DOES YOUR AGENCY
OR DISTRIBUTORSHIP AGREEMENT INADVERTENTLY CREATE A FRANCHISE RELATIONSHIP
OR,
CONVERSELY, DOES YOUR FRANCHISE AGREEMENT
CREATE AN AGENCY OR DISTRIBUTORSHIP RELATIONSHIP
Certainly, no supplier-distributor
or principal-agent expects to end up defending franchise law violation
allegations. Yet, these situations arise with considerable frequency both in
the United States and other regions of the world. Manufacturers, suppliers, and
trademark owners often overlook a possible franchise connection when they enter
into relationships with independent third parties to sell their products or
services.
Given the prevalence of
franchising and the interstate, national, and even international scope of so
many franchise networks today, attorneys need to know about potentially
applicable federal, state, and foreign franchise laws. Franchise sales in the
United States are subject to dual regulation at the federal and state level,
depending on where the parties reside or do business. The federal franchise
sales law, originally adopted in 1978 and overhauled in 2007 regulates
franchise sales in all 50 states, including wholly intrastate transactions, per
the 2007 version of 16 C.F.R. § 436 (Amended FTC Rule).
Why then, is a discussion of
commercial agency and distributorship laws relevant? The first thought when
dealing with international franchising may be, why should I be concerned? After
all, agency and distribution models are likely not what the franchisor has
established in its home market; it has chosen a franchise model over those
other models. In fact, it is quite likely that the boilerplate provisions in
the domestic franchise agreement specifically states that the agreement does
not create a principal-agent relationship.
However, it has been our
experience that when expanding internationally, franchisors may not wish to strictly
adhere to the American-style franchise model. For example, the franchise
legislation in the desired new market may be considered overly burdensome, or
there may be business reasons for why the franchisor does not believe its
domestic franchise model will work in the new market and it is therefore looking
for alternative models. In those cases, the franchisor should carefully
consider commercial agency and distributorship laws in the markets it is
looking to enter. But the franchisor who wants to continue using its franchise
model internationally should not ignore these laws either. The definitions of a
franchise, agency, and a distributorship arrangement differ from country-to-country
(or state-to-state, or province-to province). And even when the franchisor does
not wish to establish an agency relationship or grant a distributorship, even
when this type of relationship is denied by the express wording of the
franchise agreement, an agency or distributorship may still be the unwitting
result. Simply speaking, the laws of each country vary and a relationship that
is not deemed to be an agency or distributorship in the franchisor’s home
country may qualify as such in the new market.
It is not all that surprising
that there may be overlap between franchise laws and agency and distributorship
laws, as the underlying relationships share many characteristics: all three
regulate a relationship where one party holds the knowledge and valuable
intangible or tangible assets, and the other party, through its work and
effort, is looking to exploit such knowledge and assets. The reasons for
engaging an agent or distributor are also often the same as for engaging a
franchisee. The local party can overcome language and cultural (including
business culture) barriers and may already have an established network of
business contacts that will help the franchised business expand faster than if
the franchisor were to try to establish itself in the new market. The local
party will have knowledge of local trade practices and know how to navigate the
local bureaucracy necessary to obtain necessary permits and licenses. It may
even be necessary to have a local party fulfil the function if local law
restricts certain types of business activities to citizens of the country. The
local party can also provide service locally in a way that the foreign party
will not be able to do from a distance: help with installation, provide
warranty repairs, and offer aftermarket sales of products and service in a way
convenient to the local customer. The local party can also provide invaluable
assistance in adapting the foreign party’s offering to local tastes and
preferences, be that adapting the product itself, or marketing and product
information. Finally, and typically one of the reasons a company chooses to
franchise, the cost for getting started in the new market is often
significantly less when the local establishment is set up by a local party and
not the franchisor itself.
Because of a perceived imbalance
of power in the franchisor-franchisee, supplier-distributor and principal-agent
relationships, consumer protection laws have been drafted to protect the “weaker”
party. Frequently in international dealings the allocation of power in these
business relationships is often quite different. It is not unusual that the
franchisee, distributor, or agent is a large organization and, at the very
least, has significant local market knowledge that may be as important as the
franchisor’s, supplier’s, or principal’s know-how. But be that as it may, the
laws are there to protect the perceived weaker party, and franchisors expanding
internationally need to take commercial agency and distributorship laws into
consideration, so as not to find themselves unable to terminate the
relationship as they wish according to the terms of their express agreements,
or only able to terminate at considerable cost.
Differences Between Agencies
and Distributorships
Before delving into more detail
about common features of agency and distribution laws, it is important to point
out that agencies and distributorships are not the same. While the definitions
of agents and distributors vary between countries just as the definition of a
franchise does, generally speaking, in an agency relationship the agent never
takes title to the goods being sold. The agent solicits buyers for the supplier’s
products or services, but the purchase agreement is then entered between the
supplier and the customer directly. The agent is compensated on a commission
basis, typically at a percentage of the sales price that the supplier receives.
A distributor, on the other hand, usually takes title to the goods sold. The
distributor typically buys the products from the supplier and then resells them
to its own customers. The distributor’s compensation is the margin between the
price at which it purchased the products from the supplier and the price at
which it sold the product to its customers. The distinction between agents and
distributors matters for many reasons and not in the least because they are
often subject to different governmental regulatory regimes, statutes, or jurisdictional
departments in different countries. For example, in many European countries
there is no specific regulation of distributorships, but agency agreements are
heavily regulated. However, in Germany (and most other European countries),
distributorships are not specifically regulated, but agency relationships are.
As a result, while a supplier may freely terminate its distributor in Germany,
it must give its German agent as much as six months’ notice and may have to pay
a termination payment to the agent.
A franchisor should also not
assume that simply because the structure of its agreement made it an agency
agreement or distributorship in one country, that will be the case in all other
countries. As already alluded to, this is a country-specific determination.
For example, in the United Arab
Emirates, a commercial agency is defined as the “representation of the
principal by an agent for the purpose of distribution, selling, display or
rendering of a commodity or service in the state, against a commission or profit.”
Under German law, an agent is a
self-employed intermediary who has continuing authority to negotiate
transactions on behalf of a principal or conclude transactions in the name of
the principal.
The Swedish law regulating
commercial agents defines a commercial agent as somebody who, for profit, has
agreed with another, the principal, to act on behalf of the principal
independently and continually for the purpose of selling or purchasing goods
through the act of passing orders to the principal or entering into agreements
in the name of the principal.
These three definitions are quite
different. To some extent they simply approach the agency relationship from
different perspectives: the definition in the UAE is focused on the activities
that the agent will undertake, while the German and Swedish definitions are
more focused on the end result. But there are more material differences: the
German and the UAE definitions appear to cover both products and services,
while the Swedish definition only applies to products. In other words, a
relationship that falls under one of the statutes may not fall within the scope
of the other. These are but three examples and it is important to always
understand the scope of agency and distributorship laws in countries a franchisor
is entering.
Public Policy Laws and Default
Contract Terms
Similar to franchise laws, in
many countries both agency and distribution laws are deemed to be public policy
laws, and as such, cannot be contracted or assigned to third parties. However,
even if that is the case there may still be room to structure the agreements to
minimize any perceived negative impact of those laws.
An additional point to be made is
that the absence in a country of a specific statute regulating agencies and
distributorships does not necessarily equate with a lack of regulation of those
types of agreements. Even if there are no statutory rules specific to agency
and distributorships, a franchisor should not assume that the country does not
have rules regarding agency agreements or distributorship agreements. In many
countries there is a commercial code with general rules regarding different
types of agreements and there may be case law specific to agency and
distributorship agreements. For example, in Germany there is no specific
statute applicable to distributorships. However, through case law many
statutory provisions applicable to agency agreements have been expanded to also
apply to distributorships. And, even though there is no statutory requirement
regarding termination notices for distributorship agreements under German law,
there is case law supporting the idea that some of the statutory requirements
for agency agreements should apply to distributorship agreements as well in
some cases.
Specific Issues Arising Under
Agency and Distributorship laws
Understanding the applicable
agency and distributorship laws upfront is extremely important for at least two
reasons. First, agency and distributorship laws often impose default provisions
that will apply to the parties’ agreement if the agreement is silent on that
point. Second, though the agency and distributorship laws are public policy
laws, the default provisions (excluding termination-related provisions) can
often be amended by contract. In other words, understanding these laws will
help the franchisor draft an agreement that will reduce the number of surprises
later on in the relationship, and that may help regulate the relationship in a
way as close as possible to the supplier’s intent.
Some may presume that the
statutorily imposed rights and obligations are always in the agent’s or
distributor’s favor. While this is often the case, it is not always the result.
Agency and distribution laws also impose obligations on the agent or
distributor, such as the party’s best efforts to not compete with the supplier;
keep the supplier informed about developments in the territory that may impact
the business; maintain books and records; maintain a sufficient inventory of
spare parts; and provide service to customers in the market. For example, under
the Swedish agency law, the agent is required to use its best efforts, follow
reasonable instructions from the supplier, inform the supplier of important
developments in the market, take good care of inventory in its possession, and
keep its funds separate from those of the supplier. German law similarly requires the agent to
provide the supplier with necessary information and must perform its
obligations with due care. These types of provisions are not limited to EU
countries and can also be found in other parts of the world, for example in
Argentina.
Restrictions on Right to Terminate
One of the most common
restrictions imposed by agency and distributorship statutes is on the
supplier’s right to terminate the agreement.
On this point, contract drafting
choices may have a significant impact on the legal obligations of the
franchisor. Franchise agreements are typically for a definite term and require
at least some steps to be taken by the franchisee, agent, or distributor in
order to be renewed, so typically they would be considered agreements for a
definite term under agency and distributorship statutes. From a supplier’s
perspective, it is typically better to have an agreement for a definitive term.
It avoids local law provisions regarding notice periods and termination
indemnity. However, the just cause requirements described below in at least
some countries apply not only to termination, but also to non-renewal, thus
capturing within their scope definite term agreements.
Agreements for an indefinite term
can be significantly harder to terminate in some countries than a franchisor
may be used to, as they can often only be terminated for “just cause.” But this
is not an issue solely for indefinite-term agreements. For all agreements,
termination during the term is often restricted to just cause termination,
which may render express contractual termination provisions unenforceable. Just
cause is not necessarily the same thing as the often-exceedingly long
enumeration of defaults that the supplier may have included in its agreement.
Often statutes will contain relatively short lists of what constitutes just
cause (though it is also not unusual for statutes to simply refer to material
breaches by the other party as constituting just cause).
Just cause may generally include
breach of contractual obligations to the supplier, but will typically require a
truly material breach of the contractual obligations. The agency law in the
Dominican Republic provides a good example in that it requires a failure to
comply with “the essential obligations of the (agreement), any action or
omission that could adversely affect in a substantial way the interest of the (supplier)
in the promotion or negotiation of the import, distribution, sale, lease, or
any other form of trade of his merchandise, products or services.”
In other jurisdictions general
contract law provisions will affect a party’s right to terminate. For example,
in Argentina the general termination provisions of the Civil and Commercial
Code apply to agency agreements. The Civil and Commercial Code allows a party
to terminate when the supplier is deprived of essential or substantial benefits
of the agency agreement.
Termination Notice Requirements
Even if the applicable laws do
not require just cause for termination, it is not uncommon that a lengthy
notice of termination be provided. In EU countries in particular, termination
notice for agency agreements can be significant, starting with one month for
agreements that have lasted a year, and up to six months for agreements that
have lasted six years or longer. However, an agreement for a definite period of
time will expire upon the end of its term, without any notice. Long termination
notice periods are not unique to the EU though. For example, in Argentina, for
indefinite term agency agreements, the terminating party must give the other
party one month’s notice per year of the contract term.
Termination Payments
Together with statutes that limit
a franchisor’s ability to terminate an agreement other than for just cause, the
statutory provisions that tend to give franchisors and other suppliers and
principals the most grief are provisions requiring some type of termination
payment. Often these payments are due whether the termination is for just cause
or otherwise, though they tend to be significantly higher if a franchisor or
other supplier terminates without just cause.
For example, in Germany and
Sweden (reflective of other EU countries), an agent is entitled to termination
payments, up to an amount of the total commissions for one year, if the agent
has brought new clients to the supplier, or otherwise increased sales to
existing customers.
In Colombia, agents are also
entitled to payments upon termination, in the amount of one-twelfth of their
commissions per year of the contract duration. This is assuming the supplier
had just cause to terminate. If the agreement was terminated without just cause,
then the supplier must pay indemnification reflecting the efforts the agent put
in to promote the supplier’s goodwill.
But in other countries, these
payments may be significantly higher. For example, in the Dominican Republic,
an agent is entitled to payment to compensate them for the business that the
agent is deprived of because of the termination (or non-renewal) of the
agreement without just cause, the value of the services rendered to the
supplier, the agent’s investment in equipment, furniture and fixtures used
specifically for the agency business, and any inventory that the agent may have
had that it can no longer use after the termination or non-renewal. More
importantly, the agent is also entitled to the supplier’s gross profits from
the sale of the products or services for the past five years, or possibly even
more.
However, not all countries afford
this level of protection to agents. For example, in Argentina termination
payments are limited to situations where the supplier terminated its definite
term agreement without just cause, or where an indefinite term agreement was
terminated without proper notice.
Restrictions on Competition
Another topic often covered by
agency and distributorship laws is the agent’s or distributor’s right to
compete.
In Germany, a post-term
non-compete is permitted in agency agreements for up to two years after
termination. However, the scope of the non-compete must be narrowly tailored to
the territory of the agent or the customers the agent was assigned, and the supplier
must pay reasonable compensation for the non-compete. Similarly, post-term
non-compete provisions are permitted in Argentina for up to one year after
termination, but must also be reasonable in scope.
Compensation
Many agency and distributorship
laws set at least general parameters for how agents and distributors may be
compensated. For example, both German and Swedish law dictate what agreements
an agent is entitled to receive commission on and when. The payments are tied
to the agent’s performance and value that is perceived to have been created
through the agent’s efforts. In the UAE, a supplier is restricted to how many
agents it may have (no more than one per state) and consequently the agent is
entitled to commission payments not only on sales it helps close itself, but on
all sales into the agent’s territory.
Registration
Another feature of agency and
distributorship laws that is relatively unusual for franchise laws, is that the
agreement must be registered. Many countries do not require registration of
agents or agency or distributorship agreements, but in those that do, suppliers
need to make sure they understand the implications of the registration. Leaving
aside such practicalities as whether the entire agreement needs to be
registered (or just an excerpt), and if the agreement or excerpt needs to be
translated into the local language before it can be registered, registration
often raises many other issues. For example, in some countries, the
registration obligation may be on the agent, and the franchisor has little need
of, or derives little value from the registration. In those situations, the
franchisor may not wish to encourage registration. In other countries, the
registration requirement may be on the franchisor or supplier, or it may be
impossible for the agent to perform its duties without proof of registration.
In some instances, the registration triggers the applicability of the statute,
and in others, the supplier may not be able to register a new agency agreement until
the previous one has been properly terminated.
Nationality Restrictions
While agency and distributorship
laws are always consumer protection laws, they can sometimes also serve as laws
reserving domestic enterprise to the citizens of the country. This is
particularly common in the Middle East (though not exclusively in that part of
the world). In some instances, only certain industries are protected, but
sometimes the restrictions can be broader. It is crucial for a franchisor to be
aware of these restrictions before entering countries with these types of
restrictions. For example, in Saudi Arabia and the United Arab Emirates, an
entity acting as an agent must be 100 per cent owned by nationals, and in
Bahrain, Kuwait and Oman, at least 51 per cent must be owned by nationals.
The Fine Line Between Employee
and Agent
The question of how franchisees,
distributors and agents should be classified for labor and employment law
purposes has received significant attention over the past several years in the
United States and elsewhere. This is a serious concern in many countries and
the consequences may be significant. Reclassification of an agent as an
employee can have an impact on the obligations of the franchisor, both with
respect to taxes and benefits, but also with respect to the supplier’s ability
to terminate the relationship with the agent or employee. In addition,
reclassification can have additional tax consequences in that the agent’s
business could be considered a permanent establishment of the franchisor. As
with other issues raised in this article, it is often possible to structure the
contract and relationship to avoid an employer-employee relationship.
Generally, the agent or distributor taking economic risk and having contractual
independence are likely to be important factors. It is also generally advisable
that franchisors do not appoint individuals as their franchisees, agents, or
distributors in other countries. But rather, select established companies with
a strong management team and marketing expertise.
2306 Wales Drive
Tel 619-994-2258 • Fax 760-632-0772
Cardiff by the Sea, CA 92007 carl@kosnar.com http://www.kosnar.com