Franchising of Restaurants in the Gulf Cooperation Council

by King & Spalding
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A number of food and beverage groups (particularly restaurant groups) access the Gulf Cooperation Council (GCC) markets through franchising arrangements. With a young and fast-growing population (many of whom spent time studying or living in Europe or the U.S. and have high levels of disposable income) the GCC is typically viewed as a high-priority target market. There are arguably more branches of Western fast food chains such as Five Guys, McDonalds, Burger King, Fogo de Chao, and Tim Hortons than there are of local or regional chains. We are, however, seeing a rise of regional groups such as Kudu, Operation Falafel, Al Baik, Zaroob, etc.

While no formal franchise laws exist in most of the GCC, most parties who enter into franchising relationships in the GCC rely on the local commercial agency laws, such as in the UAE and Saudi Arabia. In both jurisdictions only nationals of the relevant country or entities wholly owned by such nationals are eligible to serve as registered commercial agents. However, in Saudi Arabia a draft of a new franchise law was recently issued which clarifies some of the issues relating to franchising arrangements in Saudi Arabia.

In both the UAE and Saudi Arabia where the relevant commercial agency regulations have typically held sway, such regulations do not impose penalties on the foreign principal for non-registration. Instead, the relevant regulations provide for statutory fines to be levied on local agents who fail to register. We are not aware of any penalties ever being imposed on a commercial agent, in a franchise or any other context, who has not registered his commercial agency agreement.

In Saudi Arabia, however, the local regulators are making it more difficult for the foreign party to import food products and for the local party to display signage with the foreign party’s name without registration.

Typical provisions in the relevant commercial agency regulations provide certain benefits to the commercial agent that may affect a franchisor’s ability to rely on the negotiated terms of its franchise agreements as the relevant regulations, in practice, can provide powers to the local agent/franchisee above and beyond what is provided in the relevant franchise agreement. Such provisions can include, among others;

  •  first, the commercial agency regulations may provide that a registered commercial agent would be entitled to an exclusive area of operation, which, for example may be the U.A.E. as a whole or one or more individual Emirates or Saudi provinces (e.g., the Eastern Province).
  •  second, registration normally provides for the mandatory application of local law and forum for the resolution of disputes between franchisor/franchisee. For example, we have seen parties negotiate a foreign governing law clause only to be confronted by the fact that the form to register the agreement specifically provides for mandatory use of Saudi law and local tribunals.
  • third, a registered franchisee who has been terminated or is in a dispute with the franchisor could, in theory, hinder the franchisor’s expansion of the franchise system in the relevant jurisdiction by (a) contesting the registration of a new franchisee by invoking its statutory right to exclusivity, (b) seeking an order by the customs authorities blocking the import of goods which are subject to the registered commercial agency, and (c) claiming damages and/or commission on sales by the new franchisee.
  • fourth, the agency law in the UAE purports to prohibit the franchisor from terminating the agency agreement unless there is a “reason justifying its termination.”
  •  fifth, most regional commercial agency regulations provide that if termination of the agency leads to the infliction of harm, then the party who is harmed may claim compensation for the harm suffered.

Registration of a franchise agreement pursuant to the relevant commercial agency law is costly to a foreign franchisor that has negotiated its agreement in English. Although the registration itself is a simple procedure, all agreements must be translated into Arabic for registration. For various practical reasons, the version that is registered is typically a short-form, Arabic version of the franchise agreement. In any event, the Arabic version of the agreement that is registered will likely be viewed as the controlling agreement by the local authorities notwithstanding any contrary representations within the documents themselves. Thus, foreign franchisors who will register their franchise agreements are best served to prepare a full and mutually agreed-upon translation in dual English/Arabic format, and have that document executed and registered, in order to have control over the Arabic text that will ultimately serve as the basis for any enforcement action in the GCC.

Because of the combination of (1) the absence of a history of registration in the franchise field, (2) the corresponding lack of enforcement by the relevant ministries, (3) the detrimental effect of registration on the franchisor, and (4) the cost of translation, franchisors often refrain from allowing their franchisees to register under such regulations. To counteract a franchisee’s unilateral attempt to register under such regulations, franchisors often resist translating any agreement into Arabic. We note that if at any time a franchisor were forced to take legal action in the local courts, the contested agreement, supporting document(s) and any other document proffered for evidence would have to be translated into Arabic. Furthermore, the franchise agreement should contain express representations, waivers and covenants regarding the ancillary right to any payment of compensation arising out of termination or non-renewal of the agreement.

Franchisees, particularly in Saudi Arabia, however, may argue that failing to register would place the franchisee in violation of mandatory law, and such franchisee has therefore only agreed to enter into a contract if it is permitted to register. Although deciding to permit registration is ultimately a business issue, if a franchisee insists upon registration and the franchisor decides to relent in favor of completing the transaction, it is critical to revise the agreements to build in certain protections and conditions related to the registration and the additional rights that could be afforded the master franchisee on account of such registration (e.g., making the agreement explicitly non-exclusive, agreeing that not meeting agreed minimum number of store openings or sales targets is a justifiable reason for termination, etc.).

Most franchised businesses will need to provide to the governmental authorities some form of proof of the franchise relationship to obtain permission to put up signage utilizing the franchisor’s trademark. A stand-alone trademark license agreement has normally sufficed for purposes of the signage permissions, but in certain recent instances the authorities took the initial position that presenting proof of registration under the relevant agencies law was a condition for obtaining signage approval.

We note that there is a recent trend towards allowing de-registration and termination of registered commercial agency agreements in accordance with their terms in Saudi Arabia but less so in the UAE. It is extremely important to have well drafted termination clauses that clearly define the triggers for and consequences of termination.

In the event of a termination or non-renewal, the foreign principal may be required to compensate the commercial agent for non-renewal of the agreement if the agent has successfully promoted the grantor’s products and a subsequent agent has benefited from such promotion.

Factors considered for awarding damages include the duration of the agency relationship, the performance of the agent, and the amount of money expended by the agent in promoting the grantor’s products, and the annual gross sales and net profit collected by the agent during the agency relationship. The terms of the agency agreement and the grantor’s reasons for termination will play the predominant role in establishing whether any damages are owed to the agent. Saudi courts generally do not award “speculative” damages (e.g., lost future profits). We note, however, that the Saudi Ministry of Commerce & Investment has published a Model Franchise Agreement calling for “reasonable compensation” to the terminated franchisee based on the apparent success of the business. While not mandatory, the Ministry’s model agreement reflects the Ministry’s “protective” approach in this area.

In our experience, a Saudi court might be more likely to enforce an obligation to pay a fixed sum (and thus decline to entertain claims by the franchisee for a higher amount) because the franchisor could argue that the parties had mutually agreed to this sum after discussion. Accordingly, we recommend providing for liquidated damages in a nominal amount (for example, the Saudi riyal equivalent of $4,000 or so) to be paid upon termination.

Also to further reduce a claim of damages, the franchisee should be required to represent and warrant it had, prior to entry into the agreement, already had sufficient licenses, personnel, warehouses, leases, vehicles, etc. to reduce claims of expenditures by the local agent.

We also note that some franchisors need to take further steps in terms of protecting their intellectual property. There are examples of franchisees learning a particular method of doing business and keeping the entire business other than changing the trademark protected name.

Lastly, we are seeing a number of new franchise relationships that often involve the foreign principal owning a stake in the franchisee. Some ownership schemes involve joint ventures either offshore (to improve enforceability) or onshore.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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