Following this article’s part one analysis and synthesis of various Singapore laws in the context of franchising in the Law Gazette’s February issue, this second part is an environment scan of franchise-specific laws and practices adopted in some other countries, together with the rationale behind those laws. Home-grown Singapore brands that plan to extend their reach worldwide via franchising would find this information practical.
The Legal Environment of Franchising in Singapore and a Comparative Overview of Franchise Laws in Some Other Countries
- Part 2: Franchise-specific Laws in Some Other Countries
Interestingly, it is not a case where developed countries are legislating franchising more than their developing brethren. Both the developed countries (such as US, Japan, Europe, Australia) and the developing countries (such as China, Indonesia and Malaysia) have franchise-specific legislation. Yet, some developed countries (such as the UK, including Singapore) and developing nations (such as India, Thailand and the Philippines) chose not to legislate franchising, probably preferring to rely on the existing healthy commercial law environment and industry-led Codes of Ethics to regulate franchising.
Rationale Behind Such Franchise-specific Laws
Understandably, why and how a country is triggered to legislate franchising depends on its own domestic issues. In this article, the author chooses to highlight the experiences of the US and Australia.
In the US, based upon an original rulemaking record,1 it was stated2 that the US Federal Trade Commission (“US FTC”) found widespread deception in the sale of franchises and business opportunities through both material misrepresentations and nondisclosures of material facts. Specifically, the US FTC found that franchisors and business opportunity sellers often made material misrepresentations about the nature of the seller and its business operations, the costs to purchase a franchise or business opportunity and other contractual terms and conditions under which the business would operate, the success of the seller and its purchasers and the seller’s financial viability. The US FTC also found other unfair or deceptive practices pervasive: franchisors’ and business opportunity sellers’ use of false or unsubstantiated earnings claims to lure prospective purchasers into buying a franchise or business opportunity, and franchisors’ and business opportunity sellers’ failure to honour promised refund requests. The US FTC concluded that all of these practices led to serious economic harm to consumers. All these led to the 1978 Franchise Rule which was subsequently updated in 2007.
We now turn to the latest franchise law reform in the world and its rationale.
The Australian federal government reformed its Franchise Code of Conduct3 (“AU Code of Conduct”) in July 2010. The AU Code of Conduct is prescribed under the Australian Trade Practices Act which was renamed the Competition and Consumer Act 2010 on 1 January 2011.4 It empowers the Australian Competition and Consumer Commission (“ACCC”) to conduct random audits of franchisors to investigate and act against breaches of the AU Code of Conduct from 2011 with new information-gathering powers and the authority to issue public warning notices about rogue operators and to seek redress for all of those franchisees affected by such breaches. There are no financial penalties for franchisors who breach the Code.
Small Business Minister The Hon Dr Craig Emerson MP (this was his title in March 2010, he is now the Australian Minister for Trade) said5 the reforms aim to better protect franchisees from unconscionable conduct and false and misleading representations from unscrupulous franchisors while retaining for good, honest franchisors the flexibility they need to make franchising a commercial success for themselves and their franchisees.
Dr Emerson, releasing the report of an Expert Panel6 set up to look at specific areas of concern in the franchising community, said it was vital that people who were considering buying a franchise had a complete understanding of the contract.
While each country has its specific reasons for legislating franchising, the Business Franchise Guide7 which surveys franchise laws around the world noted:
… many franchises reflect a profound imbalance of contractual power in favour of the franchisor, and fail to give due regard to the legitimate business interests of the franchisee, as a result of the franchisor reserving pervasive contractual rights over the franchise relationship. Therefore, governments see regulations as necessary to restore freedom to contract, and to remove restrictive barriers impeding entry into industries and markets dominated by franchise systems.
The next few paragraphs are examples of franchise-specific legislation in various countries (Japan, Malaysia, China, the US, Australia, Brazil).
Registration of Franchises
Some countries require a franchisor to first register his franchise with the relevant government department before the franchise can be offered for sale.
For example, in Malaysia, it is an offence for any franchisor to offer his franchise without having first registered with the Registrar8 unless he has secured an exemption9 from the Minister in charge of Franchise. As the definition of a “franchisor” includes a master franchisee with regard to his relationship with a sub franchisee,10 a franchisor may allow his master franchisee to register his franchise. The non-registration of a franchise is prescribed as an offence punishable with a fine. Violations can result in fines from RM5,000 to RM50,000 for the first offence and additional fines of RM10,000 or jail terms of up to five years or both for the second offence.
Foreign government agencies overseeing the franchise registration process11 are usually equipped with law enforcement powers. As such, non-compliance of franchise laws are to be taken seriously.
Registration in some countries is in the form of registering the franchise agreement with the relevant government departments. Coupled with this requirement is the need for the to-be-registered franchise agreement to be translated into the local language.
For example, in Brazil, a franchise agreement registered at the National Institute of Industrial Property has to be in the Portugese Language. It is upon registration that the payment of franchise fees and royalties can be legally remitted overseas and the franchisee can qualify for tax deductions.
The time frame required to register a franchise agreement is also important to note in order to avoid any delay in launching a franchise.
For example, in China, the document preparation to register a franchise agreement with the Chinese Ministry of Commerce (“MOFCOM”) takes two to six weeks or longer, considering the possible notarization and legalisationof relevant documents. It takes three to five working days to obtain an “Identification” from MOFCOM Filing Office for log-in into the MOFCOM filing system. According to the provision of Administrative Measures for Archival Filing of Commercial Franchising Business, upon completion of the regisgtration process, MOFCOM would, theoretically, within 10 days after its receipt of all the materials which comply with its requirements, approve the archival filing and publish the information on its website. However, the requirements and policies may change from time to time, so it may require additional time for providing supplementary materials if required by MOFCOM. Overall, the whole exercise may take approximately one to two months, if it went smoothly.
Below are several different provisions of relationship laws that are mandated by statute.
In Malaysia12 for example, a franchise agreement must provide for a cooling-off period of not less than seven working days during which the franchisee has the option to terminate the Agreement.
Similarly in Australia,13 a prospective franchisee is entitled to a cooling-off period of seven days after the signing of a franchise agreement (not a renewal, extension or transfer).
On the other hand, a “cooling off period” does not apply to a franchise agreement in Japan because a franchise agreement is made between entrepreneurs legally independent of each other and a franchisee is not regarded as a consumer to be protected by law.
Refund of Monies to Franchisee Upon Termination Within Cooling Period
The Malaysian Franchise Law14 stipulates that upon termination of the franchise agreement within the cooling period, an amount to cover the reasonable expenses incurred by the franchisor to prepare the agreement may be retained by the franchisor from the initial fees paid; however all other monies must be refunded to the franchisee.
In Australia, if a franchisee changes his mind within the cooling-off period, he is entitled to a full refund of his investment within 14 days, less any reasonable expenses incurred by the franchisor.15
Compensation When the Franchise Agreement is Not Renewed
Malaysian Franchise Act16 lists the circumstances where a franchisor who refuses to renew or extend a franchise at the end of its term must compensate the franchisee either by buying back the franchise or by other means at a price to be agreed to between the franchisor and the franchisee after considering the diminution in the value of the franchised business caused by the expiration of the franchise.
Similarly, in Japan, there is a risk that a franchisor will not be allowed to refuse to renew or extend a franchise agreement at the end of the term if such refusal is deemed to be offensive to the public order and morals or the principle of faith and trust. When determining whether such refusal is offensive to the public order and morals or the principle of faith and trust, a Court would consider the following matters:
1. Whether or not the franchisee made an effort independently of the franchisor to obtain or develop products and meet the needs of consumers;
2. The degree to which the franchisor has contributed to the spread of trademarks, trade names, and other indications of the franchisor; and
3. Whether or not it has been a general rule between the franchisor and franchisee to renew or extend the franchise at the end of the agreed term, etc.
Terminate with Good Cause
In Malaysia, the Franchise Act17 prohibits termination before the expiration date without good cause. Events that qualify as “good cause” are provided by statute.'
In Japan, there is no law explicitly prohibiting you from terminating a franchise agreement before the expiration without good cause or advance notice to a franchisee. Nonetheless, in a franchise system, since a franchise is legally independent of a franchisor, the relationship between a franchisor and a franchisee is subject to the Act on Prohibition of PrivateMonopolisation and Maintenance of Fair Trade (“Antimonopoly Act”). Therefore, if a franchisor terminates a franchise agreement prior to the expiration date without good cause, the franchisor might be regarded as using its stronger bargaining position and placing the franchisee in a disadvantageous position in light of normal business practices, and the franchise agreement might thus violate the Antimonopoly Act.
Opportunity to Remedy a Breach
Generally, in Malaysia,18 advance notice is required and the franchisee must be given an opportunity to remedy a breach cited as a cause for termination.
Similarly, in Japan, a franchisor might be regarded as abusing its stronger bargaining position and placing a franchisee in a disadvantageous position in light of normal business practices, and the franchise agreement might violate the Antimonopoly Act, if the franchisor does not give the franchisee an opportunity to remedy a breach cited as a cause for termination. The franchise agreement would fall under “unfair trade practices” as provided by the Antimonopoly Act19 and would be null and void.
According to Japan’s Guidelines Concerning the Franchise System Under the Antimonopoly Act,20 when determining whether a franchisor occupies a stronger bargaining position, you should consider a range of factors, which include:
1. The overall degree to which a franchisee depends on a franchisor, including the degree a franchisee depends on a franchisor for management guidance, the proportion of products and raw materials that a franchisee purchases from a franchisor or a party recommended by a franchisor;
2. The position that a franchisor holds in the market;
3. The degree of difficultv a franchisee faces in leaving a franchise – including initial investment, whether a franchisee has the right to cancel the agreement before it expires, the details of the right to cancel the agreement, the penalty that applies to such cancellation, and the term of the agreement; and
4. The difference in the size of the businesses between a franchisor and a franchisee.
Pre-sale Franchise Disclosure Laws
Such disclosure laws, which vary in scope and depth from country to country, aim to protect the person planning to buy a franchise as they require franchisors to supply a full disclosure of the information a prospective franchisee needs in order to make a rational decision about whether or not to invest. The information provided is compiled into a document commonly known as a Franchise Disclosure Document, which is similar to a prospectus issued to attract investments.
Generally, a franchisor is required to give a potential franchisee a disclosure document and a copy of the franchise agreement within reasonable period of time (this time frame varies from country to country) before the franchisee enters into, renews, extends the franchise agreement or pays a non-refundable deposit for the proposed franchise agreement.
In Australia, under the newly reformed Franchising Code of Conduct,21 a franchisor is required to disclose specific facts to franchisees and to follow set procedures in their dealings with franchisees. Dr Craig Emerson, the Australian Minister for Trade, said the Australian Government had agreed with an Expert Panel’s view that franchisors be asked to provide plain English guides, as well as its other recommendations in relation to unconscionable conduct, unilateral contract variations, unforeseen capital expenditure, attribution of legal costs, confidentiality agreements and the sale of the business.
In the US, federal and state franchise laws prohibit a franchisor to collect payment from a franchisee or sign a binding agreement with a franchisee prior to giving that franchisee a Franchise Disclosure Document. Remedies for legal violations include damages, rescission, civil fines and penalties, government investigation, and even criminal penalties for knowing violations.
In Japan, a general duty of disclosure is provided for in the 1973 Medium-Small Retail Business Promotion Act. The Act was implemented by the Medium-Small Retail Business Promotion Act Enforcement Regulation and is administered by the Japanese Ministry of International Trade and Industry (“MITI”).
The Japan Fair Trade Commission (“JFTC”), the competition authority of Japan, published guidelines on franchising. The guidelines consist of three parts: (i) a general description of franchising; (ii) provisions for the disclosure of necessary information at the time of the offer of a franchise; and (iii) a part on vertical restraints between a franchisor and its franchisees.
According to the second part of the guidelines, the failure to provide necessary information shall constitute deceptive customer inducement, which is one of sixteen types of “unfair trade practices” listed under the Antimonopoly Act and shall be subject to a cease and desist order by the JFTC. The aggrieved party is also entitled to raise a suit for injunction against such an act.
These guidelines list the following as examples of the items to be disclosed:
1. the conditions regarding the supply of goods to the franchisee (eg, recommendation of the supplier);
2. the details of the assistance to be offered the franchisee, such as a description of the assistance to be offered, its manner, frequency and costs;
3. the nature, amount and conditions of repayment, if any, of the fee to be paid at the time of entering into a franchise agreement;
4. the amount, method of calculation, as well as the timing and manner of payment of royalties;
5. the description of any settlement arrangement between the franchisor and the franchisee, as well as the interest rate of any loan to a franchisee offered by the franchisor;
6. whether or not the franchisor is prepared to indemnify the franchisee for its deficit or to render assistance to the operation of a franchised unit that is not doing well;
7. the terms of the franchise agreement and the conditions of its renewal, resolution as well as termination; and
8. whether or not the franchisor in the franchise agreement reserves a right to operate a unit on its own or to grant another franchise close to the franchisee and whether or not the franchisor plans to do so.
The guidelines also require that if the franchisor provides the franchisee with the projected sales or profits, such projection shall be made in a reasonable manner, on the basis of reliable data. The underlying data as well as the way in which the projected sales or profits are worked out must be disclosed to the franchisee.
In Japan, with regard to the vertical restraints imposed by a franchisor upon its franchisees, the third part of the guidelines by JFTC observes that if these restraints go further than is needed to duly operate the franchised business, they can be condemned as an abuse of a dominant position, as a tie-in, as dealing on restrictive terms or as retail price maintenance.
Also, the parties may agree in advance on the amount of the penalty for breaching an agreement. Therefore, a franchisor and a franchisee may agree that the franchisor retains an amount to cover the reasonable expenses incurred by the franchisor or even all the initial fee as the penalty if the franchisee cancels the agreement before maturity. However, it should be noted that if the penalty is excessive, a franchisor would be regarded as abusing its stronger bargaining position and placing a franchisee in a disadvantageous position in light of normal business practices, and thus, the franchise agreement would violate the Antimonopoly Act.
In the UK and European Union (“EU”), agreements which restrict or distort competition between the EU member states or in the UK, and have no net beneficial effect, may be held unenforceable and in extreme cases, render their parties subject to fines.
The focus of modern EU/UK competition laws is on the economic effect, or likely economic effect, of the agreement. As such, it can be difficult in individual cases to determine whether or not a particular agreement falls foul of the competition law rules. This is something, nevertheless, the parties have to determine for themselves by referring to the following two important competition law instruments:
1. A so-called “block exemption”: effectively a “safe harbour” for documents of a relevant kind, within which the parties can generally be certain that the competition rules will not affect them; and
2. A set of guidelines which assist in the interpretation of the block exemption and in understanding how the competition rules are likely to apply outside the safe harbour of the block exemption.
On 1 June 2010, a most recent block exemption on so-called “vertical restraints” came into effect. There is also a new set of guidelines on the same subject.
Further Regulations That Affect the Franchising Industry
Besides the above franchise- specific laws, there are also other laws that affect the franchise industry.
One example is the United States’ Section 4205 of the Patient Protection and Affordable Care Act of 2010.22 This law is designed to create single national nutrition disclosure standards for chain restaurants with 20 or more locations. It requires disclosure in a “clear and conspicuous manner” the nutrient content disclosure statement adjacent to the name of the standard menu item.
Another example is Brazil’s requirement that follows the registration of a franchise agreement and an instrument of receipt of the franchise offering circular, signed by a Brazilian franchisee. The contract and the certificate of recordation must be submitted to the Central Bank of Brazil so that an Electronic Declaratory Registration may be issued. This is a document that enables the franchisee to transfer the funds for the initial franchise fee and royalties to the foreign franchisor.
Franchise-specific Laws for Singapore?
The franchise industry in Singapore is self-regulated and the instrument of regulation is the Franchising and Licensing Association (Singapore) (“FLA”) Code of Ethics,23 which is binding on members of FLA.
While it may be intrusive and restrictive for franchise-specific laws to allow Parliament and the law to come between commercial relationships and business players, there may be a need to protect individual Singaporean franchisees who pour their hard-earned investments into buying a franchise only to find out eventually that their investments are not as high yielding as it appears.
If franchise-specific legislation were to be proposed in Singapore, it would be to respond to substantial numbers of franchisees’ complaints of being mistreated and ripped off by franchisors. Policy makers would have to do a delicate balancing act to allow franchise-specific laws, if any, to operate with confidence and provide certainty, without being unduly intrusive and restrictive. Further, they would have to constantly review compliance burdens and be mindful that introducing franchise registrations would add to business costs and possibly delays in launching a franchise.
Perhaps, it would be helpful to note the views of prominent persons from the local franchise industry, one of whom is Mr Albert Kong, Executive Committee member of the FLA, and Chairman/CEO of Asiawide Franchise Consultants Pte Ltd, an established, home-grown franchise consultancy business that has made its presence felt around the world:24
My almost-20 years in the franchising arena have brought me to many nations to speak, participate in franchise exhibitions and consult with many franchising companies and practitioners. Quite often, my perception is that countries like the USA and Australia have rather onerous laws (federal and state being different, too) vis-a-vis others that rely on self-regulation (eg New Zealand, Singapore, the UK, etc). However, whenever a black sheep appears, it is tempting for the franchising fraternity to call for tighter controls via legislation. A good example is that of Green Acres in New Zealand in 2007 where many franchisees were awarded franchises ‘fraudulently’ ... .
In case franchisors selling their franchises in Singapore – with their hefty bargaining power – think that they are a law unto themselves, they are advised to think again. Despite not having specific statutory provisions for franchising, nor a franchise-focussed government agency tasked to regulate franchise activities, Singapore has a healthy commercial legal environment (as laid out in the Part 1 of this article which was published in the February Issue of the Singapore Law Gazette) to level the playing field between franchisors and franchisees.
Goh Phai Cheng LLC
A member of Mozaic Group Law Practice
E-mail: [email protected]
* LLM (London); Advocate & Solicitor (Singapore); Barrister-at-law (Middle Temple), Solicitor (England & Wales).
Disclaimer: The opinions expressed in this article are the sole responsibility of the author and do not necessarily reflect any position or policy of Goh Phai Cheng LLC (‘the firm’). While every effort has been made to ensure that the information contained in this article is correct, neither the author nor the firm can accept any responsibility for any errors or omissions or for any consequences resulting therefrom. Nothing in this article is intended to amount to legal advice and professional opinion should be sought on a case by case basis.
Acknowledgment: The author thanks Mr Albert Kong, Executive Committee member of the Franchising and Licensing Association (Singapore), and Chairman/CEO of Asiawide Franchise Consultants Pte Ltd26 and Senior Counsel Mr Goh Phai Cheng for their comments. All references with hyperlinks were last accessed 14 January 2011.
1 (Dec 21, 1978) 43 FR 59614. Along with the 1978 Franchise Rule, the Commission published a Statement of Basis and Purpose, (Dec 21, 1978) 43 FR 59621 and later, “Final Interpretive Guides to the Rule” (Aug 24, 1979) 44 FR 49966.
2 Federal Register/Vol 72, No 61/30 March 2007/Rules and Regulations by the Federal Trade Commission, p 15445.
3 For more detailed information, you may refer to http://www.accc.gov.au/content/index.phtml/itemId/816055.
4 The renaming of the Australian Trade Practices Act 1974 was announced on the ACCC website http://www.accc.gov.au/content/index.phtml/itemId/3737.
5 Better Protection for Franchisees published in Media Centre for Senator the Hon Dr Craig Emerson MP on 3 March 2010.
6 Expert Panel report: A presentation titled Australian Franchising and the Government by Senator The Hon Nick Sherry, 11 October 2010. See http://minister.innovation.gov.au/sherry/Pages addresstothenationalfranchisingconference.aspx.
7 Business Franchise Guide, New Developments Transfer Binder No 245A (CCH, April 6, 2000) para 7373.
8 Section 6(2) of the Malaysian Franchise Act.
9 Section 58 of the Malaysian Franchise Act.
10 Section 4 of the Malaysian Franchise Act.
11 For instance, Ministry of Commerce (“MOFCOM”) in China, Ministry of Domestic Trade, Co-operatives and Consumerism in Malaysia, Ministry of industry and Trade in Indonesia, National Institute of Industrial Property in Brazil, Department of Law, Franchise & Securities Division in New York, USA.
12 Section 18(4) of the Malaysian Franchise Act.
13 Schedule Part 3, para 13(1) of the Australian Franchising Code of Conduct.
14 Section 18(5) of the Malaysian Franchise Act.
15 Schedule Part 3, paras13(3)and 13(4) of the Australian Franchising Code of Conduct.
16 Section 32 of the Malaysian Franchise Act.
17 Section 31(1) of the Malaysian Franchise Act.
18 Section 30(1) of the Malaysian Franchise Act.
19 Article 2(9)(v) of the Act on Prohibition of Private Monopolization and Maintenance of Fair Trade; Abuse of a position of strength.
20 Issued on September 20, 1983 and revised on January 1, 2010 by Fair Trade Commission.
21 For more detailed information, you may refer to http://www.accc.gov.au/content/index.phtml/itemId/816055.
22 Source: Presentation at the International Symposium on Franchising 21-22 October 2010 held in Singapore, speaker Ms Melissa Bernheim, General Counsel, Smoothie King Franchises, Inc (North America).
23 Published in Developing and Managing a Franchise (LexisNexis, 2004).
24 www.asiawidefranchise.com. Asiawide Franchise Consultants Pte Ltd has strategic partner and franchisee offices in Australia, Brazil, Cambodia, Canada, China, England, Germany, Greece, Hong Kong, India, Indonesia, Italy, Japan, Korea, Lithuania, Malaysia, Mexico, Middle East, Mongolia, New Zealand, Philippines, Russia, South Africa, Thailand, UK, USA, and Vietnam.