Taking your franchise brand to the USA? Ayla Karmali of Goldstein Legal offers sound advice
It is broadly agreed that the USA is the first home of business-format franchising. Most world-renowned franchise brands originated there and franchising accounts for over US$890 billion in direct economic output (2015/2016). There are approximately 780,000 franchise businesses in the USA, which employ 8.8 million people. US franchising also often outperforms the economy in terms of overall growth1 and in 2017, it was projected to grow by 1.6%.
The popularity and steady growth of franchising in the USA is an attractive prospect for a UK franchise brand. With a huge market (the population is approximately 324 million people) coupled with a shared language and similarities in culture, the USA is certainly worthy of consideration.
If you are thinking of taking your franchise brand stateside, there are a number of factors you ought to consider.
The Legal Framework and the Franchise Agreement
The USA is a federal state, i.e. a union of 50 different member states. The legal system distinguishes between federal laws, which apply across the country, and state laws. This means that a franchisor must comply with a set of federal laws as well as the distinct laws of the state they wish to operate or do business in. As each state law is somewhat different, the requirements of doing business and franchising in one state will differ to the requirements of another.
These differences cannot be taken for granted as they concern not only franchise regulations, but other business laws, for example, business opportunity laws and relationship laws – all of which impact a franchisor’s contractual relationship with the franchisee and the rights and obligations of the parties.
Accordingly, prospective franchisors must seek comprehensive legal advice from legal professionals familiar with the state(s) they wish to franchise in as the franchise proposition and franchise agreement will need to comply with that state’s laws.
Franchise Regulations – Pre-Disclosure and Registration
Unlike the UK, franchising is regulated in the US, both at federal and state level. The regulations impose registration or disclosure obligations on franchisors to varying degrees.
The most famous of the regulatory requirements is pre-sale disclosure where franchisors must issue a Franchise Disclosure Document (FDD) with respect to the franchise offering.
The disclosure requirements are intended to increase transparency and prevent deceptive and unfair trade practices, as well as to help franchisees assess the investment prospect. The FDD document requires disclosure on a number of aspects of the franchise including:
The identity of franchisor, its officers, and its experience
Current and prior law suits
All fees payable and an estimate of the initial investment
Financial statements of the franchisor
Details of the franchise business
A copy of the franchise agreement
Failure to comply with the disclosure obligations would constitute an unfair or deceptive act or practice in violation of Section 5 of the Federal Trade Commission Act. Penalties range from fines and bans on engaging in franchising to money damages for victims. The penalties can be applied to the franchisor entity or to its officers, directors or managers with direct control.
In addition to the FDD, some states impose additional pre-disclosure requirements on franchisors while others, including California and New York, require a franchisor to register with a local government department before it can begin offering franchises in that state.
A registered trade mark is essential for the protection of your brand. Once you have a registered trade mark, it prevents other people from using the same mark, or something similar, in relation to the same categories of goods and services. Before launching in the US, you ought to:
Investigate whether you can register your brand as a trade mark and whether there are any conflicting trade marks; and
Apply to register your trade mark.
We recommend you carry out the conflict search as early as possible to mitigate wasted costs.
If there is already a potentially conflicting brand, your options will either be to; re-brand, obtain legal advice as to whether there is still scope to register, or enter into a co-existence agreement with the conflicting brand’s owner.
The appropriate franchise structure will depend on a number of considerations. The main models are as follows:
1. Direct Franchising
2. The Area Developer
3. Master Licensing
A UK franchisor can choose to enter into a franchise agreement directly with US-based franchisees, or it can establish a US subsidiary or branch office in the US. Many foreign franchisors often do establish a US subsidiary if choosing this model, however, it is imperative that you take professional advice from US legal counsel and accountants before deciding. This is because there will certainly be tax, employment and immigration restrictions and implications.
The main advantage of direct franchising is that the franchisor can retain more control over the growth and development of the franchise network. However, being able to do this successfully will require substantial resources as the franchisor will need to be able to recruit franchisees and fulfil its obligations under the franchise agreement, e.g. training; providing guidance and support; continuously improving the system to meet market demands, and adapting its operations in view of local regulations and market conditions. This is a tall ask and almost impossible to do from afar, which is why many successful franchisors who choose this model also invest in local or regional “HQs” to deliver.
Just as with direct franchising, the franchisor contracts directly with the franchisee except the franchisee is granted the right to open multiple franchise units in the territory, usually in accordance with a development schedule. In this scenario, the franchisee will likely be more experienced in the industry and will itself have substantial resources to meet the development schedule. This method is usually a precursor to the grant of a master licence, and as the area developer is usually well resourced, it may be more involved in adapting the system to meet local requirements.
This is perhaps the most popular method of franchise expansion. It essentially means that the franchisor grants a licence to a “master franchisee” to use the franchisor’s brand and system and grant franchises to “sub-franchisees” in the foreign territory.
The “master” then takes on the obligations of “franchisor” in territory. It recruits the franchisees; delivers on its obligations as franchisor under the agreement; it ought to be able to provide invaluable knowledge and assistance with adapting the system to meet local requirements, and it is accountable to the franchisor for the growth and performance of the brand in the territory.
This option has its own risks and complications, and while it might assist the franchisor in that the financial burden and risk is shared, the franchisor overall has less control over the brand/system in the territory.
Preparing a Strategy
Expanding your franchise into the US is likely to be an expensive and time-consuming project. To protect yourself from wasted costs, create a clear plan for action.
Determine your franchise structure – this will depend on the advice of your professional advisers, your financial and operational resources, as well your relationships with potential partners, i.e. masters or area developers;
Apply to register your trade mark; and
Determine your point of entry, i.e. your franchise agreements and disclosure documents will need to be compliant with the specific state(s) you franchise in.
ABOUT THE AUTHOR
Ayla Karmali is a consultant at Goldstein Legal. She is a dual-qualified lawyer, qualified to practice in England & Wales and New York and her practice focuses on general commercial and corporate matters with a specific focus on franchise agreements, distribution agreements, services agreements and trademark protection. Ayla is a bfa accredited Qualified Franchise Professional (QFP). Goldstein Legal is a straight-talking commercial law firm based in Berkshire. Our services cover business and commercial, franchise, employment and commercial property law. We offer a full suite of expert legal advice for business, which means we can provide our clients counsel along every step of their commercial journey.
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