Franchising Legal Update Autumn 2012

British Franchise Association (BFA) Code of Ethics could apply whether or not the Franchisor is a bfa Member

The BFA’s Code of Ethics is a straight forward code which is designed to encourage ethical franchising amongst its members. The Code covers the minimum requirements expected from both franchisor and franchisee in respect of recruitment, advertising and disclosure and those terms which must and must not be included in the franchise agreement. The BFA has issued guidance on the Code’s application which is currently being revised and due to be published at the end of 2012.

It is generally assumed that the Code only applies to BFA members. However, the Code’ sapplication is wider than that. It is, therefore, worth reminding all franchisors in the UK (including non BFA members) that the Code could apply to them. The leading case on this topic dates back to 2004 regarding non BFA franchisor, Drivertime Recruitment (see Drivertime Recruitment Ltd and another company).

In the Drivertime case the court held that by neglecting to disclose failures of previous franchisees, failing to provide the level of support promised to potential franchisees, failing to provide local advertising and access to local blue chip leads and providing franchisees with unrealistic profit projections, the franchisor had specifically and purposefully evaded the Code.

The court noted that the Code was not binding law and that Drivertime was not a member of the BFA. However, the judge suggested the Code sets out a standard of “commercial morality which can be usefully applied in this unregulated industry”. Whilst it was significant in the Drivertime case that many potential franchisees specifically asked about previous failures of other franchisees and the franchisor failed to disclose accurate information, the judgment does reiterate the importance of complying with the Code: “It is obvious that any person asking about closures or failures wants to be given the full picture; honest answers to questions, and compliance with the BFA Code should have led Drivertime to reveal cases where the franchisee had left the network to set up in competition.”

So, this is a reminder to all franchisors to ensure that you read, understand and (most importantly) comply with the BFA Code of Ethics. A copy of the Code and guidance can be found on the BFA website: www.thebfa.org. Compliance should not be too onerous as ethical franchising will by its very nature operate in accordance with the principles set out in the Code.

Minimum Performance Standards must be reasonable

Franchisors typically like to set benchmarks and targets and provide template business plans for their franchisees in order to assist in the running of the franchise and to encourage performance. Targets should be set at an achievable level in order to stimulate rather than dishearten franchisees.

Franchisors also often stipulate minimum performance standards, the failure to achieve which may give rise to a right to terminate the franchise agreement. These minimum performance obligations need to be carefully considered. Under the BFA guidelines the levels set must be reasonable. Exactly what is deemed to be “reasonable” will vary depending on the type, size and maturity of the franchise network but the following should be considered:

• Against what is minimum performance measured? The BFA suggests that it should be no higher than 70% of the average of all franchisees which have been operating for at least a year.

• Is there an opportunity to remedy the failure? A remedial plan could be agreed, the territory reduced and/or exclusivity limited.

• How strict are the provisions? Is it simply failure to achieve minimum performance levels in any single quarter? Or, for example, is the franchisee allowed to fail in any one off quarter provided failure does not occur on two consecutive quarters up to a maximum of four in any 5 year terms.

The bottom line is that a franchisor should not simply use minimum performance standards as a tool to remove the low performers unless they are actually performing unsatisfactorily and only once they have been given the opportunity to improve.

For franchisees, it is incredibly important that at the outset a careful review is carried out of minimum performance obligations (especially if the franchise is not a member of the BFA) to ensure that the mechanism in place are reasonable and to comply with the BFA guidelines.

Deposits and Refunds Best Practice

Most franchisors ask prospective franchisees to pay an initial deposit. This is an entirely acceptable practice and is commercially sensible in order to weed out any time wasters and ditherers.

Nevertheless, any such deposits should be refunded in full if either party decides to withdraw. The only costs that the franchisor should be able to deduct from the deposit are those direct costs (for example, agents and/or legal fees but not including franchisor time) which have been incurred by the franchisor from the time the deposit was paid and which were clearly communicated to the franchisee in advance or agreed subsequently. The BFA has issued very clear guidelines on this point.

Franchisors should ensure that their standard form deposit / intent to proceed agreements are drafted appropriately.

Franchisees should ensure that they carefully read and understand the terms of any deposit / intent to proceed agreements before signing and paying a deposit, especially if the franchise is not a member of the BFA.

Legal issues recently reported on:

• Competition law: EU Block Exemption • Data Protection Compliance • Late payment interest • Serving notices • Disclosure requirements • Side Letters – are they enforceable? • Restrictions – do you have the flexibility to protect your brand? • Trademark – who holds it? • Olympics and Force majeure clauses • Bribery Act 2010 • Social networking • Remedial Plans vs terminating the franchise agreement