UK Franchise Regulations
The UK franchise industry is estimated to contribute over £17billion to the UK economy. Employing over 710,000 in 48,600 units with over 60% had an annual turnover of £250,000 and over a third of franchisees having more than one unit according to a 2018 British Franchisee Association / NatWest survey.
What is UK Law based on?
The four primary sources of UK law are constitutions, statutes, cases, and regulations. England and Wales operate a common law system that combines the passing of legislation but also the creation of precedents through case law.
In the UK there are no franchise-specific laws. Franchising is not defined under statutes and no clear definition under case law. There is no statutory recognition of the legal and financial independence between the franchisor and franchisee entity.
Unlike many of our global peers, the UK has no legislation on disclosure in entering or on-going or exit strategy in a franchise partnership or legal benchmarks for disputes before they escalate to litigation as case law can be bare a proportionally high costs for franchisees to underwrite which relies heavily on a Judge’s perception of ‘Good Faith’.
Starting up a Franchise?
There are no legal obligations on a UK franchisor to disclose any relevant information about their franchise business either at the start of the franchise relationship or on an ongoing basis (unlike the USA many other jurisdictions).
The Franchisor may provide a glossy brochure however most franchise agreements will contain provisions that the franchisor is not legally responsible for the representation provided. Franchisors are however subject to the laws relating to fraud and the Misrepresentation Act 1967.
Franchise Agreement
The franchisor’s obligations are set out in the franchise agreement, often on a non-negotiable ‘take it or leave it’ basis, creating consistency so all franchisees run from the same agreement. The initial obligations allow a franchisee to start operating the franchise business and continuing obligations include providing assistance, training, and guidance to develop the franchisees.
In addition, recent cases are suggesting that franchisors may owe franchisees a duty of care in the way that they provide advice and guidance to their franchisees. The Franchisor must be honest and must comply with a duty of good faith, communicate fully and answer all franchisee’s questions and operate the franchise in a way that does not prejudice the franchisee. If they do this negligently, a franchisee could have the right of action against them. The exact extent of this obligation is currently unclear and it will depend on the circumstance of the dispute which will depend on the nature of the franchise.
Franchise Operating Manual
The franchise operations manual is a fluid how-to guide, with set guidelines and advice on every aspect of the company. It is also a quality control document, which can be used as a legal document to help enforce the standards of the franchise if necessary.
Franchise Supply Chain
Many franchises operating manuals require their franchisees to purchase products or services either from the franchisor or from the franchisor’s nominated suppliers. Competition law limits Franchisor’s ability to enforce franchisees to purchase more than 80% in value but if the franchisor owns the premises or the agreement only lasts for 5 years then a franchisor has pretty much a free hand to oblige franchisees to purchase from them. This indicates if a franchisee purchases from an alternative source they could be in breach of the franchise agreement.
One of the main advantages of being part of a franchised network is that franchisees should be able to purchase goods or services at a far better rate than they would as a sole operator. In many cases, the franchisor is the manufacturer or wholesaler of bespoke branded items which will include a kick-back or retrospective discount which is paid directly to the franchisor. There is nothing wrong in principle for franchisors retaining some of the bulk buying benefits, if franchisees are still able to obtain the specified goods or services more cheaply than they would be able to independently.
Some of these benefits are passed onto franchisees, but perhaps not all. It’s however good practice that they should be transparent and notified to the franchisees. Indeed, the British Franchise Association believes that keeping such practices secret is unethical on the part of the franchisor. A franchisee can seek a court order to disclose but this is expensive as franchisors are often not willing to open up company secrets and courts do not condone ‘fishing’ without strong evidence.
However, deceptive practices for financial gains are defined as fraud. The Fraud Act 2006 gives a statutory definition of the criminal office in three classes; false representation, failure to disclose, and abuse of position. So, companies who receive constant kickbacks and take notable steps not to disclose could be treading a fine ethical and legal line.
Who Controls the price of goods sold and Market Exclusivity?
Any restriction on a franchisee’s ability to determine its sale price on products and services by restricting, distorting, or preventing competition in the UK is prohibited under the Competition Act 1998, as it is considered a ‘hardcore’ restriction. This will invalidate the entire franchise agreement and may also render the franchisor open to the payment of fines of up to 10% of worldwide turnover and claims for damages. The main competition law issues relating to franchising are: –
Pricing controls
The franchise agreement cannot dictate minimum prices for products or services. Franchisors may provide franchisees with a list of recommended prices. In doing so franchisors should be careful that they do not have the indirect effect of achieving a fixed or minimum resale price. Examples of such practices may include providing a franchisee with an incentive to sell at a certain price by printing a recommended resale price on the goods or imposing penalties on franchisees who do not adhere to franchisors’ predetermined prices.
Franchisors cannot impose promotional or discount prices on goods sold by franchisees. If a franchisor wants to implement a promotion, it can only do so where the franchisee has agreed to participate. Crucially, the franchisee must be free to opt-in and out of the promotion, and the franchisor should make it clear to customers that the promotion is available at participating outlets only. However, in certain circumstances, this is allowed such short-term (2 to 6 weeks) product launches, or low-price campaigns. A franchisor can impose a maximum resale price, above which a franchisee would not be permitted to sell the goods.
Exclusivity
Franchise agreements often grant an exclusive territory that stops franchisees from selling products or services in another location. But franchisees should still be allowed to make passive sales. A passive sale is one where the customer is located outside the franchisee’s allocated territory but has approached the franchisee directly. The franchisee can therefore offer goods and/or services on the web without actively soliciting customers as opposed to an active online sale where specific conducts aimed at attracting consumers to the website by sending ‘emails or advertising. The European Commission categorises online sales as ‘passive selling’, so a franchisor cannot stop a franchisee from selling its products or services online. Franchisors can require that the franchisee’s internet use complies with certain standards and conditions. Some franchisors also restrict their franchisees from selling through third-party online platforms such as Amazon.
Some franchise agreements often provide that some particularly important customers are designated as national accounts and these customers enter into contracts with the franchisor. The franchisee performs the obligations under the contract with the national account customer as the franchisor’s sub-contractor. The national customers should be clearly defined to prevent the franchisor from designating any customer as one. Such as marketing online patients ‘passive sales’ customers away from Franchisee Territories. The relevant competition law considerations are complex and individual cases would need specialised legal advice.
Exiting a Franchise, Termination and its consequences
A primary reason for the success of motivating a self-employed franchisee is the incentive of making a capital gain at the end of the day and not as a wasting asset with a finite term. For this reason, the franchised business should be capable of being sold. Naturally, the criteria by which a prospective purchaser will be judged by the franchisor, even if the franchisee takes the initiative in seeking a purchaser.
Some franchisors insert in the contract an option to buy the business back, this should be at least the same price offered to the franchisee. Many franchisers use the EDITDA (earnings before depreciation, interest, and tax) as a measure of a company’s performance. Any artificial formula (such as net asset value) which might enable the franchisor to buy at less than the market value should be resisted.
Some terminations are enforced by the franchisor as the franchisee could be at the default of the franchise agreement, in which case the franchisee should be allowed to put right minor remediable breaches. Or a repudiatory breach which is where a breach is so serious that it effectively renders the contract useless and therefore gives the innocent party the option to terminate.
Following termination, the franchisor will usually take steps to ensure the franchisee ceases to claim any association, no longer enjoys the use of the trademark / tradename and other property rights owned by the franchisor. Also, the franchisee will be under an obligation not to compete with the franchisor within an area and given period nor would be allowed to make use of the franchisor’s system or other methods.
However, there are no laws of compensation rights on the expiry or non-renewal of a franchise.
3rd Party Claims
Understanding responsibility is imperative to provide the relevant insurance cover and protect all parties across all elements of the business. The liabilities of data protection breaches alone can be £17,500,000 or 4% of annual turnover!
• Does the franchisor require a franchisee to adopt a particular procedure (employee/employer position)?
• Did the franchisee fail to run compliance with proper procedures and standards prescribed by the franchisor?
The Trading Schemes Act 1966
This is designed to regulate pyramid schemes where franchisees discover it is more profitable to recruit and grant sub-franchisees rather than to sell goods and services themselves. This would make the franchise model near impossible without the exemptions provided by the Trading Schemes (Exclusion) Regulation 1977, where an agreement is exempt. This unintentionally regulates franchisee agreements as they fall within trading schemes and imposes criminal sanctions for a breach even though none have been reported to date. If a franchisee and franchisor are VAT registered or working a single-tier franchise scheme, then this act will not apply.
Unfair Contract terms Act 1777 (UCTA)
UK franchise agreements commonly contain exemption clauses seeking to limit or exclude the franchisor’s liability to a franchisee. The enforceability is determined in reference to the UCTA only if they are fair and reasonable. These are only usually challenged once a loss has occurred and not purely on principle.
Resolving Conflict in a Franchise Agreement
Litigation
This is the process of resolving disputes by filing or answering a complaint through the public court system. Costs can spiral where generally the losing party is burdened with all the fees; however, the court will consider the reasonableness of the legal costs. The risks to the franchisee will always be proportionally much greater as they are often a small party whose family home could be on the line.
English courts have previously consistently taken the view on the grounds of ‘commercial certainty, where obligations of good faith cannot generally be implied into contractual relationships governed by English law. However, there have been several recent decisions in non-franchise cases that were faced with clear dishonesty and egregious behaviour on the part of the contracting party, the courts have found favour of the injured party. The courts advanced the theory that in a long-term relational agreement, which requires ongoing corporation, honest communication, and mutual trust, a stand of conduct would be regarded as commercially unacceptable by reasonable and honest people in this context should be censured.
Arbitration
This is considered litigation in private, with a judge (the arbitrator) chosen by the parties often because of the special knowledge of the business. Both parties must agree and no one party can force the other. Proceedings are private, the timing can be fixed to suit both parties’ convenience. Both parties can save time and expense by establishing the rules. Binding arbitration has limited opportunities scope to appeal.
Mediation
This involves the appointment of an independent persona as a mediator who without taking sides looks to find common ground and assists to seek a mutually agreeable settlement. All parties can open up confidentially to the mediator off the record and no one is bound by the deal unless all agree, as mediators are there to mediate and will not provide an award or final decision.
The British Franchise Association (BFA)
An association is a group of people organized for a joint purpose. Benefiting its members with camaraderie, practical experience, and support with fellow peers, especially for less experienced franchisees running their own independent company often for the first time.
The British Franchise Association (BFA) is a trade association for the British franchising industry established in 1977 and claims to be the voice of ethical franchising in the UK. This is optional for the franchisor to join. Under a third of UK franchisers operating in the UK are members of the BFA.
Only franchisors who are members have to abide by their ethical code and part of the BFA’s role in self-regulation is to work with franchisors through the application process and recommend changes to their standards. Franchisees cannot join and benefit unless their franchisor has joined.
The BFA has provided a guide to the code, which gives practical assistance on the way it should be implemented. The code of ethical conduct generally adopts the European Franchise Federation’s definition in its Code of Ethics for Franchising but is not available to non-members. Although the code only applies to their members, it represents good practice, it has been recognised by the courts and referred to in litigation to educate the court about franchising principles. However, unless stated the code does not form any part of the contractual agreement between franchisee and franchisor.
Prospective franchisors are initially assessed and are periodically re-accredited to ensure compliance with their code of conduct.
Franchisors who are members of the BFA are required to follow their guidance in providing prospective franchisees disclosure information concerning the business and its financial position, the people involved in the franchisor company, the franchise proposition, details of its franchisees, financial projections, the franchise agreement, and other contractual documentation.
Franchisors must pilot the concept before starting to franchise ensuring its market viability is profitable enough to support a franchise network. Recruitment advertising must be free of ambiguity and misleading statements. The franchisor must be able to demonstrate their ability to share information as the transfer of knowledge and experience is crucial for a franchise to be a success. Both parties must exercise fairness in all dealing with each other, including in the resolution of disputes. The BFA has schemes for both mediation and arbitration with experience in franchise-specific topics such as fee calculation and rights of renewal.
At the outset, the British Franchise Association’s Code of Ethics would give comfort to all, and questions could be asked why a franchisor would not want to sign up for ethical practice? As a franchisee whose franchise is not a member cannot join why would the BFA discriminate against legal independent franchisee businesses because the franchisor does not want to take part?
On 22 May 2007, hearings were held in the UK Parliament concerning citizen-initiated petitions for special regulation of franchising by the government of the UK due to losses incurred by citizens who had invested in franchises. The Minister for Industry and the Regions, Margaret Hodge, conducted hearings but saw no need for any government regulation of franchising with the advice that government regulation of franchising might lull the public into a false sense of security. Mr. Mark Prisk MP suggested that the costs of such regulation to the franchisee and franchisor could be prohibitive and would in any case provide a system that mirrored the work already being completed by the BFA. The Minister for Industry and the Regions indicated that if due diligence were performed by the investors and the banks, the current laws governing business contracts in the UK offered sufficient protection for the public and the banks. The debate also referred to the self-regulatory function performed by the BFA recognizing that the association “punched above its weight”.
In the 2010 case of MGB Printing v Kall Kwik UK Ltd., the High Court established that a franchisor may assume a duty of care to a franchisee in certain circumstances. Kall Kwik, a design and print franchisor, had incorrectly advised MGB, who was purchasing a franchise, of the costs of undertaking refit work needed to meet Kall Kwik’s franchising requirements. In this particular case, Kall Kwik had stated that they would provide professional advice to potential franchisees, and because they had not provided details of the fitting standards which must be met, they had encouraged MGB to rely on the advice offered by themselves.’