil law jurisdictions are largely based on legislation and regulations which are then interpreted by the courts. A rough guide is that in common law countries what is not expressly prohibited is permitted whereas in civil law countries what is not expressly permitted is prohibited. The United Kingdom, the United States of America, Canada, Ireland, India and Australia are some of the countries that are common law jurisdictions. Most other countries are based on civil law.
Several aspects of U.S. law will also govern any sale or operation of an international franchise. Although applicable generally, the requirements of U.S. anti-terrorism laws can take on added prominence when contemplating and concluding an international transaction. A violation of these laws does not have to be purposeful or knowing to result in legal problems for the franchisor, and officers and directors of a company in prohibited transaction are personally liable. Accordingly, we strongly recommend that our clients engage a company to perform a comprehensive background check on the parties on the other side of the transaction. You should obtain a background check on each prospective franchisee, partner or investor to ensure that you comply with the USA Patriot Act and Executive Order 13224. Moreover, The USA Patriot Act requires various entities to implement anti-money laundering procedures and to observe certain reporting and record keeping requirements.
Further, U.S. franchisors doing business in foreign countries must comply and attempt to ensure their franchisee’s compliance with the Foreign Corrupt Practices Act, which prohibits bribery of foreign officials and imposes certain accounting and recording requirements on publicly traded companies. In addition, a U.S. franchisor considering expansion into certain Arab countries in the Middle East must navigate the U.S. anti-boycott regulations if the target countries have laws which require a boycott of Israel and of companies that do business in Israel.
Finally, various and complex tax issues may arise in international franchising, including the target countries’ withholding taxes on initial and on-going fees and other income streams, duties and sales or Value Added Tax on imports, sales or supplies of goods or services, the availability of tax treaty relief, and possible stamp duties payable on contracts, which will affect the contractual arrangement, as will the U.S. tax treatment of the franchisor.
In order to structure the international franchise offer so that it complies with the applicable laws of the target country and best addresses any unique tax issues, we work with local counsel in each jurisdiction in order to ensure that the agreement is enforceable as intended and to minimize any tax implications of the transaction.
When proceeding internationally, the importance of completing a thorough due diligence review cannot be underestimated. This review should include an investigation of: (1) how business is conducted in a particular country, its laws, and whether the system can be adopted to a particular foreign market; (2) background information about the reputation and credit history of the potential franchisee; (3) the prospective franchisee’s capital and management capacities to fulfill their contractual obligations; and (4) product and equipment sourcing in the target country.
While some franchisors elect to expand internationally offering the same type of franchises as sold in the United States, i.e. single units, options, multi-unit agreements, and area development agreements, in which the franchisor and franchisee are both parties to the governing agreement, most franchisors elect to offer either area development rights or master franchises internationally. However, many franchisors will treat expansion into Canada as an extension of their U.S. franchise program and offer traditional agreements given Canada’s proximity, North America’s relative economic integration, and common law legal system.
Regardless of your method of international expansion, as a threshold matter you should immediately take steps to register the franchisor’s trademarks in the target countries. Prior to filing for a trademark registration we also recommend that the company obtain a search report in each country to ensure that the mark is available.