Considerations for International Franchising
Overview
Over the last 20 years there has developed three basic vehicles in which a U.S. franchisor expands internationally: (i) directly; (ii) joint venture; and (iii) master franchising, with master franchising being the most common method.
The best format depends on a number of factors, including:
-
Existing management resources of the franchisor;
-
Capital resources of the franchisor;
-
Foreign investment restrictions and/or tax incentives;
-
Currency restrictions;
-
Foreign exchange and foreign trade restrictions;
-
Tax treaties and taxation;
-
Industrial and intellectual property laws;
-
Corporate laws;
-
Import/export controls;
-
Excise taxes and duties; and
-
Political and economic stability issues.
Each of these issues must be looked at when expansion is contemplated to determine the best approach. The best vehicle must be determined on a country-by-country basis as well as a transaction-by-transaction basis.
Direct Franchising
In direct franchising, the U.S. franchisor directly enters into a development agreement (multiple units) and/or a franchise agreement (single unit) with a foreign franchisee without the use of an intermediary (e.g., master franchisee or subfranchisor). Inquiry must be made to insure that the laws of the target country permit direct franchising and what the U.S. franchisor must do to comply with the target country’s laws. You may be required to establish a branch office or a foreign subsidiary in the target country.
Joint Venture Agreements
The U.S. franchisor enters into a joint venture agreement with a joint venture partner who is usually a national of the target country whereby the parties form a joint venture company, joint venture partnership or trust. The joint venture then opens its own units in the target country or grants franchises.
International Master Franchise Agreements
An international master franchise agreement is similar to the sub-franchisor concept used in the United States. The U.S. franchisor grants to the master franchisee an exclusive territory (e.g., country) and the master franchisee is responsible for selling and servicing foreign unit franchises within the exclusive territory. The basic structure of an international master franchise agreement (all subject to negotiation by the parties) is as follows:
-
The master franchisee is granted an exclusive territory (e.g., country) and must develop a prescribed number of franchises pursuant to a schedule of development contained in the international master franchise agreement. The master franchisee may or may not be granted the right to open its own units.
-
The U.S. franchisor gives to the master franchisee rights to the trade name and other proprietary marks, the business format, loan of the manuals, initial training (train-the-trainer) and other assistance.
-
The master franchisee usually pays an up-front master franchise fee to the U.S. franchisor for the international master franchise agreement rights.
-
The master franchisee signs the franchise agreement with the foreign unit franchisee (the U.S. franchisor is not a party). The master franchisee assumes all sales and servicing functions, including training and ongoing support of the foreign unit franchisee.
-
The master franchisee receives all initial franchise fees and royalties from the foreign unit franchisees and remits a portion of each (e.g., 1/3) to the U.S. franchisor.
Advantages of International Master Franchises
The reasons why a U.S. franchisor would want an international master franchisee instead of opening company-owned units or direct franchising include:
-
Rapid expansion
-
Greater resources
-
Reduced staff
-
Sharing of risk
-
Access to other ideas
-
Local presence and knowledge
-
Greater incentive for the master franchisee to sell and service franchises
-
Foreign investment restrictions
-
Alleviate various tax and tariff problems.
Disadvantages of International Master Franchises
The disadvantages of master franchising include:
-
Loss of control
-
Loss of revenue
-
Increased risk of vicarious liability
-
Difficulties in enforcement
-
Concessions required by a master franchisee.
Key Issues in Structuring an International Master Franchise Agreement
In negotiating and drafting an international master franchise agreement, the following key issues should be addressed:
-
Description of the right to be granted by the U.S. franchisor to the master franchisee, including the proprietary marks, know-how, confidential information, manuals, right to franchise, etc.
-
The master franchise territory
-
Exclusivity
-
Initial term and renewal term
-
Duties of the U.S. franchisor
-
Master franchise fee, sharing of initial franchise fee and royalties and other fees such as renewal fee and transfer fee (including type and method of payment, risk of currency fluctuations, exchange controls and inflationary safeguards)
-
Withholding of taxes and gross up provisions
-
Duties of the master franchisee
-
Schedule of development
-
Proprietary marks
-
Confidential manuals and confidential information
-
Accounting and records
-
Transfer of interest (assets or stock)
-
Default and termination
-
Obligations upon termination
-
Independent contractor and indemnification
-
Representations and warranties
-
Choice of law and venue.
Impact of Foreign Laws on Franchising – In General
The United States has the most extensive franchise laws in the world with its FTC Franchise Rule and various state disclosure/registration and/or relationship laws. While there is no exact counterpart to the FTC Franchise Rule in other countries (other than the province of Alberta, Canada), other types of laws will directly impact your franchising activities. Furthermore, other countries are looking to the U.S. franchise laws as a model for their own franchise legislation. Some countries have already made limited pre-sale disclosure a voluntary measure as part of an attempt at self-regulation such as Canada, Great Britain and Australia, while other countries have made limited pre-sale disclosure mandatory such as France. With each transaction, a review of current laws in the target country and their applicability to the transaction at hand must be made. It is extremely important to retain local counsel in the target country knowledgeable in the target country’s laws that may affect the relationship.
Impact on Foreign Laws on Franchising – Specific Laws
Some of the types of laws that may impact on whether, and in what manner, a U.S. franchisor may franchise in a target country may include:
Trademark Laws
A United States trademark registration gives the trademark owner certain rights in the United States but not elsewhere. The foreign franchisee will want to know that your company has rights to the trademarks in the target country. The United States trademark should be registered as a foreign mark in the target country. The trademark laws in the target country may be different from those of the United States including actual use versus intent to use, initial term and renewal rights, the need for registered user agreements, sublicensing rights and the right to sue for infringement, to name a few. In addition, the laws may be substantially different, or do not exist at all, for the protection of trade secrets.
Forms of Doing Business
Depending on which way your company intends to franchise in the target country, issues of foreign investment restrictions, required investment and the participation of a national of the target country, authorization, qualification and registration requirements as well as tax considerations arise.
-
Can you franchise directly or must you establish a branch or subsidiary?
-
Are you required to register of otherwise qualify to do business in the target country?
-
Are there minimum capital investment requirements or local investment requirements?
Tax Aspects
Taxes are a major consideration in structuring an international franchise transaction.
-
Does a tax treaty exist between the United States and the target country?
-
What types of business entities are taxed in the target country and in what manner?
-
Can double taxation be avoided in some fashion?
-
Is there a foreign tax credit given against taxes paid by the U.S. franchisor in the target country?
-
Are franchise fees, royalties and other payments amortizable or deductible by the franchisee?
-
Must a franchisee withhold taxes in connection with payments made to the U.S. franchisor?
-
Are there different tax rates between fees paid by the franchisee for services and other technical assistance and fees for the use of the U.S. franchisor’s trademark and other proprietary property?
-
If so, is it possible to “unbundle” and allocate the royalty fees among the various services and rights granted by the U.S. franchisor so as to minimize the amount of taxes withheld or otherwise due?
-
Besides income taxes, are there other types of taxes such a value-added taxes (VAT), excise taxes, import or export duties and tariffs, stamp taxes or other taxes not based on income?
It is extremely important to retain tax counsel knowledgeable in international taxation involved at the inception of structuring the transaction to minimize the amount of taxes that must be paid by all parties to the transaction.
Antitrust (Competition) Laws
Does the target country have any antitrust or competition laws that may make certain provisions commonly included in a U.S. franchise agreement unenforceable or illegal? These provisions may include territorial or customer restrictions, required purchases from the U.S. franchisor or master franchisee or their affiliates, exclusive dealing arrangements, agreements limiting competition and in-term and post-term covenants not to compete.
Other Laws
Other laws that may impact your franchise expansion include:
-
Special laws that regulate the industry in which your company and its franchisees operate
-
Foreign investment tax or other incentives
-
Tax abatement or subsidies
-
Labor laws
-
Real estate laws
-
Insurance/liability laws.