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Amended ICC Model International Franchise Contract is Problematic for Franchising

Franchising World August 2011

 

By: Carl E. Zwisler

 

The idea was simple.  Create a model international franchise agreement which could be used by companies and lawyers who are unfamiliar with international franchising and international franchise agreements.  Gather a group of leading franchise lawyers and professors and focus their efforts on developing one or two best practices for each issue commonly addressed in franchise agreements, provide explanations for the options and release it under the auspices of the International Chamber of Commerce.  Known for model contracts and contract clauses in areas such as commercial agency, international sales, distribution and trademark licenses and for its international arbitration expertise, the ICC had first attempted a model franchise contract in 2000.  The original model was not well known.  An Internet search suggests it is only available for purchase from the ICC and according to lawyers who had attempted use of it, it was so deficient that it needed to be revised.  The ICC’s drafting group, which is chaired by Professor Fabio Bartolotti of the University of Torino (Italy) took on the task of revising the model in 2008.  Professor Bartolotti also practices franchise and distribution law and is the founder and chair of the International Distribution Institute.

 

After multiple meetings, at least 10 drafts and after receiving comments from various international franchise lawyers, including the author, the ICC has completed and released its amended model, complete with comments and analysis.

 

What is the model?  It is a relatively simple form of a single-unit franchise agreement intended for use in international franchising.  A significant improvement on its predecessor, the model follows a common law format, in that it attempts to clearly specify the parties’ rights and duties, and does not rely upon references to a civil code to interpret the parties’ intentions.  The model agreement is intended to be “fair” to both franchisors and franchisees.


The ICC has completed and released its amended model, complete with comments and analysis.

According to the model contract introduction:  “This model franchise contract aims to provide those who are considering entering into a franchise contract with a set of clauses that can guide the parties in preparing their own franchise contract.  The model follows the traditional ICC approach in seeking to strike a fair balance between the interests of the franchisor and those of the franchisee, taking into account the core obligations of an international franchising contract.”

 

To their credit, the drafters decided to narrow the scope of the model to distribution franchises through which manufacturers or suppliers of products sell them through franchised retail outlets.  Distribution franchisors would account for fewer than 10 percent of franchised outlets in the United States, based on a 2009 IFA Franchising Survey conducted by PricewaterhouseCoopers.

To companies which are just beginning to franchise internationally, and to lawyers for those companies who are unfamiliar with international franchising, the idea of having an ICC endorsed model contract is compelling.  They can simply purchase the contract online from the ICC for 60 Euros and theoretically avoid many hours of research and thousands of Euros in legal fees typically charged by bona fide international franchise lawyers.  The model is not intended by the ICC for use by companies already involved in international franchising or for sophisticated international lawyers.

 

The drafters exhort lawyers to become familiar with the “mandatory laws” of countries where their model will be used, including franchise disclosure and relationship laws, antitrust laws and laws restricting the repatriation of funds to the franchisor.  The advice is sound and needed.

 

In the Introduction, the ICC concludes, the “contract will contribute to the promotion of franchising generally by placing at the disposal of these small undertakings a unique and useful model form.”  It is certainly unique, and it may be helpful as a partial checklist for a lawyer with some franchising background.  But is it really an advantage or disadvantage for the intended users?

 

Why the Model Contract Doesn’t Meet Aspirations
The principal problem with the model franchise contract begins with its objective of attempting to delineate a “single solution on every issue” typically covered in an international franchise agreement, although sometimes an alternative provision is offered.  This is designed to suit the needs of all retail distribution franchise in all cases.  Early in the drafting process, one drafting committee member argued that the committee’s time would be better spent developing a checklist of issues to be considered for drafting a typical franchise contract.  His arguments about the difficulty, if not impossibility, of drafting a one-size-fits-all approach to franchising lost out.  The sponsor of the draft, the ICC, has a long history of drafting model contracts, and this seemed like no time to challenge the traditional ICC approach.


A “single solution” is not a realistic goal for most of the issues addressed in a good franchise agreement.

That decision may cause the model to be more of a problem than a blessing for new international franchisors and their novice international franchise lawyers.  Anyone who has had the experience of working with franchisors knows that a good franchise agreement must reflect scores of business and legal decisions that make each franchise unique.  Those of us who regularly advise new domestic and international franchisors know all too well that our personal or firm model agreements, which are based upon years of collective experience, are merely an imperfect starting point when drafting franchise agreements for a new franchisor client.  Dozens of hours are typically required to adapt those models to the needs of each new franchisor client.  A “single solution” is not a realistic goal for most of the issues addressed in a good franchise agreement.

 

The process of preparing the first international franchise agreements for a franchisor usually involves adapting domestic franchise documents to account for cross border issues, use of master franchising and other formats not used domestically, and drafting revisions required by the laws and business practices of the new country.  The ICC apparently assumes that either the user of the model will be small companies using franchising for the first time in another country, or that existing franchisors will consider abandoning the agreements they have used domestically and use the model agreement instead.


From the author’s perspective as a U.S. franchise lawyer, it is troubling to think that a small company with no domestic franchising experience would retain an inexperienced lawyer using a “single solution” model contract to begin franchising in other countries.  Without expert guidance in the development and execution of a franchising program or a lawyer who appreciates the business and legal complexities of international franchising, the risks to the franchisor and its future franchisees are enormous.

 

It is also difficult to imagine that even a small, but experienced franchisor would abandon the franchise agreement it already uses, especially in the United States, in favor of the model.

 

A Fair Balance
The traditional ICC approach of providing a “fair balance” between the interest of franchisors and franchisees will render the model unworkable for most franchisors.  Consider the following example.


Sec. 12.1 “In the event the Franchisor makes any changes to the System, it shall without delay communicate the same to the Franchisee and the Franchisee shall within a reasonable time make use of such improvements free of all further royalties, charges or payments whatsoever, in the manner specified by the Franchisor in writing.  The Franchisee may refuse to conform to changes which imply unreasonable costs.  Should the parties not find (sic) an agreement, the Franchisee shall have the right to terminate the Contract with a notice of __”  (emphasis added)
Most franchise agreements authorize the franchisor to change or add to the system and to require franchisees to comply with the modifications within a specified amount of time.  Although some franchise agreements limit the amount of additional investment a franchisee may be required to make when implementing a change (in the author’s 35-plus years of experience, none allow a franchisee to either ignore the change if he believes the cost is “unreasonable” or to terminate his franchise agreement if the franchisee decides a modification is unreasonably expensive.)  Why?  Because franchising is based upon providing a consistent customer experience from unit to unit.  When franchisees may opt in or out of changes designed to make the brand more competitive, the value of the brand is weakened.

 

A Model “International” Franchise Agreement?
The model is a single-unit agreement.  Because of the costs of adapting and translating a franchise program to a new country, most franchisors use master franchising or area development franchising internationally.  Multi-unit franchise structures warrant the payment of the higher fees needed to compensate the franchisor for the costs of entering a new market, and they warrant the investment a franchisee will need to make to adapt a foreign franchise to his market.  Neither the model nor its commentary explains how the model contract would be used by franchisors which adopt customary multi-unit strategies for international franchising.

 

U.S. Franchise Laws Would Demand Major Changes to the Model
In its effort to provide a simple, single solution to franchise agreement issues, the ICC has drafted model language which would be considered simplistic and inadequate under the U.S. FTC Franchising Rule.  For example, FDD Item 12 requires U.S. franchisors to disclose whether “territories” are exclusive or nonexclusive.  The model contract’s Article 7 advises the drafter to use the model territory provision, or not to use it.  It provides no language for the use of nonexclusive territories or alternative distribution channels, catalog sales, telemarketing, national accounts and other issues which the U.S. FTC Franchising Rule requires U.S. franchisors to address in their FDDs and franchise agreements.


While very helpful for franchisors targeting an EU country for expansion, the model is unnecessarily restrictive in most other countries.

Because members of the drafting committee are all from Europe, it is not surprising that language dealing with customer and territorial restraints and Internet sales, for example, all reflect European Community antitrust (competition) standards.  Those standards are generally more rigorous than U.S. standards in that they allow franchisors less control over territorial and customer strategies and the use of the internet than do U.S. antitrust laws.  While very helpful for franchisors targeting an EU country for expansion, the model is unnecessarily restrictive in most other countries.

By reading the model and its commentaries a neophyte franchisor or neophyte international franchisor lawyer can learn much about the elements of a franchise agreement.  Many of the clauses and comments are excellent models which will work for some franchisors.  Unfortunately, that is not enough.  If novice international franchisors rely solely on the model and its explanations, the model is likely to create a false sense of security and lead to failure for franchisors who might use it as an appropriate solution to their client’s needs.

 

In the United States, the American Bar Association Model Rules of Professional Responsibility, Rule 1.1 states “A lawyer shall provide competent representation to a client.  Competent representation requires the legal knowledge, skill, thoroughness and preparation reasonably necessary for the representatives.”  By relying on the model for his or her knowledge of franchising, a lawyer risks violating his or her duty of competence.


Carl E. Zwisler, a former IFA General Counsel, practices international and domestic franchise law in the Washington, D.C. office of Gray Plant Mooty.  He reviewed early drafts of the model and attended one of the drafting sessions at the invitation of the Committee Chair.  He can be reached at carl.zwisler@gpmlaw.com or 202-295-2225.