Cross Border Franchise Disputes

 In Insights

When entering into the world of international franchising, one of the key issues to be addressed, understood, documented and filed away until the needed, is how to handle cross border franchise disputes.  Franchisors and Franchisees do not enter into a relationship expecting the worst, but the parties must be aware of how deal with the worst when and if it occurs.

This Article will address jurisdiction options including the enforceability of judgments/awards as well as provisions that can be included in a franchise agreement to keep litigation or arbitration as a last resort option.

Jurisdiction Options:

While the governing law and jurisdiction for resolving a dispute between franchisor and franchisee will be a matter for negotiation, most franchisors prefer to nominate jurisdiction to courts wherein the franchisor is domiciled.  The franchisor feels more comfortable on its own turf and may assume that a more favourable result can be achieved. This is not always the best solution, especially when trying to enforce against a franchisee.

In such a case, careful thought must be given to the enforcement of the court judgment.  Enforcement of foreign judgments in a country is regulated by its laws.  In many countries, foreign court judgments are difficult to enforce, especially in the absence of a treaty between the foreign country and the country wherein the judgment is sought to be enforced.

Even if there is a treaty in place, typically in order for a foreign judgment to be enforced most countries require that certain conditions are satisfied. The biggest hurdle is usually the fact that the local courts will not recognise a foreign judgment in circumstances where it would have had jurisdiction over the matter. In the Middle East countries , the local courts are typically grantedjurisdiction to hear all actions brought against individuals or companies having an address or place of residence in the relevant country.

An application for the ratification and enforcement of a foreign judgment must be accompanied by evidence including proof that the judgment is final and not subject to any appeal (usually in the form of expert evidence from a practitioner in the foreign country), proof that the defendant was duly summoned (in accordance with service procedures of the country of domicile of the franchisee) and represented during the hearing, and evidence that the country where the judgment originated has a reciprocal arrangement with the relevant country.

Therefore, before a franchisor accepts the law and jurisdiction of its country of domicile, it determine (a) if there is a treaty in place with the target country; and (b) if yes, what are the procedures and chances of enforcing the judgment.

An alternative the enforcement of a judgment issued by a court is to include a provision for arbitration in the franchise agreement.  A foreign arbitral award has the advantage of being enforceable through the United National Convention on the Recognition and Enforcement of Foreign Arbitral Awards 1958 (“the New York Convention”). The nationality of the award will be determined by the “seat” or “place” of arbitration. Provided that the seat of arbitration was in one of the 144 signatory states, and provided that the relevant conditions are met, then the award should be enforced by the local courts.

The relevant conditions for enforcement are set out in Article IV(1) of the New York Convention. The party applying for enforcement must provide: (a) the duly authenticated original award or a duly certified copy thereof; the original agreement referred to in Article II or a duly certified copy thereof. The award and the agreement must also be made in the language of the country in which the award is relied on, or a certified translation must be supplied (Article IV(2)). If these conditions are met, the courts of any other member state must enforce the award without amendment, as if it was a judgment of its own.

If the award is rendered in a non-signatory state, or in a state which does not have specific treaty agreements with the franchisor’s country of domicile, then the arbitration award is unenforceable.  It should be noted that some countries may have included certain reservations when signing the New York Convention, which may include additions terms and conditions which will impact the enforcement of the foreign arbitral award in that jurisdiction.

If a country is a signatory to the NY Convention, the procedure for enforcement of the foreign arbitral award should be simply a matter of the local court confirming that the relevant conditions for enforcement as set out in Article IV(1) of the New York Convention have been met. Unfortunately, it is not always this simple.  In many jurisdictions, the courts will only ratify the judgment after ascertaining that certain conditions have been satisfied, some of which many include the following:

  • The local court did not itself have the competence or jurisdiction to hear the case;
  • The arbitration panel had the jurisdiction and competence to hear and decide the case;
  • The parties were properly served and represented in the hearing;
  • The judgment is based on the merits, in conformity with the lex fori and is final (res judicata); and
  • It was not contrary to public policy or to a previous court judgment.

Care must also be taken in selecting a jurisdiction for the arbitration. Many parties agree to select what they deem to be a ‘neutral’ jurisdiction.  In this case, there is also a risk that the local courts may only recognise a choice of law other than the law of the jurisdiction of the parties if they are satisfied that there exists an appropriate nexus between the contract expressed to be governed by such law and the foreign law system chosen.   Further, in many of the Gulf Cooperative Countries, or countries based on Shari’a law, the courts will not honour any provision of any foreign law system they recognise as validly chosen if such provision is contrary to Islamic Shari’a, public order or morals or to any mandatory law.

Finally, IT IS IMPORTANT TO NOTE THAT, in many countries wherein a franchise relationship is viewed as a commercial agency and are governed by relevant Commercial Agency Law, and such laws were not applied in issuing the Arbitration Award, the local Courts can reject the Award on the grounds that the local Courts have jurisdiction as the relationship is governed by a law particular to that jurisdiction.

In general, arbitration is a better option than the courts if the jurisdiction of each party is a signatory to the NY Convention, however, it does not guarantee that the award will be enforced with ease or at all. It is also important to note that arbitration also preserves confidentiality over the proceedings, a result which cannot be ensured by litigating in a trial court. The drawbacks of arbitration are most notably, the lack of appeal process and a considerable cost that is often similar to the cost of litigation if not higher.

Provided all goes as expected, and the award or judgment is deemed enforceable, finding assets on which to execute a judgment/award and maintaining the market without damaging the brand during the lengthy period of litigation is another issue to be considered.

Jurisdiction of the Franchisee/Master Franchisee:

Another option which is not always welcomed by franchisors is to select the jurisdiction of the franchisee as the venue for litigation or arbitration.  Franchisors, justifiably, are concerned about taking in action in the jurisdiction of the franchisee for fear of the unknown, the perceived prejudices against foreign entities taking action against local entities, or the lack of sufficient legal advice regarding the local courts or arbitration system.

However, this option should not be ruled out however.  More often than not we find that when a dispute arises, the claimant starts to seriously think about issues regarding the action when they are forced to deal with issues of service, lack of responsiveness from the defendant to actions being taken in the jurisdiction agreed in the contract, the substantial funds to be spent on litigation or arbitration, the length of time and effort; and in the end being faced with the risk of not being able to enforce the judgment.  Then the claimant is confronted with this reality, they start to search for ways to take action in the jurisdiction of the respondent- but find that the agreement does not provide for this option. If they proceed to take action in the jurisdiction, despite the terms of the agreement, they run the risk that the local courts will reject the claim on the basis of the terms agreed in the agreement.

Furthermore, in cases where injunctive relief is required on an urgent basis, proceeding in the jurisdiction of the franchisee may be the only option to obtain the relief and protection necessary. While the jurisdiction of the franchisee may not be the best option, it must be an option that is studied carefully prior to being rejected.

While governing law and jurisdiction is not an issue that is pressing at the time of signing a franchise agreement, it is an issue that the parties must seriously consider.  The contract is drafted to protect the parties; if the parties cannot enforce it, it loses its ability to protect the parties efficiently and effectively.

Minimizing the Risk of Disputes:

Litigation or arbitration should be viewed as a last resort in trying to resolve a dispute between franchisor and franchisee.  The parties, instead, should focus on finding deterrents for breach or more cost and time efficient ways to resolve disputes.

There are provisions that can be included in the franchise agreement that can assist in deterring or providing a solution for common problems encountered in franchising.

Development Schedule:

One of the main disputes encountered in franchising arises from the inability or failure of the master franchisees or developers to meet the development schedule in the franchise agreement.  Often the development schedule is arbitrary and is not based on the actual potential in the local market. Further the delays which may arise due to local laws, compliance and regulations are not addressed adequately. Ways to address this issue fairly is to agree on a development schedule backed by a business plan provided by the master franchisee/ developer so as to agree on a schedule which is realistic and capable of being met within the defined time lines. This may also assist in determining if the development schedule is insufficient for the market demand in the territory.  In addition, rather than termination of the agreement, alternative solutions can be included in the agreement such as payment of a shortfall payment for royalties for that would have been due had the master franchisee/developer met its obligations, or a fee for an additional extension in order to meet the development obligations. Other solutionswould be to reduce the geographic territory; reduce the number of units to be developed, or forfeiture of exclusivity rights. These remedies do not terminate the contract, but allow the parties to continue the relationship within terms that are achievable for the master franchisee/developer without losing the investment already made and in a manner that ultimately benefits both parties.

Subfranchise Agreements:  ​

Problems often occur when there is a termination of a master franchise and the franchisor is left trying to manage franchisees under existing subfranchiseagreements.  Provisions to be included to protect the franchisor include the right to step into, amend or assign the subfranchise agreements.

Payment Guarantees: ​

A common problem faced by franchisors is collecting royalty payments.  Many franchisors include a personal or corporate guaranty as part of the franchise agreements.  Unfortunately these can be rendered worthless if the guarantor has no assets of value. The franchisors goal is to obtain payment; not to end up in litigation to collect payments due. An option would be to secure a bank guarantee or letter of credit to allow the franchisor to draw down on funds in the event payments are not made.  While franchisees may object to the idea of the bank guarantee or letter of credit due to the cost of maintaining the same, it does serve as a deterrent to non-payment and will save both parties far more in legal costs than the cost of securing the guarantee or letter of credit.

Follow up Training and Inspections: ​

The main reason franchises fail is due to insufficient training or failure to comply with obligations under the franchise agreement or in the manuals. Conducting follow up training and regular inspections can help arrest a problem before it becomes unmanageable for both parties and beyond reconciliation.

Penalties for Breaches:

​Rather than proceeding to termination or the threat of termination, including provisions for penalties payable for certain breaches may serve as a deterrent to keep franchisees in compliance. Franchisees want to avoid additional payments and the knowledge that these may be imposed will force them to comply or request additional support from the franchisee if they are having trouble in operating the franchise to the standard required. These would include penalties for not complying with operations manuals, late payments, failing inspections, etc.

Liquidated Damages: ​

While it is difficult to determine the damages that would be sustained in the event of default, including liquidated damages which are reasonable and can be defended can serve as a deterrent for breach and keep the parties at the negotiation table to achieve an amicable resolution.  Liquidated damages can be provided for defaults including, breach of confidentiality, failure to compliance with transfer restrictions, breach of reporting obligations, and some post-termination obligations.

Registration Requirements:

In countries wherein a franchise is considered a commercial agency, provisions should be included to specifically address that the agreement is not a commercial agency and shall not be registered. Franchisee protection under the agency laws may make termination of the franchise agreement substantially more difficult, can create market exclusivity where none was provided, and or prevent the exporting of goods into the country. Other approaches to reducing the risk of agency laws include obtaining, a letter of credit or bank guaranty to subsidize any compensation payment, and a right to execute on a security interest in the franchisee’s ownership, including voting rights or a right to exercise an option to obtain control of the franchisee’s assets.

Language:

The agreement should be drafted only in the language of the franchisor.  Any translations for local use should be approved by the franchisor. If the agreement is translated to a local language, reference should be included that in the event of conflict in translations, the original text should prevail.

Dispute Resolution: ​

Another method to resolve disputes before proceeding to litigation is to include a provision for mediation.  Mediation can be set in the jurisdiction of either party by an independent mediator experienced in franchising.  The mediation terms can be customized to the requirements of the parties and can be helpful in addressing cultural differences between the parties.  Furthermore, the process of mediation is more flexible and is more cost-efficient than proceeding to arbitration or litigation. Mediation can assist the parties by bridging the gap through meaningful discussions lead by an objective party.  At the conclusion of the mediation, the parties may agree on a settlement or agree to continue with the relationship with a renewed understanding. If they are unable to resolve the dispute, either party is still free to proceed with litigation or arbitration.

Before entering into the world of international franchising, care must be taken to ensure that the agreement is appropriate and will withstand the potential issues that arise when dealing with cross border transaction.   In this respect, forethought, good counsel, an understanding the local law and cultures, and careful planning will be the most important tools.

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