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Thursday, September 22, 2022
Perspectives

Franchising in Latin America: The Regulations


A closer look at franchising regulations in Argentina, Brazil, Chile, Colombia, Mexico and Peru.

LATINVEX SPECIAL
DLA Piper

In this overview, attorneys from DLA Piper, Campos Mello Advogados (an independent Brazilian law firm working in cooperation with DLA Piper) and DLA Piper Martínez Beltrán provide a detailed overview of legislation that impacts franchising in Argentina, Brazil, Chile, Colombia, Mexico and Peru.

ARGENTINA

Although Argentina has had significant franchising activity during several decades, its legal framework has become a lot more detailed and predictable during recent years. In 2015 a new Civil and Commercial Code came into effect, including specific rules on franchising. In addition, other legal areas, such as antitrust and labor law, have become significantly more relevant in recent years for franchising organizations.

The Civil and Commercial Code

Articles 1512 to 1524 include provisions specifically applicable to franchising operations. Although the parties are generally free to structure such operations as may result from their contractual negotiations, the Civil and Commercial Code provides certain minimum rules bearing on the parties.

Provisions on the duration and termination of franchises are specially relevant. The general rule is that franchises must have a minimum duration of four years, with the exception of special cases such as fairs. Termination requires prior notice of one month per year of the contract’s duration, with a maximum of six months. Post-termination non-compete clauses may be agreed, within certain time and territory limits. The general rule is that the franchisor is entitled to continue the relationship with clients previously engaged by the franchisee.

Termination without cause or without the required prior notice creates the obligation to compensate the damages thus caused.

In principle, the parties are free to agree as to the applicable law and jurisdiction. However, since franchise agreements are adhesion contracts, choice of law and jurisdiction clauses may be challenged if they prevent the franchisee from protecting his or her rights or if they are used to hamper the implementation of Argentine public policy provisions.

Antitrust Rules

Argentine antitrust law does not include specific rules on franchising; hence, the general provisions on restraints of competition and abuse of dominant positions are applicable. The Civil and Commercial Code provides that franchising arrangements do not constitute by themselves restraints on competition; such restraints may result from specific clauses or conduct, and in that case they may be subject to antitrust scrutiny. Antitrust claims may be brought before the antitrust agency, or result from investigations conducted by such agency, or be part of claims for damages filed in ordinary courts.

Antitrust litigation in connection with franchising has been very limited.

Labor Law

The Civil and Commercial Code provides that the franchisee is an independent entrepreneur, not linked to the franchisor by an employment relationship. The franchisee’s employees are not related to the franchisor by an employment relationship. The franchisor is not liable for the franchisee’s obligations. However, labor law provides certain exceptions to these basic rules. The franchisor may be liable as an employer if the franchise relationship is considered to be a sham. In addition the franchisor may be liable for the franchisee’s obligations towards its employees for various reasons provided by labor law, such as the franchisor’s control over the franchisee or the direct relationship existing between the franchisee’s employees and the franchisor.

Contractual Practice

The widespread use of franchising mechanisms, before specific legislation was enacted, has resulted in a highly specialized contractual practice, adjusted to the peculiarities of the Argentine legal system -e.g., in labor matters- and to the different requirements of various industries.

BRAZIL

The franchise system is widely spread out in the Brazilian economy, being one of the preferred business models adopted by local investors within the country. Undoubtedly, it is a very important sector of the economy in Brazil, which moves significant resources and is part of the lives of millions of Brazilians, whether as entrepreneurs, employees of franchised businesses, suppliers or consumers.

In this context, the Franchising Law nº 13.966, which entered into force at the end of March 2020, replaced the Federal Law nº 8955/1994, promoting specific adjustments in comparison with the former law, as well as introducing new provisions related to franchise agreements.

Article 7º of the Franchising Law in force provides for specific differences between international and national agreements. The Law defined that international agreements are those which have connections with more than one legal system, considering the actions involved in their conclusion or performance, the situation of the parties regarding nationality or domicile, or the location of its object.. It means that, in case of any connection with a different jurisdiction, such as a foreign party or the performance of its object, the agreement will be considered as an international one. On the other hand, national agreements are the ones that produce effects exclusively in Brazil.

This differentiation is relevant as the Franchising Law establishes specific requirements to be observed depending on the type of agreement to be executed in what concerns its nationality.

In relation to the language, national agreements shall be written in Portuguese, while international agreements shall be either written originally in the Portuguese language or certifiably translated into Portuguese. As the former law did not include such provision, there was no obligation in the past to translate the agreements into Portuguese if it was written in other languages. In other cases, there would be the provision that the English version would prevail in case of any conflict with the Portuguese version. Such practices have now to be adapted based on the new provisions of the Franchising Law. 

In relation to the applicable legal venue, the Franchising Law in force allows the parties to opt, in international agreements, for the legal venue of the country of domicile of one of them, which grants and confirms the autonomy of the parties to establish the jurisdiction of the agreement. In addition, if a legal venue is stipulated in the international franchise agreement, the parties must constitute and maintain a duly qualified legal representative or attorney-in-fact domiciled in the country of the legal venue, with powers to represent them in the administrative and judicial spheres, including to receive judicial summons.

For national agreements, the Franchising Law only establishes the obligation of the agreements to be governed by the Brazilian legislation and does not provide any provision about the legal venue. Notwithstanding the foregoing and following the principles and provisions of the applicable laws, it seems that the legal venue cannot be outside Brazil. On the other hand, there is also no provision in relation to the law that must be applied in the international agreements, but as the legal venue can be freely stipulated, it can also be interpreted that the parties have autonomy to include the governing law.

One of the most important highlights is that the law expressly authorizes the use of arbitration for the resolution of conflicts arising out of international franchise agreements, hence confirming another understanding that was not unanimous in courts, although the adoption of arbitration clauses has always been very common in international franchise agreements.

The former law was silent regarding the possibility (or not) of using arbitration to resolve conflicts, which used to lead to distinct interpretations in different courts and created several setbacks to the parties whenever an actual dispute arose.

This is because the Brazilian Arbitration Law stated that an arbitration clause in an adhesion contract (in which the adhering party has no real option to negotiate the terms and conditions) is not automatically enforceable against the adhering party. Such a clause will only be considered valid if the adhering party initiates the arbitration proceeding or expressly consents to the specific arbitration proceeding commenced by the other party. Since franchise agreements can be understood as adhesion contracts in some cases, the Superior Court of Justice had already ruled that an arbitration clause was null and void absent the express agreement of the franchisee to arbitrate a particular dispute.

The current law has solved this problem with an express provision stating that the parties may elect arbitration to solve possible controversies arising out of the franchise agreement.

In sum, the definitions of international and national agreements are relevant in relation to certain obligations to be followed by the parties, such as the language to be adopted, the legal venue, as well as the applicable law. However, due to the novelty of the Franchising Law, which entered into force only in 2020, it is important to observe how the courts shall decide regarding the open issues discussed above. The inclusion of an express provision admitting arbitration was also relevant to confirm the understanding discussed in courts regarding the possibility to  use  arbitration to resolve disputes in franchise agreements.

CHILE

In Chile, there is no franchise law or other specific regulations for franchising; rather, a variety of legal regulations from different areas of law are applicable. Primarily, therefore, the conditions of a franchising relationship are determined by the contract concluded between franchisor and franchisee, to which, in case of doubt, the general civil and commercial law rules on the interpretation of contracts apply, including the rules on good faith.

When reviewing and, if necessary and possible, negotiating the contract, the franchisee must be aware, on the one hand, that franchise models per se restrict the entrepreneurs' freedom to make their own decisions regarding the conduct of the business; on the other hand, however, the franchisee must ensure that the contract contains not undue restrictions and permits the successful operation of the business, including the necessary marketing measures. To this end, in addition to sound legal advice, it is essential that the franchisee has a detailed knowledge of the local market and the particular type of business.

In the following, the main legal aspects to be considered for this type of business model in Chile are outlined.

Intellectual Property

The use of intellectual property rights are a fundamental part of any franchising model. The franchisee generally uses the franchisor's trademarks, know-how and possibly other industrial property rights, and the franchisor has an interest in protecting this intellectual property in the best possible way, both during the franchise relationship and after its possible termination.

The franchisor will register its trademarks in the trademark register of the National Institute for Industrial Property (INAPI) when entering the Chilean market. Since July 2022, franchisors can benefit from the International Trademark System after Chile joined the Madrid Agreement. This allows, after applying for or registering a basic trademark at a national trademark office, to bundle the administrative proceedings to register national trademarks in other countries that have joined the agreement, saving time and costs.

For the franchisor and licensor, it is important to note that since May of this year, the Industrial Property Law (DFL 4 of the Ministry of Economy, Promotion and Tourism for the establishment of the new, coordinated and systematized text of Law no. 19.039 on Industrial Property) now provides, for the first time, for an obligation to use registered trademarks, as has existed for a long time in other countries. Even if the period of 5 years is sufficiently long, the franchisor should take this into account when drafting the franchise agreement, ensuring that the periods for the franchisee to start up the business and for the associated use of the trademarks in Chile are set sufficiently short, so that even in the event of a possible failure of the business relationship with the franchisee, there is still sufficient time to ensure the use of the trademark by other franchisees or the franchisor itself in the country.

Regarding know-how, in addition to the possibility of applying for a patent if the corresponding - high - requirements are met, protection is granted in Chile through the regulations on trade secrets. The requirements are the existence of undisclosed information that can be used in a productive, industrial or commercial activity, that have an economic value resulting from its secrecy and is kept secret by its owner through appropriate measures.

In any case, it should be noted that in Chile, the granting of licenses for industrial property rights requires an entry in the corresponding register of the INAPI in order to be able to assert them against third parties.

Tax Law

If the foreign franchisor is resident in a country with which Chile has concluded a double taxation treaty, a withholding tax is levied on the payment of royalties, generally limited to 5% to 15%. In contrast, without the existence of such a double taxation treaty, Article 59 (1) of the Income Tax Law applies without limitation, which generally provides for a 30% withholding tax rate on royalties.

Since the franchise agreement may include different types of services, it is important to define them precisely, as they may be treated differently for tax purposes.

Antitrust Law

From a competition law perspective, the mutual dependence between the parties and the subordination of the franchisee is more pronounced in a franchise agreement than in other commercial distribution agreements. In principle, this is justified by the franchisor's legitimate desire to protect the reputation of the brand it has built up and of the know-how and business experience transferred to the franchisee.

As a result, and despite the existence of efficiencies that may lead to greater consumer welfare, such contracts may give rise to vertical restraints that may restrict competition. In particular, such contracts may include exclusive distribution clauses, customer exclusivity clauses, exclusive supply clauses, price fixing, among others.

Therefore, the incorporation of this type of clauses in the franchise agreement, although not prohibited, must be analysed on a case-by-case basis, considering factors such as the market share of the parties, the existence of barriers to entry, and the specific efficiencies of the agreement.

Data Protection

Finally, the franchisee must ensure to comply with applicable data protection laws. Although this area of law has been somewhat neglected in Chile to date, it is foreseeable that the importance of data protection will strongly increase in the future. Clauses that oblige the franchisee to share customer databases or similar with the franchisor must therefore be examined from a data protection law perspective so that they can either be adapted or the franchisee can implement appropriate processes that ensure compliance with data protection laws.

COLOMBIA

In Colombia, the use of franchising as a business model has been considered a boost for the economic development of the country as it has encouraged the generation of employment and investments. In this sense, over 600 brands are estimated to operate within a franchising model business in Colombia.

Currently, franchising is not regulated by a specific law, but by general mandatory provisions of the Civil Code and the Commercial Code. Hence, based on the principle of private autonomy and freedom of contract, the franchisor and franchisee are entitled to set the contractual conditions when entering a franchising agreement. However, since franchise agreements are mainly adhesion contracts, self-regulation has also been implemented based on a Code of Ethics developed by “Colfranquicias,” which seeks to encourage good practices between franchisors and franchisees.

Considering the duality that arises from the franchise agreements regarding parties’ autonomy vs adhesion contracts, from a competition law perspective, it is worth highlighting how the local authority (the Superintendency of Industry and Trade) has approached these agreements as they may include clauses that are usually seen as anti-competitive, such as resale price maintenance.

Antitrust Regulation

Colombian antitrust regulations do not include specific provisions for franchising business models. Therefore, general antitrust provisions are applicable. 

Under such rules, pressuring a business to sell at fixed resale prices is deemed anticompetitive in most cases, as it can lead to higher prices paid by consumers. However, considering franchise agreements have specific characteristics whereby an undertaking requires a uniform distribution contract, the Superintendency of Industry and Trade has considered that general provisions that apply to similar business models (e.g., distribution agreements) do not apply to franchising when analysing unilateral price-fixing as a vertical restraint (see Resolution 40598 of 2014).

In relevant decisions, the Superintendency of Industry and Trade has recognized that due to the very structure of franchising agreements, they require the imposition of restrictive conditions for their business model to fulfil its economic function. This authority considered that price is a part of the know-how of the business, which is essential for the proper functioning of a franchise business model. In franchise agreement, know-how for the use and distribution of goods or the provision of services is communicated to the franchisee for marketing purposes. Hence, the franchisor has an adequate economic justification for unilaterally imposing resale prices.

Based on the foregoing, unilateral price fixing in the franchising business model is not seen as anti-competitive per se. On the contrary, the competition authority understands that uniform distribution contracts may even lead to pro-competitive effects. However, vertical restrictions in franchising must be analysed on a case-by-case basis, considering market economic efficiency.

New Regulatory Projects

As previously stated, currently, franchising is not regulated by a specific law. Nonetheless, in 2020, Law 2069 (also known as the “Entrepreneurship Law”) was issued. According to article 11 of this Law, National Government must regulate the technical conditions for the franchising model business as well as the obligations and the liability regime of the franchisor and the franchisee. However, even though the National Government has already drafted an initial Decree regulating franchising agreements, such a Decree has not yet officially been issued.

In this regard, franchising is soon expected to have a specific regulation. Nevertheless, upon its issuance, the Superintendency of Industry and Trade's interpretation of unilateral price fixing in franchising is not likely to change.

MEXICO

The franchising sector in Mexico is a fundamental part of the Mexican economy. With more than 90,000 franchised units which generate an estimate of one million jobs; such sector has proved to be a very attractive investment model for local capital.

Franchising transactions gained popularity in Mexico in the mid-80´s, when several food chains based abroad (mainly, in the U.S.A.) used this model to expand their business into Mexican territory. The franchise agreement was first regulated in the Industrial Property Law, published in 1991, which was then superseded by the current Federal Law for the Protection of Industrial Property, published in 2020 (although the ancillary regulations of the former Industrial Property Law remain effective). The provisions related to franchise agreements did not suffer any changes as a consequence of such recently enacted legislation.

It is important to highlight that the franchise regulation in México is not very extensive. Its most important features can be summarized as follows:

1.    Identification of a franchise agreement. A transaction will be deemed to be a franchise, and therefore, subject to franchise regulations, when a trademark is licensed, technical knowledge is transmitted, or technical assistance is provided, to enable the franchisee to produce or sell goods or render services in a uniform matter, and using the methods established by the franchisor, aimed to maintain the quality, prestige, and image of the licensed mark. In accordance with the general principles of Mexican law, contracts are interpreted by the content of their clauses, and not by their name or title; therefore, an agreement that fulfills the elements mentioned above should be deemed to be a franchise for all applicable legal purposes, even if lacks such title. 

 

2.    Disclosure obligation. Franchisor must disclose, with at least, 30 days in advance to the date in which the execution of the franchise agreement, certain information regarding the status of franchisor´s business. The specific information that must be provided is detailed in the ancillary regulations of the Industrial Property Law.

 

3.    Formal requirements. The franchise agreement must contain a list of formal requirements described in the corresponding legislation. Some of these requirements include (a) the geographic zone in which the franchise will be effective; (b) terms and conditions for sub-franchising; (c) royalties and income distribution; and (d) methods of supervision and evaluation by franchisor.

 

4.    Franchisor´s right to interfere. Franchisor has the right to interfere in the franchised business solely in order to oversee franchisee´s compliance with the terms of the agreement; however, the law expressly sets forth that franchisor may impose change of control restrictions to franchisee, without these being considered as unlawful interference.

Although, due to the very nature of its model, a large percentage of franchise transactions are classified as “cross-border” (typically, the franchisor being located abroad, and the franchisee located in México), the applicable legislation does not differentiate between a pure local and a cross-border franchising transaction. This could lead to different interpretations concerning the applicable law and jurisdiction of a franchise agreement, as many of such agreements are held subject to foreign law and jurisdiction, while the franchised business is located in Mexican territory.

Over the years, the franchise industry has found a solution to harmonize both law and forum positions described above in the execution of franchise agreements. This solution consists in basically use the Franchisor’s standard franchise agreement as a baseline to negotiate the terms of the Mexican franchise, and to set forth as governing law of such franchise agreement, the laws of the jurisdiction in which the franchisor is located; but including a chapter in the agreement corresponding to Mexican law´s specific provisions. Usually, such chapter contains (1) a representation whereby franchisee acknowledges the fulfilling of the disclosure obligation by franchisor pursuant to the terms set forth in the Federal Law for the Protection of Industrial Property (if not acknowledged elsewhere in the agreement); and (2) a clause acknowledging that the franchise agreement contains all the formal requirements set forth under such law and making reference to the section of the agreement in which each of them is contained. The main purpose of this solution is that, while an eventual controversy will be resolved in accordance with foreign laws, the agreement cannot be declared as null and void by a Mexican court, for lacking the formal requirements set forth in Mexican laws, or for contravening the provisions of Mexican franchise regulation; therefore, the judgment issued by the foreign court could be enforced in Mexico as it would not breach any public order principle.

Another challenge faced by cross-border franchising transactions is their registration with the IMPI (Mexican Institute of Industrial Property, by its acronym in Spanish), which is the competent authority for registration of trademark and any rights thereto. In connection with the scheme described in the previous paragraph, it is worth noting that the IMPI accepts the registration of franchise agreements subject to foreign law. Considering that franchise agreements are usually quite extensive and contain detailed provisions related to the operation of the franchised business, many of the information contained thereunder would be preferred to be kept as confidential by the parties. Therefore, a common practice is to file a summary of franchise agreement which makes reference exclusively to the legally required provisions of a franchise agreement. Such filing mechanism has been widely accepted by the IMPI.

As a conclusion, the commercial and legal industries associated to the franchising sector, together with the competent authorities, have recognized that franchising transactions are prone to involve parties located in various jurisdictions and therefore, they have developed mechanisms that provide the parties with legal certainty with respect to the choice of a foreign law and forum in their franchise agreements, while ensuring their compliance with Mexican laws.

PERU

Public International Law has played a fundamental role when it comes to franchising in Peru, because there is no extensive regulation in the country on the subject.

Even so, this business model has had an exponential growth in Peru since currently more than 1200 franchised companies generate jobs for more than 20,000 Peruvians.

It is worth mentioning that franchise contracts are of the atypical type that deal with the transfer of intellectual property rights in which a specific method is included on the exploitation of a commercial activity recognised in the market. However, before doing so, it is essential to take up certain key concepts in order to better understand franchising.

Firstly, the licence of the registered trademark is necessary, since it is the central object of this contract, which will be legally transmitted to the franchisee. Now, in addition to this, the franchisor's know-how is another essential element in this type of contract, as it forms part of the whole structure of the business to be franchised, including business management, methods of administration, distribution and sale of products, among others.

Apart from that, when we are talking about a commercial contract, the monetary factor is unavoidable. This takes the form of royalties and fees in this type of contract. Royalties are monthly payments from the franchisor to the franchisee, usually on a monthly basis, for the profits of the operation. On the other hand, the fee is the initial payment that provides the "right of entry" to the franchisee when it purchases its participation in the franchisor's network.

Thus, the applicable legislation is framed in the Peruvian civil code, in the commercial, tax, competition and intellectual property legislation, the latter being of important relevance since the controversies that may arise in the reality of our country would be mainly referred in most cases to the most important asset of the business, the trademark.

In what refers to the applicable law, intellectual property regulation in Peru is Supranational because Peru is a signatory of the Andean Community together with Bolivia, Colombia and Ecuador. The Andean Community is an International Organization, that establishes mechanisms and policies for development through Andean integration.  Intellectual Property is one of its areas of action which have common rules, Industrial Property Act (Decision 486 and 689), Copyright Act (Decision 351), among others.

Each country has its own local legislation regarding the procedures in application of the Supranational regulation, in Peru the local legislation is the Legal Decree No. 1075 for Industrial Property (trademarks and patents) and Legal Decree No. 822 for Copyright.

Intellectual Property

With this in mind, intellectual property law plays an important role in this matter.

Proof of this is the meticulousness with which new components must be introduced through the operating manual of the franchise This manual can be taken as the very essence of the franchise network as it not also serves as a step-by-step guide on the exploitation stages and clarifies the most common doubts, within it we can find (i) method of franchise exploitation, (ii) necessary means, (iii) specific instructions: containing standard forms, didactic means, advertising, among others,

However, it is clear that the lack of a specific legal source in Peru allows controversies to arise in this matter. Generally, the main issues in our country arise because the franchisee does not use the intellectual property rights provided by the franchisor in an appropriate manner; or when a third party infringes the intellectual property right in such a way that it is necessary to file a complaint and cover the costs of it, this is when the question arises of the franchisor contributing or becoming a party to the litigation.

In this scenario of lack of specific regulation, also the terms agreed in the franchise agreement in what refers to the defence and cessation of use of the intellectual property involved in the franchise at its termination, take vital relevance since the obligations agreed in the contract and the application of the intellectual property legislation will be what governs the solution of possible controversies.

In addition, there is also the problem of disclosure of confidential information acquired during the franchise period. It is therefore essential to inventory trade secrets, including scientific and technical information as well as strategic, financial and commercial information.

Based on what has been mentioned, international regulatory sources continue to be predominant in Peru to this day. For this reason, it is essential not to lose sight of international decisions that may radiate paradigms or new rules that modify the Peruvian context.

 

This overview was written by DLA Piper senior partner Guillermo Cabanellas (Argentina section), Campos Mello Advogados partner Paula Mena Barreto and attorney Ana Paula Pitta de Moura (Brazil section), DLA Piper associate Lisa Hondl (Chile section), DLA Piper Martínez Beltrán  associate Felipe Rodríguez Helo (Colombia section) and DLA Piper partner Jorge A. Benejam and associate Joaquín Gallástegui (Mexico section) and DLA Piper Of Counsel Ana Teresa Barreto (Peru section).

Campos Mello Advogados is a Brazilian law firm that works in cooperation with DLA Piper.

 

 

 

 

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