The Legal Elements of Franchising

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Introduction

Franchising is a popular business arrangement. It is where an organization grants another the right to use its brand or operational framework. The agreement lasts for a predetermined period. The franchiser is the entity allowing giving out its rights to another firm. A franchisee is a firm that seeks rights from the franchisor. Both parties derive benefits from the arrangement. The franchisor can infiltrate the market without having to invest in the construction and stocking of the chain stores (Bruckmann 23). In addition, the franchisor can sell large volumes of the products with the aid of the franchisee. The risk of having to invest in new markets is also avoided. Through the practice, franchisors can effectively market their products. They achieve this by encouraging franchisees to operate using their brand.

In the current paper, a discussion of how different governments define and regulate franchises is provided. The research focuses on the United States federal law and California state legislation with regards to franchising (Bruckmann 23). The paper also seeks to analyze how franchising is regulated among European countries. In addition, a review of how a franchise turns into an agency is provided.

How the Federal Law in the US Defines and Regulates Franchising

In the US, laws are enforced at the federal and state levels (Bruckmann 23). As a result, there is a lack of uniformity in the control of franchising activities. Franchising practices in this country are regulated by the Federal Trade Commission [FTC] (Bruckmann 22). The commission works together with regulators at the state level to ensure uniformity. The law was established to regulate the sale of franchises. It also standardizes the offer of franchises among enterprises operating in the country. According to FTC, a franchise exists as a commercial arrangement between a buyer and a seller.

According to FTC, franchising has three major aspects. The elements should exist for the arrangement to be considered as a franchise. To begin with, the seller grants the buyer the right to operate using the firm’s trademark (Bruckmann 23). As such, the latter will operate using the logo and name of the former. In addition, the franchise may involve the provision of the right to distribute the products of the seller (Bruckmann 24). In most cases, franchising also involves the permission to brand products to resemble those provided by the seller.

Secondly, a franchisee must involve the provision of assistance to the buyer (Bruckmann 23). In this case, the law requires the seller to guide the buyer in the implementation of the business models to be used as per the arrangement. The buyer must also receive training on how to operate the franchise. In most cases, the seller may require to be paid for the training services offered to the buyer. The cost of the training is often added to the total price required for the purchase of the franchise.

Alternatively, the seller may provide the training for free. In other cases, assistance may not be necessary. Such instances include when two firms are renewing their franchise contract. Despite the sharing of information concerning operations between the two parties, the franchisor reserves the legal right to control the business. Upon expiry of the franchise agreement, the seller has the right to determine whether to renew the arrangement or not (Az 34).

Thirdly, for an arrangement between two firms to be considered as a franchise, a fee must be paid. The payment covers the sale of the trademark and the operational model (Bruckmann 27). It is generally assumed that businesses only buy franchises from other entities regarded to be more successful than them. The buyer seeks to make profits through the process. The gains made are at the expense of the franchisor. As such, the buyer is required to pay the seller for the rights to use a trademark. The payment can be made once or in installments within an agreed duration of time. The federal law of franchising requires the buyer to pay at least 500 U.S dollars or more within the first 6 months of operations.

The federal franchise law enforced by FTC acknowledges every business agreement that fits the description of a franchise regardless of what the parties call their relationship (Bruckmann 23). Any legal matters arising from the arrangement of such parties are addressed following the laws put in place to govern franchises. However, the law states that for an arrangement to be considered as a franchise, the parties must be engaging in purely commercial activities. In this case, the buyer must benefit as a result of their association with the franchisor (Bishop 45).

The US FTC Rule requires the agreement between the franchisor and the franchisee to exist in writing (Bruckmann 21). The written agreement must show evidence that the seller has allowed the buyer to use their trademark in conducting business transactions. The franchisor must have permitted the franchisee to sell their products (Bruckmann 22). There must also be evidence that the two parties have an arrangement that will enable the buyer to adopt the seller’s model of operation.

Assistance offered to the buyer helps them to benefit from the model. However, the seller must be seen to retain control over the trademark. Retention is an important identifier of a franchise. It distinguishes it from other forms of business agreements, such as the sale of trademarks and production rights, where control shifts to the buyer. A franchising agreement must also have evidence of payment. Some state laws define oral agreements between the franchisor and the franchisee as a franchise. However, the FTC Rule does not recognize such arrangements.

The US federal law recognizes three general categories of franchises. The first is business opportunity franchises. The others are package and product distribution franchises (Bruckmann 23). The three categories describe the form of relationship between the buyer and the seller. All forms of franchises in the US fall under one of the classifications.

The business opportunity franchise involves the seller allowing the buyer to exploit existing opportunities in the market. In this case, the seller can allow the buyer to exploit ideas used by the former’s brand name, such as machine routes (Bruckmann 23). Here, the buyer is allowed to exploit innovations made by the seller. The arrangement between the two parties may involve allowing the seller to incorporate a technology owned by the franchisor in the production of goods and services. Another common form of business opportunity franchise involves the use of the franchisor’s trademark in the display racks of the franchisee. In such a scenario, the products stocked by the distributor are viewed as superior to others owing to the use of a renowned brand name. The practice serves as an effective marketing strategy.

Package franchises in the US are also commonly referred to as business format franchises. The FTC rule describes them as a situation where the seller allows the buyer to use their business model (Bruckmann 22). The arrangement is common, especially in the service industry. In this form of franchising, the franchisee operates as an independent entity. However, the business uses the trademark of the franchisor. The nature of services provided by the buyer of the franchise is similar to that of the seller. In this form of a business transaction, the franchisee needs to undergo intensive training to be in a position to match the quality provided by the franchisor.

The franchisor stands to benefit by ensuring that the buyer fully understands the operational model. Such a move enhances uniformity in the quality of the goods and services provided. The aim is to avoid negatively affecting the integrity of the trademark. A good example of this form of franchise in the United States is McDonald’s Corporation which has stores across the country run by different franchisees. Firms operating under the trademark offer homogenous services to their customers across the country. They also use a common operational and marketing design. The practice is also gaining popularity in other service delivery industries, such as real estate development.

The third category is the product distribution franchises. In this kind of arrangement, the franchisee sells goods that are produced and supplied by the franchisor. As such, the goods bear the trademark of the franchisor. The franchisee therefore fully operates under the control of the franchisor. As is the case in the package franchise, the franchisor provides a great deal of support to the franchisee. A franchisee in this case is also required to have a good understanding of the operational methods used (Bruckmann 23).

The arrangement also allows the franchisor to enjoy additional marketing of the product by the franchisee in its attempt to promote sales. The fee paid by the buyer of the franchise to the seller is for the provision of distribution rights. In this category, payment can take two forms. The franchisee can pay in terms of the purchases of goods supplied by the franchisor. Alternatively, payment can be in form of a predetermined franchising fee at the beginning of the operations of the franchise. The proceeds from the sales of the goods sold by the franchisee are divided between the franchisor and the franchisee following a predetermined ratio.

The agreement made by the franchisor and the franchisee before the commencement of operations must clearly outline the category under which the agreement falls. Both parties must honor the terms of the agreement. It is therefore important both the franchisor and franchisee understand the category of a franchise that exists between them (Bruckmann 28). As such, they will have a good understanding of their obligations. Failure to adhere to the provisions of the agreement could result in legal measures taken against a party. In such a case, the dispute can either be settled in a court of law. Arbitration has also proved to be effective in finding a solution for such problems. It is important to note that such disputes would result in the termination of the franchise.

The Individuals and Parties Protected by the Franchising Law

The federal FTC rule is viewed to be protecting both the franchisors and the franchisees. It provides a level playing field for both parties to the seller and the buyer of the enterprise (Bruckmann 27). It also seeks to provide guidelines that when used would reduce the chances of disputes occurring between parties to the agreement. The rule also provides guidelines on how the disputes occurring in franchises can be addressed reasonably.

To begin with, the FTC rule protects the franchisor under the Trademark Law. The rule considers the trademark license to be the most important aspect of the relationship that exists between the franchisor and the franchisee. As such, a franchisee typically becomes part of the franchisor’s business. The success of the franchisee is attributed to the success and the popularity of the franchisor’s trademark (Bruckmann 23). The franchisor trademark is therefore viewed as the reason as to why the arrangement originally exists. For this reason, the FTC rule allows the franchisor to make restrictions about the extent to which the franchisee can use the mark. Before franchising operations start, the franchisee and the franchisor must therefore agree on the restrictions that are to be exercised.

The FTC rule considers the selling of the franchise to the franchisee as an act of goodwill. The buyer of the franchise must therefore be willing to enjoy the favor extended to them by the franchisor while adhering to the limitations that have been put in place (Bruckmann 23). The rule recognizes the trademark as intellectual property. As a result of the reasons discussed above, the franchisor plays the greatest role in the formulation of measures to be taken to safeguard the trademark. The control of the trademark is also left in the hands of the franchisor. The franchisee is thereby required by FTC rule to work in close collaboration with the franchisor.

The FTC rule also protects the franchisee. The FTC Franchise Disclosure Rule, 16 CFR 436 of 1978 requires that the franchisors disclose in detail to the franchisee the franchise experience (Bruckmann 24). In this case, the franchisor is required to provide information, such as the performance of previous franchising activities. Information that pertains to the franchisor’s performance should also be provided. Such information pertains to the history of bankruptcy and ligation.

The current financial status of the franchisor should also be disclosed. To this end, the seller must furnish their partner with financial reports. Statements for the past 36 months are needed. As such, the franchisee will be in a position to assess the risks involved in the buying of the franchise. The obligations of the franchisee upon the signing of the franchise contract should also be stipulated.

To protect potential franchisees, the FTC rule also requires that the buyer of the franchisee be furnished with all statistics of the current and future franchising activities by the franchisor. The practice helps the franchisee to assess the viability of the market that they wish to do business in (Bruckmann 22). Usually, the territory in which a franchise is to operate in is determined before the signing of the contract. The franchisor must not sell another franchise to another business before the expiry of the contract to avoid unfair competition. Inappropriate pricing resulting in unfair competition by the franchisor must also be avoided.

The franchisee is also protected by the United States federal law from fraudulent activities by the franchisors (Bruckmann 24). In this case, information containing the cost of the investment should be disclosed. The franchise fee is also predetermined before the signing of any binding contracts between the franchisor and the franchisee. In addition, the federal laws governing franchising prohibit the franchisor from soliciting any form of payment from the buyer.

They can only do this after a formal agreement has been entered into. Following the signing of the contract, a cooling period, usually made of ten working days is allowed to give the buyers of the franchise enough time to consider their decision. Reasons for termination and non-renewal of the franchising contracts are also well outlined to avoid unfair treatment

The Legal Implications of the Franchise Law

As stated earlier, both the franchisors and the franchisees are protected by US federal law (Bruckmann 23). To begin with, the franchisor’s trademark is recognized and protected by the law as intellectual property. Since the law recognizes the trademark as the franchise’s backbone, the franchisor is the major decision-maker. The seller of the franchise is therefore in a position to put in place the necessary measures to protect the trademark by limiting the extent to which the franchisee can use it.

As a result, the franchisor is seen to reap maximum benefits from the franchise even after the sales of the trademark rights. The franchisees are also required to follow the guidelines stipulated by the franchisor concerning the use of the trademark (Fealing 34). The growth of the franchising firm is therefore inhibited. Since the signing of the franchise contract is conceptual, the franchisor is not liable for the performance of the franchisee.

The FTC Franchise Disclosure Rule, 16 CFR 436 requires the franchisor to disclose information concerning the franchise contract to the franchisee (Bruckmann 23). When this is done, the franchisee will be required to adhere to all the terms and conditions of the contract. Failure to adhere to the conditions can result in them being sued for breach of contract. The FTC rule also prohibits unfair business practices. Such practices include unfair pricing, and violating territorial agreements.

Failure to adhere to these requirements can lead to legal measures being taken by the franchisee against the franchisor. Franchisees are also protected from fraudulent activities, such as inflated and hidden costs (Bruckmann 23). The franchisee however has to read and understand the terms of their agreement. If such information had been disclosed, then the franchisor cannot be found liable.

How the State Law in the US (CA) Defines and Regulates Franchising

Some aspects of business transactions in California are under the control of the federal government (Fealing 61). As such, franchising in the state is carried out under the regulations stipulated in the FTC laws. However, there are several instances where this form of business is controlled by the existing state law. Such instances include situations where the sale or offer of a particular franchise is made within the jurisdiction of the state. There are situations where the new enterprise is located within the state. Under such circumstances, the existing legislations are likely to apply. Another example where the local legislative framework applies is where the state is the place of residence for the franchisee.

As is the case in most states in the US, California has domesticated several laws that regulate franchising activities. In light of this, the California Franchise Investment Law outlines the requirements and procedures to be adhered to in the formation of franchises. The law was developed over four decades ago (Fealing 57). The main reason for the formulation of the legislation was to effectively deal with security issues surrounding franchising. It is important to note that close to all businesses in the state of California are franchises. The entities vary from food stores, construction companies, and real estate development agencies.

With the trend rising rapidly, the government of California saw the need to step in to control the practice (Fealing 67). The state government of California is charged with the responsibility of enforcing the law. However, the implementation of the legislation at the state level is constrained as a result of the scarcity of resources. As such, it is not as effective as the federal government’s regulation of the practice.

It is important to note that California has its laws used to regulate franchising. However, the government still works in collaboration with the FTC rule developed by the federal authorities (Fealing 62). As a result of varying legal frameworks, regulation of the practice at the state level has been associated with high levels of complexity. The main reason behind this is that federal regulations of franchising vary widely from those adopted by the state of California. As a result, franchisors and franchisees tend to seek the counsel of lawyers specializing in this field before embarking on the practice. Most of the aspects that parties to a franchise tend to seek advice on including the licensing of trademarks, regulation of trade, and leasing of property.

In California, the trademark of the franchisor is considered to be the most important aspect of franchising. The reason behind this is that franchising involves allowing another business to operate under the brand of the franchisor (Fealing 64). The seller is often a successful business in the market. In most cases, it is one of the top performers in the industry where it operates. Franchisees operating under the trademarks of such successful firms are likely to attract high numbers of customers, leading to increased revenues. However, franchisors need to retain control of their trademarks. The major objective of this requirement is to ensure that the franchisor attains a competitive advantage over other firms operating in the industry. As a result, California law acknowledges trademarks as intellectual properties belonging to the originator.

The franchisor is, as a result, granted permission by law to limit the use of this intellectual resource. On their part, the franchisee is required by law to adhere to the limitations stipulated by the franchisor in the business contract. Failure to adhere to the requirements is considered a violation of a contract.

Franchisees operating in California are also concerned with the regulation of trade in the state. As a result of the complexity created by the variation between state and federal laws, businesses intending to buy and sell franchises are not sure of the exact guidelines to operate with. In most cases, they are uncertain of the legal repercussions that they may have to contend with by disregarding some aspects of the federal and California state laws (Fealing 61). As a result, most of the franchisors and franchisees tend to seek legal advice on the matter. The legal fee increases the cost of franchising and related business in California. The costs are included in the franchising fee charged to the franchisee. The high cost of this form of business in the state discourages investment.

Another issue that parties to a franchise in the state of California have to contend with is the leasing of property. Franchisees are faced with several uncertainties with regards to the need to acquire assets to support their trade. One of the activities undertaken by the franchisees is the determination of the most appropriate location of the new business establishment. They proceed to lease enterprises in preparation for the start of operations. However, the registration and approval of franchises in California is a time-consuming process. In some cases, the application for a franchise can be declined by the authorities (Fealing 68). As a result, franchisees may lose their investment if they had already leased enterprises before the denial of a permit.

The California Franchise Investment Law has put in place some of the most complex regulations for franchising in the US. The state of California requires franchisors to file their offer with the government. In addition, they are required to provide a detailed list of potential franchisees. The information is to be submitted alongside the disclosure document. The document is later scrutinized thoroughly to decide whether the franchisor’s offer to local franchisees is to be accepted or rejected (Fealing 62).

The process takes a lot of time to complete. Franchisors have to wait for long durations of time for the verdict to be made. The form of regulation differs from that adopted by the federal government. With the FTC rule, franchisors are not required to file a registration with the federal or the state government. The complex registration process discourages many franchisors from expanding their businesses into California. They prefer to open franchises in other states where there are few restrictions exist. Although the practice plays a role in the protection of local franchisees, it discourages investors.

The California Franchise Investment Law provided for the establishment of a regulatory body to play an oversight role in the regulation of franchises in the state. The body conducts thorough scrutiny of the disclosure document. Different aspects of the document are scrutinized. Aspects that are of key importance during the review include the registration documents tabled during the application, the financial statement of the franchisor, and the agreement to be signed by the franchisees (Fealing 62). Special attention is also given to executives from the franchising agency and the franchisor. California’s government’s move to scrutinize the applications of the franchisors is aimed at protecting its residents from deceptive companies.

Registration documents are scrutinized by the government to ascertain the legitimacy of the franchiser. The documents also contain a brief description of the franchisor. They also contain information on the nature of goods and services produced by the seller of the franchise (Fealing 64). The goods and services produced by the franchisor must also be of the locally accepted standards. Reasons, why the seller intends to work with a potential buyer in California, are also stated. In cases where the information provided by the franchisor is not adequate, the regulator writes letters to the franchisor to seek clarification. Franchisors are advised to respond to the letters promptly to speed up the evaluation of their applications.

The financial statement of a franchisor is scrutinized to determine its ability to conduct business in California with minimal financial problems. The evaluation is carried out to protect the local franchisees from entering into business with firms that may not be in a position to offer a steady supply of products (Fealing 63). Franchisors that are not financially stable are likely to cause serious losses to the local franchisees in terms of failed ventures. A franchisor is therefore required by the law of California to demonstrate that indeed they can satisfy the needs of the franchisees especially in terms of producing adequate amounts of goods to be sold in the local market by the franchisees.

Documents that are prepared by the franchisor in advance to be signed by the franchisees are also scrutinized by the government (Fealing 61). The main aim of the scrutiny is to make sure that the franchisor is honest to the franchisees and is not intending to deceive them. The California Franchise Investment Law also protects the franchisees from unfair terms and conditions stipulated in the franchise agreement. The buyers have the right to negotiate with their business partners. As such, the government of California requires that the contracts tabled by the franchisors to be signed be flexible to accommodate the needs of the franchisees.

To protect the local franchisees from fraudulent practices by the franchisors, the government of California also scrutinizes the executives of the firm selling the franchise (Fealing 61). The nature of a company’s dealings is directly related to the conduct of its executives. As such, scrutinizing the executives will give the government of California a picture of the expected nature of the franchisor. Franchisors with executives of questionable character have their applications declined. The executives of the agency that is involved in the sales of the franchise are also scrutinized. The scrutiny involves assessing previous franchises sold by the agent and their performance. Agents whose previously sold franchises are associated with disputes are denied registration.

The California Franchise Investment Law also restricts the power of the franchisor to deny the renewal of a franchise contract, as well as to terminate the already existing agreement (Fealing 64). The franchisor is required to have a good reason to terminate the franchise. In addition, the government of California expects them to purchase the surplus stock held by their business partner. The government also expects the same from franchisors who are not willing to renew their franchise contracts with the franchisee. In cases where the franchisee dies, the franchisor is required to continue honoring the terms of the franchise even when the franchise is under the control of the next of kin.

The franchisee is also required by the law of California to disclose their financial status to the franchisor. The information given should be accurate and should be free of errors or omissions. The franchisee is also prohibited from giving false information to the franchisor. According to the California Franchise Investment Law, the franchisee is also required to carefully study and contemplate the terms and conditions of the agreement. They are required by the law of the state of California to adhere to the terms of the agreements reached at the time of signing the contract (Fealing 61).

The Parties Protected by the State Law

The California Franchise Investment Law protects both the franchisor and the franchisee. Unlike the FTC rule, the law of California has more strict controls on franchising (Fealing 61). The regulations are seen to be geared more towards protecting franchisees at the expense of the franchisors. To begin with, franchisors are required by the law of the state to furnish the government with a disclosure document during registration. The document is thoroughly scrutinized to ascertain that the franchisors are legitimate. The law however does not require the same of the franchisees. As a result, many franchisors view the practice as a move to limit their entry into the business. The practice, therefore, discourages investors into the state (Fealing 78).

The California Franchise Investment Law also seeks to establish the financial status of the franchisor. A franchisor is required to be financially stable to protect the local franchisees from losing their investments. The financial stability of franchisors ensures that the local franchisees in California are assured of a constant supply of the products for distribution (Fealing 63). Financial stability also ensures that the franchisees residing in California do not enter into a contract with franchisors that are at risk of going bankrupt.

The executives of the franchisors and the agencies involved in the selling of the franchise are also scrutinized (Fealing 61). The move by the government is aimed at ensuring that the local franchisees only enter into contracts with businesses that are run by competent and trustworthy individuals. Those who are found to be undesirable are denied registration. The history of the franchisor, in this case, plays a key role in determining the verdict to be made by the regulator.

In California, the powers of the franchisor in a franchise are limited (Fealing 67). As such, the interests of the franchisees are protected by the law against unfair practices by franchisors which include the termination of the franchise contracts and the denial of renewals. The franchisor is required by the California Franchise Investment Law to provide a good reason they have resulted to taking the step. Even then, the seller is prompted to pay for the remaining stock held by the buyer (Fealing 63).

The California Franchise Investment Law however to some extent also protects the franchisor. The law prohibits the franchisee from withholding vital information from the franchisor (Fealing 63). Failure by the franchisee to adhere to the set guidelines in the franchise contract will result in the termination of the arrangement. The government of California also acknowledges the franchisor as the owner of the trademark, as such, the seller of the franchise is allowed to exercise control over it.

Legal Implications of the Law

The California Franchise Investment Law is viewed to be a government initiative to protect the interests of the franchisees operating in the state’s jurisdiction. Unlike the requirements of the federal law, franchisors wishing to operate in California are required by the state law to provide the government with a disclosure document. The document indicates the financial position of the franchisor, the terms and conditions of the agreement, and the executives (Fealing 61). A franchisor has to maintain good conduct to be able to conduct business within California. Franchisors with limited resources are also locked out of business by the government. Franchisees in California are therefore at a lower risk of losing their investments through franchising compared to other parts of the United States of America.

Franchisees are also advised by the government to carefully evaluate the terms and conditions of the franchise contract before signing (Fealing 69). Since the law allows for the negotiation of the terms of the agreement, both the franchisor and the franchisee are considered to be responsible for their decisions in the franchise. As a result, they are liable for their decisions. Failure to adhere to the terms and conditions of the franchise will result in legal measures taken against the party.

How the European Countries Define and Regulate Franchising

Franchising activities have a significant effect on the economy of European countries. According to the European Union (EU), franchising is a uniform commercial activity that produces desirable outcomes in an economy in terms of improving a firm’s access to the market. The practice also increases a firm’s ability to distribute its products to foreign markets (Bishop 4). Currently, there exist over 10,000 brands that have franchised their operations within the member states of the EU.

The countries enjoy over 300 billion US Dollars in terms of incomes generated through the practice (Az 16). Despite the large number of franchises that exist in the region, many economists believe that franchising in EU member states has not been exploited to its full potential compared to other developed countries, such as the United States of America and Australia. Failure to achieve the desired levels of franchising in the region has been attributed to the lack of clear frameworks to guide franchisors and franchisees through the process. The EU also lacks a regulatory body to formulate policies that clearly outline the requirements to be fulfilled by parties wishing to engage in the practice (Az 16).

It has also been noted franchises are not proportionately distributed among members of the EU (Az 14). The situation is especially evident among the major members of the regional body, such as France, Germany, the United Kingdom, Spain, and Italy. Despite the cohesion that exists between these countries, franchising as a commercial activity has not been seen to promote trade among the countries (Bishop 4). The reason behind this is that their lack of proper frameworks that control franchising between the countries. The EU member countries also have their domestic regulations that tend to differ from those used to guide franchising collectively for all the states.

As stated earlier, individual governments operating under the EU have their regulations aimed at exercising control over franchising activities within their national borders (Az 16). The regulations are aimed at protecting domestic franchisees and franchisors from incurring losses resulting from failed investments. Domestic governments are of the view that failure to regulate trade with foreign franchisers will leave the local entrepreneurs venerable (Az 17).

Competition is one of the negative effects likely to be experienced by a country because of uncontrolled trading activities. Although competition is desirable in the promotion of trade, member countries are afraid that infiltration of the country by foreign firms will hurt the local businesses by reducing the taking over the market. Domestic governments also come in to regulate the franchising activities carried out within their authority to control the quality of goods and services being consumed within their borders (Az 16). Franchisors must produce goods that are of acceptable quality in the foreign markets where they wish to franchise.

Regulation of franchising among members of the EU is carried out based on a number of heterogeneous laws agreed upon by the member states (Az 16). The regulations provide guidelines to be followed by businesses wishing to sell franchises to franchisees situated outside the country. The EU formulated regulations are established to promote franchising activities across national borders (Bishop 4).

Like other regional trading blocs across the world, the EU aims to promote free trade among its members. In line with these objectives, the EU must create a favorable environment that allows for the free movement of goods and services among its member countries (Az 17). Through franchising activities, businesses in member states enjoy increased growth as a result of the expansion of the market environment. The major limitation faced by the EU regulations is that they do not surpass domestic regulations established by individual countries (Az 12). As a result, the effectiveness of the EU regulations solely depends on the commitment by the individual countries to the regional body.

The presence of both domestic and regional regulations makes franchising a complex process (Az 16). As a result, both franchisors and franchisees experience confusion as they decide on the regulations to adhere to. The confusion has a great impact on the time taken to establish successful franchises. The reason behind this is that franchisors and their potential franchisees are required to seek legal advice before the start of operations to avoid breaking the laid down rules governing franchising (Az 25). In such a case, the regulations are viewed to be hindering regional development and integration. Most franchisors also avoid moving to foreign markets as a result of the complexity of the regulations. As a result, they embark on selling franchises only within the boundaries of the countries where they reside (Az 16).

The practice has a negative impact on the level of production. Since the goods and services to be produced are only meant for the domestic market, they are produced in small quantities. Firms are not able to enjoy economies of production as would be the case in an ideal situation whereby the EU would facilitate free movement of goods and services in an attempt to widen the market for the regional producers (Bishop 7).

The complexity of the franchising regulations also results in the growth of monopolies (Bishop 4). The situation is most evident in the domestic markets. As a result of the complexity of the rules and regulations governing franchising, franchisors are not able to supply their products to potential franchisees in the foreign markets for distribution (Az 16). The situation reduces competition among producers in domestic markets.

The producers experience exponential growth since they own both production and distribution systems in the domestic market. The situation is not ideal for trade since it results in the growth of monopolies within the countries where such businesses are located. Monopolistic practices also result in the exploitation of consumers (Az 19). As monopolies emerge, smaller brands are suppressed. Potential investors are also discouraged from entering such markets. As a result, the individual countries are bound to experience reduced economic development as one of the long-term effects of inhibiting franchising effects.

As a result of the negative effects that are associated with reduced rates of franchising often contributed to by conflicting regulations existing both at the national and regional levels, EU members countries have been able to appreciate the need to come up with a comprehensive framework to govern the practice (Bishop 4). The EU through the European Commission has over the years been able to sensitize its members on the need to encourage franchising activities across their borders by adopting a heterogeneous regulation framework (Bishop 6). Major strides have been realized following these lobbying efforts. One of the major achievements achieved is the adoption of Regulation 4087/88 in 2002 as a general standard to regulate franchising activities in the region.

The standard defined franchising as a package of legal rights which permit the use of intellectual property and industrial rights in service provision and sales of goods to their end-users (Bishop 5). The rights are sold by the franchisor to the franchisee. In the franchise agreement, the franchisee can be granted a permit to use the business models and designs of the franchisor. The franchisor can also allow for the use of other intellectual properties by the franchisee, such as the trade name used to conduct transactions, shop signs, copyrights, and trademarks (Az 13).

The franchise agreements are normally drafted by the franchisor (Bishop 4). They are drafted in accordance with the laws regulating franchising of the country in which the franchisor resides. The law allows the franchisor to draft the agreement so that it can put in place measures to protect the identity of its trademark (Bishop 3). Through the practice, the franchisor is also in a position to put in the necessary regulations that are aimed at ensuring that the reputation of their franchise network is safeguarded. In this case, the franchisors are viewed to be in control of all aspects of the relationships that exist between them and the franchisee (Az 16).

With the adoption of Regulation 4087/88, franchisees were required by law to only purchase goods and services that are produced by the franchisor (Bishop 4). The goods and services are to be later distributed to end-users. In cases where the franchisor is not in a position to supply the franchise with the goods and services directly, the franchisee can be required to obtain the supplies from other enterprises designated by the franchisor (Bishop 4).

The franchisee is hereby forbidden by the law from acquiring stock from suppliers other than the franchisor without its permission. Failure to adhere to the regulation is considered a breach of the franchise contract. The franchisor is allowed by the law to respond to such acts through actions such as termination of a contract. The franchisor can also institute legal proceedings against the franchisee on the grounds of breach of contract (Az 19).

The adoption of Regulation 4087/88 also saw the adoption of a general rule that franchisees shall not engage in a competing business (Bishop 7). The sole role of the franchisee in the commercial arrangement is to distribute the goods supplied by the franchisor. The franchisee is allowed the right to the trademark of the franchisor for use only in conducting activities that are beneficial to both parties. The trademark rights are offered to the franchisee to promote sales while the franchisor retains all the production rights (Az 12). The franchisee is also prohibited from selling the franchise without the franchisor’s consent. The new owner of the franchise must also comply with the terms and conditions of the original franchise contract (Bishop 3). The franchisor can also result in designing a new contract altogether.

Regulation 4087/88 also requires the franchisee to comply with all the franchisor’s standards of operations (Az 16). In this case, the franchisee is required to adopt the business models and designs that are used by the franchisor (Bishop 2). The provision is aimed at maintaining homogeneity like the goods and services sold within the entire franchise network. As such, the integrity of the franchisor’s trademark will also be guaranteed. The franchisee should also be maintained as per the franchisor’s requirements. The franchisee is required to paint and name the business as per the franchisor’s requirements. Failure to adhere to these requirements may result in the termination of the franchise contract (Bishop 4).

The franchisee is also required by law to pay a fee to the franchisor (Bishop 3). In many cases, the franchisee is also required to invest in the franchise network. The investment is often in form of a capital contribution. The advertisement cost is also shared between the franchisor and the franchisees (Az 16). The schedule of payment for these fees is as stipulated in the franchise agreement signed by both the franchisee and the franchisor. Failure to pay the fees constitutes a breach of contract (Az 13). The franchisor can result in taking legal actions, such as taking legal measures in response to the breach of contract. The franchisor in this case can also terminate the contract.

The Parties Protected by the Law

The EU regulations are seen to protect the interests of the franchisor. To begin with, the franchisor is granted the right to draft the franchise contract (Bishop 2). No consultations take place between the franchisor and the franchisee in matters concerning the terms and the conditions of the contract (Az 16). In this case, the franchisor is said to be in full control of all aspects of the franchise.

The franchisee is also required to buy goods directly from the franchisor (Bishop 8). Alternatively, the franchisee may be required to obtain supplies from a third party designated by the franchisor. As a result, the franchisor benefits from the arrangement by developing channels for the distribution of their product. The franchisor is also protected by the law in that it retains all production rights. The franchisee is not allowed to engage in activities that are viewed to bring competition to the franchisor (Az 13). The franchisee is also prohibited from selling the franchise without consulting the franchisor.

The EU franchise regulations are also viewed to promote the interests of the franchisor by requiring the franchisee to adhere to the franchisor’s operational standards (Az 16). As such, the services and products sold by the entire franchise network are similar. Through consistency, the integrity of the trademark is guaranteed (Az 14). The requirement that a franchisor makes a capital investment to the franchise network increases the worth of the franchise. The franchisee also compensates for a fraction of the advertisement costs incurred by the franchisor (Bishop 4). The regulation helps the franchisor cut the cost of operating the franchise network.

The Legal Implications of the Legislation

The franchisor is the major decision-maker in the franchise network (Bishop 4). It drafts the franchise contract in a manner that ensures the protection of the trademark (Az 16). The franchisee is also prohibited from selling the franchise without the consent of the franchisor. As such the franchisor’s intellectual property is recognized and protected by the law (Bishop 7). The signing of the franchise contract by the franchisee is an indicator that it has clearly understood the terms and conditions of the contract and guarantees to abide by them. The franchisor is therefore empowered by the law to institute legal proceedings if the franchisee fails to abide by the terms of the contract. Termination of the franchise contract is also justified in such cases (Bishop 4).

The transfer of intellectual property rights also comes at a fee. The franchisee is required to adhere to the entire payment schedule as stipulated in the franchise contract (Bishop 4). Failure to pay the franchise fee amounts to a breach of contract (Az 16). In such a case, the franchisor can sue the franchisee for failure to abide by the terms of the contract. The franchiser can also use the issue as grounds to file for the termination of the contract.

The franchisee is also required to cater for extra expenses incurred by virtual being a member of a certain franchise network. Such costs include those associated with advertising. The reason is that the franchisor advertises the entire trademark (Az 16). All the members of the entire network reap benefits from the advertising activities. Most franchisors as a result charge their franchisees advertising fees that are used to cater to future advertising expenses. The fees are paid regularly to promote consistency. Members of the franchise network who may not be willing to collaborate with the others are in most cases expelled by having their contracts contaminated because they are not working towards the development of the trademark.

How Franchising Turns into an Agency

Franchising is a commercial activity that involves the granting of permission to use successful and reputable trademarks that are currently operating in a specific industry. The arrangement is scheduled to remain in place for a specified period. It simply refers to the sale of franchises (Gillis and Combs 5). Both the seller and the buyer of the franchise benefit from their participation in the business activity. To begin with, the franchisee can adopt the business models and designs of high-performing firms. The franchisee is also allowed to operate under the trademark of the franchisor (Gillis and Combs 6).

As a result, the franchisee is likely to record substantial growth within a limited duration of time. The franchisor’s brand name is particularly likely to attract more customers for the franchisee, therefore, promoting sales. The franchisor also enjoys a number of benefits from the activity. For example, it is noted that franchising comes at a fee, which boosts the franchisor’s capital base. In addition, the franchisor can expand the market for their goods.

As a result of the widespread use of commercial activity, franchising activities have been simplified across the globe. For example, more countries and independent states are adopting legal frameworks to help fast-track franchising activities. With these regulations in place, the time taken to form franchises is significantly reduced, which benefits the investors and the economy at large. The cost aspect of the activity is also likely to be significantly lowered.

As a result of the relative ease associated with the formation of legally recognized business relations, other forms of relationships between businesses are also emerging across the globe (Gillis and Combs 5). The formation of agencies is one of the current trends. The new form of the business relationship has in the past been confused with other legal relationships existing between firms, such as franchises (Az 17).

An agency refers to a form of relationship between two parties whereby one acts on the other’s behalf (Gillis and Combs 4). The two parties are the agent and the principal. The relationship is often characterized by the principal delegating tasks to the agent. Usually, both parties have divergent interests (Gillis and Combs 2). The reason for delegation by the principal is that they lack the set of skills and knowledge that is required to undertake the task that is to be assigned to the agent. The principal in most cases also lacks the resources required to facilitate the completion of the task that has been delegated (Gillis and Combs 2). The agent is required to carry out the task diligently. They should safeguard the investments made by the principal. However, this is not often the case with the agents seeking to look at his or their interests first.

Agents in most cases tend to overstate their qualifications, skills, and conduct. The reason for this is to make them more desirable to the principal compared to other prospective agents (Gillis and Combs 2). Upon being sought to perform a particular task by the principal, the performance of most agents does not match their previous self-description (Gillis and Combs 2). The reason behind this is that they tend to withhold their efforts as they offer their services to the principal.

The reason as to why the agents tend to withhold their efforts is that the outcomes of their activities do not in any way mean that they will get higher rewards for their service (Gillis and Combs 4). A good example of a principal-agent relationship is that which exists between an employer and his or her employee. Usually, the salary of the employee is constant. It is paid regularly without putting into consideration how much effort the employee put into the tasks provided to him or her.

To encourage agents to put more effort into the tasks that have been provided to them, added incentives are introduced (Gillis and Combs 3). The incentives include rewarding the agents in terms of a proportion of the profits generated once all the costs of operations have been subtracted from the total output that was generated by the principal owing to their efforts (Gillis and Combs 5). In such as case, agents are not likely to withhold their efforts since they are aware that they are bound to reap benefits from their efforts. Through incentives, such as commissions, agents carrying out tasks on behalf of the principal also strive to put in efforts to the best of their ability to increase their earnings.

Similarities between an Agency and a Franchise

A franchise is also similar to an agency in that two parties are involved in each of the business types. For the case of franchising, we have a franchisor and a franchisee. Agencies on the other hand are composed of the agent and the principal (Gillis and Combs 3). In both cases, one of the parties is inferior to the other. In the case of franchising, the franchisee is inferior to the franchisor. In most cases, the franchisor is often a large successful firm.

Often, it is usually one of the market leaders within the industry where it operates. Its trademark is often one of the most coveted (Gillis and Combs 3). Smaller firms, such as the franchisee often seek to purchase the intellectual property rights of the franchisor to become to promote sales. The stock provided by the successful brands is also of high quality which helps market the franchisee (Gillis and Combs 2).

The interests of the parties to the two business types are also divergent (Gillis and Combs 3). In the case of an agency, the principal is interested in the success of the agent in undertaking the task that was delegated (Gillis and Combs 2). The principal also pays much attention to the quality of work that was done. On the other hand, the agent is interested in the compensation that he or she is likely to receive resulting from performing the task as per the principal’s requirements. Little or no attention is given to the quality of the task performed. In the case of franchising, the franchisor is interested in the distribution of goods through having successful franchise ventures (Gillis and Combs 4).

As a result, the franchisor is interested in identifying potential franchisees who are aggressive in marketing and those who are spread across wide geographical locations (Gillis and Combs 4). With a large number of franchisees, the franchisor will be in a better position to infiltrate the market. Franchisees on the other hand are entrepreneurs who are interested in profit-making. Their major concern is whether their franchises will pick up within a short period to generate income (Gillis and Combs 4). They are also highly concerned about the territory they operate with. They seek to invest in areas where the market is not flooded for them to make the most profits within a limited amount of time.

In both franchising and agency, the larger party often exercises control over how business activities are to be carried out (Gillis and Combs 6). The franchisor exercises control over the franchisee. The franchisor owns the trademark. Franchise laws recognize the trademark as the most important aspect of conducting business within a franchise (Gillis and Combs 4). As a result, the franchisor is allowed to come up with most of the regulations to govern the arrangement. Allowing the franchisor permission to control the franchise is justified in that it is trying to protect the trademark from being abused by the franchisees (Gillis and Combs 3).

The franchisee on the other hand has minimal say concerning the terms and conditions that are used as the guidelines for a franchise contract. In most instances, the franchisee is not even consulted when the agreement is structured. As the inferior party, the franchisee is required to sign or decline the offer made by the franchisor as it is without attempting to make changes to the contract (Gillis and Combs 5).

The same also applies to the agency type of business. The principal exercises control over the new agent. To begin with, the principals come up with the task that they wish to be completed on their behalf by the agent. The principal also comes up with the terms of being met in the final piece of work produced by the agent. The agent in this case too has no say on how business between the two parties is to be handled (Gillis and Combs 3). Typically, the agent is treated as one of the principal’s employees.

The relationship that normally exists between a franchisor and a franchisee is a typical agency (Gillis and Combs 4). In this case, the franchisor acts as the principal while the franchisee plays the role of the agent. Similar to franchising, the franchisor, in this case, the principal delegates to the franchisee, the agent the tasks to be performed (Gillis and Combs 3). In this case, the interests of the franchisor are to be given priority.

The practice is similar to that which is observed in an agency whereby the agents put the interests of the principal first (Gillis and Combs 3). A franchisee is required to promote the trademark of the franchisor by marketing and distributing products to their end-users. The franchisor enjoys increased volumes of sales since the franchisees are only allowed to stock supplies from the franchisor. Similarly, the agents are required to perform tasks delegated to them by the principals to the best of their ability.

Differences between an Agency and a Franchise

Although both business types are associated with delegation, the delegating business hires the services of the delegate for specific reasons (Gillis and Combs 3). In the case of franchising, the franchisor seeks to attract potential franchisees to help in the distribution of the goods that they produce. The franchisees, therefore, serve as the distribution channels for the franchisor (Gillis and Combs 4). The franchisor is keen to retain the production rights in order to control the franchisee’s access to the trademark. The fact that the franchisors seek the assistance of other firms however does not mean that they are not in a position to open supply chains within the preferred territory.

Franchisors often sell the distribution rights to the franchisees for them to better concentrate on controlling the production of goods a situation that allows for continuous expansion of the market through the selling of franchises. An agency on the other hand is whereby a business entity seeks the assistance of another to perform a particular task. Usually, the principal has little or no skills pertaining to the task to be carried out (Gillis and Combs 3). In other cases, the principal lacks the resources that are required to perform the required task.

Another major difference that occurs between the franchising and agency forms of business is that in franchising parties collectively work hand in hand to maximize their gains while parties to the agency are divided when it comes to matters of revenue generation (Gillis and Combs 3). Profits from the franchise are obtained from the sales of goods and services. The sale of the goods occurs at the franchisee level.

The goods however have to be manufactured by the franchisor inadequate amount to ensure that the franchise can satisfy the market. Once the goods have been manufactured by the franchisor, they are distributed to the premises of the franchisees where they are sold to their end-users. Usually, the franchisor is the manufacturer who supplies the franchisee with finished goods (Gillis and Combs 5). The sale of the goods to the franchisee generates revenue for the franchisor. The franchisee on the other hand distributes the supplies to the local people. The revenue generated from the sales made to the final user is retained for the franchisee (Gillis and Combs 3).

On the other hand, the agency composing of the principal and the agent is associated with minimal collaboration. The nature of their relationship however does not encourage cordial relationships. The agent is in many cases an employee of the principal. The agent benefits only from a salary he or she obtains from the principal. The principal on the other hand generates revenues from profitability encouraged by the use of successful business models.

Another major difference that exists between agency and franchising is that both the members of a franchise have a stake in the business while an agency is solely owned and operated by the principal (Gillis and Combs 3). In franchising, the business is solely owned by the franchisor. Up on franchising, the franchisor requires the franchisee to make a capital investment. As such, the franchisee is treated by the law as a partial owner of the business. The franchisee also buys stock from the franchisor (Gillis and Combs 4). Following the purchases of the goods, the franchisee sells them to the end-users.

The revenue generated belongs to the franchisee. Part of it will be used for the purchases of additional stock from the franchisor. The remainder of the money is used to settle some of the legal fees that exist after franchising (Gillis and Combs 5). In an agency, the agent is treated as an employee of the principal. The agent does not own any stakes in the business. There are also no laws or regulations that prohibit the termination of the contract between the principal and the agent.

Clear differences can also be identified between agency and franchising types of business based on the practice of withholding of effort (Gillis and Combs 1). Agencies are associated with the withholding of efforts while franchises are not. As stated earlier, an agent working in an agency has no motivation to spend considerable effort engaging in commercial activities related to the business. It is important to note that revenue is one of the major motivators among persons working within a firm (Gillis and Combs 3). As stated earlier, agencies are associated with small amounts of revenues. Since persons operating in the businesses are treated as employees, they are only entitled to a limited amount of income in form of a salary. The salaries are constant and do not change with the change in the output of the employee (Gillis and Combs 3).

As a result, workers become demoralized. They lack the motivation to put in a little more effort beyond that which is expected of them. The result of the practice is that the business experiences inhibited economic growth. Franchises on the other hand do not experience such effects. Both the franchisors and the franchisees are motivated to work hard since their efforts are seen to be beneficial in terms of increased revenues. Both the franchisors and the franchisees benefit directly from their efforts in terms of increased production levels (Gillis and Combs 6). They also realize the benefits of their work through increased sales volumes both in domestic and foreign markets. As a result, they will be motivated to continue putting in more effort.

Conclusion

Different countries have varying ways of conducting business. Franchising is one of the most highly regulated commercial activities. The regulations can be introduced at the local or regional levels. However, the existence of many regulatory frameworks may negatively affect the success of the practice. The reason is that the situation complicates the procedures related to the formation of these business relationships. Governments and regulatory bodies are required to come up with sound regulatory procedures that are easy to comprehend to promote the activity.

Works Cited

Az, Odavia. Franchising in European Contract Law: A Comparison between the Main Obligations of the Contracting Parties in the Principles of European Law on Commercial Agency, Franchise and Distribution Contracts (PEL CAFDC), French and Spanish Law, Munich: Sellier, 2008. Print.

Bishop, Bernard. European Union Law for International Business: An Introduction, Cambridge: Cambridge UP, 2009. Print.

Bruckmann, Barbara. 50th Annual Antitrust Law Institute, New York, NY: Practising Law Institute, 2009. Print.

Fealing, Kaye. Statewide Video Franchising Legislation: A Comparative Study of Outcomes in Texas, California and Michigan, Minneapolis, Minn.: Center for Science Technology & Public Policy, 2009. Print.

Gillis, William, and James Combs. “Beyond Agency Theory: A Resource-Based Explanation for Franchising and Franchisor Performance.” Academy of Management Annual Meeting Proceedings 3.1 (2009): 1-6. Print.

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