The legalities of franchising in the UK: What international franchisors need to know

For any successful international business, expansion into the UK offers exciting new business opportunities and growth potential.

Since the 1960s, when the very first franchise networks, such as Dyno-Rod, were launched in the UK, franchising has taken root and flourished as an effective technique for expanding businesses. According to the NatWest bfa Franchise Survey 2013, there are now approximately 930 franchisor brands operating in the UK across a variety of sectors and the ‘franchise industry’ boasts an annual turnover of £13.7 billion.

For international businesses based outside of the European Union (EU), the UK is often chosen as a base from which to establish a 'beach head' before further expansion across the EU and, indeed, further afield. There are a number of factors that contribute to the UK’s popularity as a key market for international businesses, including the UK's reputation as a lightly regulated place in which to do business, the emergence of English as a truly global language, London's status as one of the leading capital cities in the world and the perceived efficiency and fairness of the English court system in resolving international commercial disputes.

The UK and its relationship with the EU

A common misunderstanding about the UK is that it has a single legal system. In fact, the UK possesses three distinct legal systems; English and Welsh law, Northern Irish law and Scots law. Another common misunderstanding is that the EU is a genuine single market with a fully harmonised legal system. The truth, however, is that significant differences remain between the national legal, regulatory and cultural regimes of individual Member States that prove challenging to businesses entering the EU market. In addition, some countries considered ‘European’ (like Switzerland and Russia) actually sit outside the EU and are subject to wholly independent national regimes. Therefore, while a legally compliant English law franchise agreement will, by its very nature, incorporate a number of EU legal principles, if it is to be used in other Member States, it should still be reviewed for its compliance with the mandatory local laws of the relevant Member State.

The Regulation of Franchising in the UK and the EU

The disparity between the legal systems of Member States applies to franchising. Various Member States have franchise specific regulations requiring, for example, franchisors to register with the authorities and/or issue a pre-contractual disclosure document to prospective franchise owners.

The courts in some Member States do not always recognise the difference between a commercial agent and a franchise owner. By applying commercial agency laws by analogy, franchise owners in certain Member States have been able to successfully claim compensation at the expiry of a franchise agreement.

Some Members States are civil law jurisdictions, such as Germany, and have a codified duty of good faith, which applies to all elements of the franchise relationship. This can impact on a franchisor's contractual discretion and its ability to take unilateral decisions on behalf of the network.

There is no analogous legislation in the UK requiring registration of franchise agreements or pre-contractual disclosure, nor do the English courts confuse franchisees for agents. There is no general duty of good faith under English law, which applies to franchising, although some recent court judgments indicate that English law may be starting to move in the same direction as some of its European cousins.

Nevertheless, English law remains an attractive choice of law for international franchisors wishing to do business in the UK and the wider EU. The British Franchise Association is the principle trade association for franchising in the UK and its Code of Ethics, while not legally binding, provides a benchmark for good industry practice in relation to issues such as advertising, recruitment, the exercise of fairness throughout the franchise relationship and dispute resolution. Claims for misrepresentation are one of the principal sources of franchise litigation in the UK. The Code of Ethics requires its franchisor members to make a full disclosure of material information prior to signing the franchise agreement and a disclosure document can be a useful tool in defending any future claim for misrepresentation.

Structuring the Franchise Business and Protecting the Brand

At a very early stage, the franchisor will need to decide which entity or structure will best fit its needs and expansion plans. In particular, businesses launching into the UK may intend to operate corporately-owned outlets as well as franchised outlets and/or provide 'on the ground' support to its franchise network.

Foreign ownership and investment in the UK is subject to very few regulations. The UK Trade and Investment government agency exists to assist foreign businesses to invest in and move to the UK. All new companies must register with Companies House, the registrar for companies in the UK, and will be subject to official requirements, such as the filing of annual accounts.

UK employment contracts are subject to a number of statutory protections for employees, many of which derive from EU-wide laws affecting the employment relationship.

Trade marks and design rights can be registered through the UK Intellectual Property Office (IPO) or alternatively an application for a Community Trade Mark (CTM) or design right could be filed with the Office for Harmonisation in the Internal Market (OHIM) to provide protection in all 28 Member States. This is a very cost effective solution for businesses looking to franchise in more than one Member State.

Choice of Law

An important consideration for an international franchisor is which law should govern its franchise agreement for the UK, and in which venue it will choose to resolve disputes. The UK is a signatory to the New York Convention on the enforceability of foreign arbitration awards and the UK has a number of bi-lateral treaties with other countries which recognise judgements passed by foreign courts.

Understandably, international franchisors prefer to elect the law of their home country in their franchise agreements. This approach is likely to work in the UK, but it is important to check and, in any event, take advice on the impact of mandatory English law on the franchise agreement.

For international franchisors that are using the UK as a ‘beach head’ for further expansion into the EU and further afield, and/or that use multiple structures such as master franchising, electing English law to govern the franchise agreement is a sensible decision. For international franchisors that are based in common law jurisdictions, English law will feel very familiar. In addition, a franchise will be much more attractive to a prospective UK and/or European franchise owner if it is subject to English law and the venue for resolving disputes is in the UK.

Competition Law and Considerations

Franchise agreements can affect competition between either Member States (in which case the European Commission may take enforcement action against an offending party) or at a national level (and in the case of the UK, the Competition and Markets Authority may take action), particularly if they contain location restrictions, prohibitions on online activities, non-compete restrictions and pricing obligations. Not all franchise agreements fall within remit of the controls imposed by Competition Law if they are not of sufficient size and scale to be deemed relevant.

This is a complex area of law and penalties for breaches can be severe (including unenforceability of agreements and/or fines expressed as a percentage of global turnover), which is why specialist franchise lawyers should be consulted.

Other key legal issues to be aware of include:

The Fair Trading Act 1973 and the Trading Schemes Act 1996; which regulates ‘pyramid selling’ schemes in the UK and can apply to poorly drafted franchise arrangements, in particular Master franchise structures.

The Bribery Act 2010; which has created one of the strictest anti-corruption regimes in the world. The Act has not yet been tested in relation to its applicability to the franchisor/franchise owner relationship, although analogous legislation in other jurisdictions has been applied to the franchise relationship.

Data Protection; The EU has the strictest data protection regime in the world. Complex rules govern every aspect of the data lifecycle. This is particularly relevant for consumer facing franchise businesses, where a franchise owner is often collecting customer data and processing it on behalf of its franchisor. Failure to comply may result in fines, civil and/or criminal liability, unenforceable contracts and/or reputational damage.

Conclusion

It is extremely important that franchisors looking to do business in the UK invest properly in taking legal advice from a lawyer specialising in franchising ,to ensure that their business operations and franchise owner agreements are legally compliant. Understanding the risks and issues, and managing those risks through effective structuring and enforceable legal contracts, will enable international franchisors to reap the rewards of doing business in one of Europe's largest and most dynamic markets.