Franchising and Licensing law

Franchising and Licensing law

Both franchising and licencing fall in the area of commercial law and they deal with a set of contractual, quasi-contractual and non-contractual fiduciary relationships.

Franchising

Franchising is a strategy for business expansion or alternative growth for the sale and distribution of goods and services as compared to other modes of expansion e.g. by fully owned outlets or stores. It is a means of accessing venture capital by building a distribution system for servicing a brand without giving up control of the operation. The primary advantage is that the business is able to expand rapidly using the capital and resources of other people, without bearing the development cost and at the same time reduce the dangers of opening a foreign market on its own. If done correctly, it minimises the business’s capital investment and liability risk and can lead to success. Through franchising, a business may expand across countries and continents quickly and build a global presence at a low cost and risk.

It can be adopted by almost any type of carefully designed, properly executed, successful and proven business (the “franchisor”) that wishes to retain control and ownership, but wants to grant licenses (permissions) to a “franchisee” on:

Its intellectual property (e.g. name, logo, brand).
Its mode and method of business (e.g. know-how, procedures).
Its use of its business model (marketing concept, the rationale of creation, delivery, and financing strategy in economic, social, cultural or other contexts).
The rights to sell its branded products and services.

To do this the franchisor must support the franchise by providing know-how, training, procedures, marketing and other resources and skills.

The franchisee must put up the initial capital and have the skills necessary to operate branches of the same business, help to promote the brand, pay royalty (licence) fees to the franchisor and agree to comply with the franchisor’s mode and methods. In essence the franchisee pays and reimburses:

“Disclosure” (usually a one-time fee).
A royalty for the trademark.
For the training and advisory services given by the Franchisor.
A percentage of the gross income coming from sales in the franchisee’s branch of the business.

Sometimes these fees may be combined in a single “management” fee.

Licensing

The essence of licensing (which is also the basis of franchising) is that the Licensor retains ownership of his/her intellectual property (IP) while granting others the right to use it. The terms can vary considerably.

An essential element of a franchise that distinguishes it from a simple licence is the number of formalities involved in setting up a franchise which are aimed in allowing the franchisor in retaining a high degree of control of how the business is run by the franchisee. Licensing is less rigid than franchising because the Licensor aims to give permission to others to use his/her intellectual property (IP) in many possible business arrangements to which the licensor may license as much or as little of the IP as is necessary. The person receiving the license (“licensee”) compensates the licensor by paying a Know-how flat fee or royalties or both. The agreement does not transfer ownership of the intellectual property. It enables the owner of the IP to generate income various species of intellectual property such as know-how, ideas, creative output, reputation, patents, trademarks, designs etc.

An example is giving permission (a licence) to use software which does not grant the licensee ownership of anything more than the right to use it and not copy it, distribute etc. Another example is like a licence by an inventor of a process for valeting a car who grants car wash businesses the know-how in return for royalties.

Basic aims and terms of a franchise agreement

The franchise licence is a contract between the franchisor and the franchisee and it takes the form of a “Franchise Agreement”. Main provisions are usually the following:

The franchisor basically licenses intellectual property (IP) because this includes know-how and other confidential information, trademarks, logos and designs, marketing and advertising, patents and copyright materials.
The franchisor controls how the business is run by the franchisee so that the standards and service remain the same. Any changes in the business format could damage the brand generally and not just that particular branch.
Strict quality control provisions are imposed on their franchisees and the franchisors reserve the right to make random checks and cancel the agreement if substandard services are offered by the branch.
The franchise lasts for a fixed time period, and is renewable in shorter periods.
The franchise serves a specific territory, area or location. One franchisee may manage several locations.
Premature cancellations or terminations may be agreed if certain conditions are not met.
The franchise is a finite term leasing of an opportunity and is therefore a temporary business investment. There is no purchase or ownership of the business (a “wasting asset”).
A franchise may be exclusive, non-exclusive or “sole and exclusive”.
Franchisor fees are based on “gross revenue from sales” and not on profits realised.
Various tangibles and intangibles e.g. national or international advertising, trademarks, patents, training and other support services are given by the franchisor.
There must be warranties that no additional licensees will be given in the territory, area or location of the franchisee.
The franchisee must remain an independent merchant.
The franchisor must protect the franchisee from any trademark infringement by third parties.
The franchisor must provide training for an adequate period, and give instruction manuals, literature and sales documents.
Limited guarantees or warranties and recourse to courts in the event of a dispute because franchisees buy the franchise knowing that there is risk without a promise of success or profits by the franchisor.
The Law and jurisdiction for the litigation of a dispute (usually the franchisors).

The franchise licence aims to protect several interests:

The franchisor secures:

Protection for the trademark.
Control of the business concept.
Secures know-how and procedures.
Secures quality and uniform standards.
Secures advertising and marketing strategies.

The franchisee is obliged:

To offer the services for which the business is prominent or famous.
To offer standardised services.
To bear the franchisor's signs, logos and trademark in a prominent place of the branch.
To have staff wear uniforms of a particular design and colour.
To decorate the branch in a particular style
To offer services in accordance with the franchisor’s pattern.

Franchise agreements in the EU

Franchising has grown rapidly in Europe in recent years. However, franchise agreements in the EU must be very carefully drafted because of two main factors:

The franchising industry in the EU is largely unregulated. The self-regulatory environment in the EU in franchising is not homogeneous and there is no clear or consistent approach to enforcement. Cultural factors are also relevant, as local populations tend to be heterogeneous. There is no EU law governing pre-contractual disclosure obligations. In Cyprus there is a common law duty of good faith in franchise relationships that may cover this void in the legislation.
Competition laws in the EU [(EC) Regulation 330/2010] were devised for business-to-business agreements in a vertical relationship which include provisions (clauses) restrictive of trade (vertical restraints). This law prohibits agreements between undertakings (i.e. franchise agreements) that:

May affect trade between EU Member States, and
Have as their object or effect the prevention, restriction or distortion of competition within the EU.
These agreements are null and void unless they satisfy the conditions for exemption as follows:
If the terms of the agreement (in particular the restrictive clauses it contains) can be shown to provide economic benefits to both parties as well as to the EU consumer which outweigh the anti-competitive effects of its restrictive clauses, then the agreement is allowed.

Therefore vertical restraints such as resale price fixing and maintenance (e.g. a franchisor directly establishing a franchisee’s resale price or enforcing a maximum discount level), territorial protection, customer restrictions, exclusive purchase obligations, non-compete obligations (in-term and post-term), exclusive distribution and certain types of selective distribution are not allowed unless they benefit the parties to the agreement, the consumer and outweigh the anti-competitive effects of these clauses.

Completion law however, does not take into account the structure of franchising in the single market, as they are mostly concerned with intra-brand issues between franchisor and franchisee and insufficiently concerned with the bigger picture of how small companies can most effectively compete with big ones.

This lack of uniformity of franchising laws and competition laws are the two main factors inhibiting franchising growth in the EU.

Franchise agreements are by definition a vertical agreement. If in addition, the franchise agreement includes restraint clauses, then the terms of this the vertical restraints regulation must be carefully considered when drafting the agreement. Also if the franchisor requires purchase of uniforms, signs, products etc. from the franchisor then it may infringe competition law.

If a franchise agreement contains restrictive clauses (vertical restraints) but is not likely to affect trade between Member States (e.g. it is a local franchise) then it may not conflict with EU competition law. However such franchise agreement may have an impact on trade within this Member State. In such a case the competition law of that member state must be taken into account.

Our services

When adopting a Cypriot or a European strategy it is important that a franchisor takes expert legal advice. Also a franchise lawyer is required to assist the franchisee during negotiations with a franchisor or to assist a businessman to draft a franchise agreement and expand his/her business.

Our services include all franchise and licence law matters, claims and disputes such as:

Drafting franchise and licence agreements.
Legal Opinions.
Advice on EU Competition Law and Cyprus Law regarding franchises and licences.
Protection and registration (where applicable) of Intellectual Property [Hyperlink]
Dispute resolution and Advocacy at the Commission for Protection of Competition.
Appeals etc.