Saudi Arabia’s New Comprehensive Franchise Law
What you need to know about the new law, from disclosure requirements to administrative penalties.
By Carl Zwisler, Gray Plant Mooty
On October 8, 2019, the Saudi Council of Ministers approved a franchise law that is expected to become effective in April of 2020. After it is formally published in the Official Gazette, the Ministry of Commerce and Investment will issue regulations prescribing the requirements for a Saudi Arabian franchise disclosure document (FDD), setting filing fees and establishing implementing rules and procedures. The new law contains substantial, positive changes from the bill that was originally proposed in January of 2017. The registration and disclosure requirements, including requirements for all documents to be prepared in Arabic and relationship restrictions, will affect franchisors’ cost of doing business. This is because the law apparently eliminates the application of the commercial agency law to franchises, with the ultimate financial impact of the regulation expected to be far less than was originally anticipated.
The law defines “franchise” in a way that is fairly consistent with how the term is defined in U.S. franchise regulations — it only seems to apply to arrangements in which the franchisor receives a payment for something other than goods “or services” provided to a franchisee. The final version of the law and regulations will need to clarify when payments for services are excluded from the payment element.
The Experience Requirement
A variation of China’s 2+1 standard for franchising is a condition of granting franchises in the Kingdom. Only if “the business to be franchised has been operated in accordance to the Franchise Operations System for at least one (1) year and by at least two (2) persons (which may include the Franchisor or any of [its affiliates] or in two (2) separate units” may a franchisor grant a franchise.
A Saudi master franchisee must not offer sub-franchises until it or another franchisee has operated a business like the one to be franchised for at least one year in the Kingdom.
Registration of Franchise Agreement and FDD
Franchise Agreements and Saudi FDDs must be registered as provided in the yet to be published Regulations. The law fails to specify whether the registration must occur before the sale of a franchise or after the execution of a franchise agreement. It does not distinguish between the obligations of franchisor and master franchisees. It mentions nothing about exemptions.
Franchise Agreement Requirements
Twenty common franchise agreement provisions are required to be included in Saudi franchise agreements, “unless otherwise agreed by the Franchisee in writing.” Agreements and FDDs must be written in Arabic.
Franchise Disclosure Requirements
At least 14 days before entering into a Franchise Agreement or receiving any consideration from a franchisee relating to the franchise, a franchisor must provide KSA franchisees with an FDD including information to be specified in forthcoming regulations.
Obligations of Franchisees
Unless the parties agree otherwise, franchisees must obtain the franchisor’s approval for changes to the goods or services offered, the method of operating the franchise business and the location of the franchisee’s business. Franchisees must provide franchisors with accurate information about the franchise business and allow the franchisor to have access to their business facilities. Franchisees and franchisors must undertake their duties to each other in good faith.
Transfers, Terminations, Renewals and Compensation
Although the law specifies procedures and requirements for transfers, terminations and renewals, the parties may agree upon different policies and procedures to govern their relationships. However, by exercising its right to terminate or not renew for certain reasons not specified in the law, a franchisor will be subject to an obligation to repurchase certain physical assets purchased from a source directed by the franchisor and to compensate the franchisee for losses arising out of the franchise relationship.
The current language prescribing compensation is ambiguous and requires refinement. In particular, Article 19 requires franchisors which violate the registration and disclosure provisions to compensate franchisees for losses suffered as a result of the violation, but specifically prohibits a franchisee from terminating the franchise agreement under those circumstances. However, Article 17 authorizes franchisees to terminate their agreements for material breaches of the registration and disclosure obligations by their franchisors, but does not permit them to recover compensation. It is unclear whether this is intended to provide alternative remedies: either terminate or demand compensation.
Commercial Agency Law (CAL)
Although the Saudi commercial agency law has long been applied to franchise relationships, the new franchise law specifically excludes from its definition of “Franchise Agreements” agreements that are subject to the CAL. Because the CAL and franchise laws will both be administered by the same Ministry, the final regulations should specifically exclude franchises from the CAL’s coverage, although that has not specifically been addressed in the current draft of the law.
Violators of the Law and Regulations are subject to fines of 500,000 SAR (approximately $133,300 USD on October 11, 2019). The parties to a franchise agreement may agree to arbitration, mediation, conciliation or similar alternative dispute resolution approaches. The law does not specify whether the ADR must occur in the Kingdom.
Carl E. Zwisler is Principal Attorney at Gray Plant Mooty. Find out more about Gray Plant Mooty here.