Sunday, April 5, 2009

Franchisetein (Creating and taming your Franchise Agreement)

By Siesta-friendly

Regret not knowing the hidden costs of your franchise? Missing any kind of support from your franchisor? Feeling bad for over-franchising your brand? Lamenting the low quality produced by your franchisee? Did not take your franchise agreement seriously, eh? At this point, we can only advice you to settle amicably. Litigation is usually a no-win situation.

But for those who want to avoid the horror stories, then for heaven’s sake, strive a little harder and create your own brand! Of course, if you don’t have the time but have the funds (or, if you’re a franchisor) then continue reading.

For those of you who want to franchise your business (and earn more) or those who want to get a franchise (and earn quicker), you will need a franchise agreement to protect your interests. And it is in your best interests to know (and negotiate) it from beginning to end.

No Franchise Law

Although we don’t have a franchise law to guide us, that hasn’t stopped franchises from sprouting on every other busy street corner.

FYI, the U.S. has the Franchise Rule (or the “Disclosure Requirements And Prohibitions Concerning Franchising And Business Opportunity Ventures“) to help guide the parties.

We may not have anything similar (attention lawmakers!) but the Intellectual Property Code[1](IP Code) prohibits and mandates certain provisions in Technology Transfer Agreements (TTA) and, of course, there’s always the Civil Code provisions primarily on Obligations and Contracts.

The relevant Civil Code provisions are applicable to obligations and contracts in general while the relevant IP Code provisions are specific to TTAs. Hence, we will focus on the latter (as the former may be hopelessly ambiguous for now).

Technology Transfer Agreements

The IP Code defines TTAs as “contracts or agreements involving the transfer of systematic knowledge for the manufacture of a product, the application of a process, or rendering of a service including management contracts; and the transfer, assignment or licensing of all forms of intellectual property rights, including licensing of computer software except computer software developed for mass market.” (Section 4.2) If your franchise agreement involves any of the above, then it’s a TTA covered by the IP Code.

“Prohibited Clauses”

Although Section 87 of the IP Code is titled “Prohibited Clauses”, the section specifically states that in general, the following provisions are deemed prima facie (at first appearance) to have an adverse effect on competition and trade (thus, frowned upon but not exactly prohibited if evidence can be shown to prove otherwise or exemption can be had from the Documentation, Information and Technology Transfer Bureau (DITTB of the Intellectual Property Office) explained Documentation, Information and Technology Transfer Bureau (DITTB of the Intellectual Property Office) later:

1. Those which impose upon the licensee (i.e., the franchisee) the obligation to acquire from a specific source capital goods, intermediate products, raw materials, and other technologies, or of permanently employing personnel indicated by the licensor (the franchisor);

2. Those pursuant to which the licensor reserves the right to fix the sale or resale prices of the products manufactured on the basis of the license;

3. Those that contain restrictions regarding the volume and structure of production;

4. Those that prohibit the use of competitive technologies in a non-exclusive technology transfer agreement;

5. Those that establish a full or partial purchase option in favor of the licensor;

6. Those that obligate the licensee to transfer for free to the licensor the inventions or improvements that may be obtained through the use of the licensed technology;

7. Those that require payment of royalties to the owners of patents for patents which are not used;

8. Those that prohibit the licensee to export the licensed product unless justified for the protection of the legitimate interest of the licensor such as exports to countries where exclusive licenses to manufacture and/or distribute the licensed product(s) have already been granted;

9. Those which restrict the use of the technology supplied after the expiration of the technology transfer arrangement, except in cases of early termination of the technology transfer arrangement due to reason(s) attributable to the licensee;

10. Those which require payments for patents and other industrial property rights after their expiration/termination arrangement;

11. Those which require that the technology recipient shall not contest the validity of any of the patents of the technology supplier;

12. Those which restrict the research and development activities of the licensee designed to absorb and adapt the transferred technology to local conditions or to initiate research and development programs in connection with new products, processes or equipment;

13. Those which prevent the licensee from adapting the imported technology to local conditions, or introducing innovation to it, as long as it does not impair the quality standards prescribed by the licensor;

14. Those which exempt the licensor for liability for non-fulfilment of his responsibilities under the technology transfer arrangement and/or liability arising from third party suits brought about by the use of the licensed product or the licensed technology; and

15. Other clauses with equivalent effects.


In exceptional or meritorious cases where substantial benefits will accrue to the economy, such as high technology content, increase in foreign exchange earnings, employment generation, regional dispersal of industries and/or substitution with or use of local raw materials, or in the case of Board of Investments, registered companies with pioneer status, exemption from any of the requirements above (those prohibited) and below (those mandatory) may be allowed by the DITTB after evaluation thereof on a case by case basis. (Sec. 91)

Mandatory Provisions

Section 88 of the IP Code has only a handful of required agreement provisions:

  1. That the laws of the Philippines shall govern the interpretation of the same and in the event of litigation, the venue shall be the proper court in the place where the licensee has its principal office;
  2. Continued access to improvements in techniques and processes related to the technology shall be made available during the period of the technology transfer arrangement;
  3. In the event the technology transfer arrangement shall provide for arbitration, the Procedure of Arbitration of the Arbitration Law of the Philippines or the Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL) or the Rules of Conciliation and Arbitration of the International Chamber of Commerce (ICC) shall apply and the venue of arbitration shall be the Philippines or any neutral country; and
  4. The Philippine taxes on all payments relating to the technology transfer arrangement shall be borne by the licensor.

Registration of your TTA

Under Sec. 92 of the IP Code, a TTA is unenforceable if it violates Sec. 87 (Prohibited Clauses) and Sec. 88 (Mandatory Provisions) unless it is approved and registered with the DITTB for exceptional or meritorious reasons as explained above. TTAs that conform with both Sections need not be registered with the DITTB.

Common / Suggested Provisions

Now that you know, more or less, some key legal requirements, let’s list down some topics which you should either include or look out for in a franchise agreement. These are culled from practice and may or may not be applicable to your situation. Nevertheless, we’re pretty sure they are helpful.

These are:

1. franchise fee - this normally pays for your use of the franchisor’s brand and business processes (including management, operations, marketing, accounting, etc.)

2. other fees – all fees should be indicated and sufficiently explained to avoid hidden costs.

3. tax implications – to know who pays which tax.

4. franchise period – this should also cover renew conditions.

5. franchise territory – franchisor should be prohibited from granting a franchise so close to another franchisee’s territory to avoid unreasonable competition. Franchisee should seek territorial exclusivity as much as possible.

6. staff training – usually covered by the franchise fee paid.

7. continuing support – should include support for all that the franchise fee pays for.

8. sourcing requirements – franchisee should be allowed to cut costs by sourcing equipment/materials/ingredients/supplies elsewhere as long as quality standards are met.

9. warranties – sets out what either party must be able to guaranty (like freedom to enter into the agreement).

10. obligations and restrictions – these largely depend on the business but this is where franchisors should really protect their business and brand.

11. liabilities - enumerates what either party will be liable for and the consequences (say for violating the agreement)

12. reciprocal instances of default – certain actions of either party which are inimical to the other should be stopped or cured.

13. termination options – apart from the end of the franchise period, certain continuing instance/s of default should give a party the option to terminate the contract. Parties should seek an exit strategy (pre-termination or sale of franchise) due to unforeseen or unfavourable circumstances.

14. use and protection of intellectual property – another element covered by the franchise fee, thus, both parties should provide sufficient safeguard for the protection of franchisor’s tradename/trademark/other IP to prevent infringement (which could devalue the IP and eventually the business).

15. settlement of disputes – parties should be allowed to settle disputes amicably as much as possible. Reciprocal legal fees should be allowed both parties to deter unnecessary litigation.

The above should be more than sufficient guidelines in creating your franchise agreement. Anymore and you’ll have to pay our legal fees =)

[1] Republic Act No. 8293, “An Act Prescribing The Intellectual Property Code And Establishing The Intellectual Property Office, Providing For Its Powers And Functions, And For Other Purposes”, June 6, 1997.



Anonymous said...

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The Legally Inclined said...

Thank you for your comments.