By Dr. Diego F. Romero, Senior Partner
Despite the recent economic crisis and downturns in several important countries in the region, Latin America still remains a crucial trading and investment area for multinationals. For after over a decade of full-blown globalization efforts by the government and international investors, Ecuador has opened to foreign investment. Within this framework the country has welcomed dozens of international franchises including McDonald’s, Burger King, KFC, Baskin & Robbins, Pizza Hut, Domino’s Pizza, Taco Bell, Dunkin Donuts, TGI Fridays, Tony Roma’s, Hugo Boss, Blockbuster, Tower Records, and ACE Hardware. These arrangements allow the franchisee to conduct a business or sell a product/service using the methods and procedures prescribed by the franchiser. The franchiser, for his/her part, generally provides marketing, advertising, and technical assistance to the franchisee.
This brief article identifies several legal issues and laws that a perspective foreign or local investor should bear in mind when considering or preparing to establish a franchise in Ecuador. Additionally this paper illustrates why the franchise mechanism, with the proper legal protections in place, is particularly attractive to potential investors in the country.
Benefits of Legal Protections and Franchising Model
a. Advantages for the Franchiser
With the above-indicated legal protections, the franchiser is able to expand its business and distribute its product or service using independent businessmen in targeted markets. This model allows the parent chain to leverage its "know-how" and experience in return for a fixed fee or profit percentage.
The franchise model allows the franchiser to maintain its legal independence and minimize legal liabilities for the actions/obligations of the franchisee. With this independence the franchiser is spared the expense of investing in the infrastructure and labor of the local operation.
An additional benefit of franchising is that it allows franchisers to raise capital without selling stock in their business. For under the franchise model franchisers receive fees or royalties. Some franchisers also act as financiers (earning additional interest) to their franchisees providing loans to start up a local franchise.
b. Advantages for the Franchisee
The franchisee, for its part, has many built-in protections and advantages by participating in the franchise relationship. Perhaps the most important benefit for the franchisee in a developing market like Ecuador is that a franchise represents a highly successful, time tested business model. Under this paradigm the franchisee is presented a working structure, established marketing methods, and detailed sales procedures. The overall net advantage of these benefits is lowering risks for the new business.
Name recognition is another key ingredient to the success of a franchise. Ecuadorians have long been exposed to international brands due to travel, movies, pop culture, and television. As a result we tend to be eager to sample these products and become loyal consumers of international products in the process.
Also, in light of the fact that the great majority of businesses fail in their first year, the strong start-up assistance that franchisers provide allow franchisees to avoid typical new business mistakes that can be extremely costly in both money and time.
Registration of Franchise Agreements
Although not mandated by Ecuadorian law, experience has shown that both foreign and local investors in franchises benefit from the registration of their franchise agreements with the mercantile registry of the city or province where the franchise is to be set up. Registration and notarization of these contracts elevates these documents to the level of public instruments which in turn provides additional evidentiary protections to the parties in the event of a future contractual dispute. With registration (provided that individual clauses do not conflict with the country’s civil or commercial code) the parties’ can be confident that their franchise agreement will control the parties obligations and duties.
Registration of Trademarks and Ecuador’s Intellectual Property Law
On more than one occasion perspective franchisers have found that local pirates had already illicitly appropriated their trademark or product. In light of these practices, franchisers are advised to register their trademarks with Ecuador’s Intellectual Property Institute. In light of the fact that trademarks are considered property rights in Ecuador, the franchiser should also register their marks in the Mercantile Registry of the city, town, or province where the franchise is to be initiated.
Content of Franchise Agreement
In our experience in counseling both franchisers and franchisees in Ecuador we have found a wide variety of franchise agreements. While many international franchisers offer "standard" agreements that tend to be strictly biased in their favor, experience has shown that such contracts must also assure that the franchisee’s legal and business interests are protected.
Although all franchise agreements are different and naturally reflect the specific needs of the parties, we have found that the following types of clauses and protections are needed to secure the parties’ interests:
a. Grant of Rights and Stipulation of Contract's Purpose
This clause is of primary importance and should specify what rights the franchisee is to receive and what obligations he is to assume. The limitations of the franchisee’s right to use the products, trademarks, or "know-how" should also be stipulated.
Franchises, by their nature, are usually limited to a specific area or zone. When defining the scope of the zone both franchiser and franchisee must undertake their own financial and market studies to analyze whether or not the potential market will support more than one franchise. Both parties should also try to account for what should happen with the commercial relationship if the franchise faces future competition in the territory or if the population in the area declines or increases dramatically.
Franchise contracts should state the period of initial duration and whether or not there is the possibility for renewal.
d. Obligations of Franchiser
Franchise agreements stipulate the services that the franchiser is to provide. Such obligations usually include technical service, training, marketing advice and services, and specific "know how".
e. Obligations of Franchisee
In regards to the obligations of the franchisee, the franchise agreement generally specifies that the franchisee will follow the model and procedures established by the franchiser. In this clause will stipulate the exact services to be provided by the franchisee and the franchise fee and royalty payment required to operate the franchise.
f. Trademark and Intellectual Property Issues
These clauses stipulate the trade names and trademarks that the franchisee is authorized to use. The time period for such use is defined in this clause as well as the penalties for misuse. Lastly, these clauses generally specify how the franchise name and mark can be used and displayed.
g. Operations Manual
Perhaps the most valuable right that is transferred with a franchise agreement is the right of the franchisee to use the franchise operations manual. For these manuals contain the formula for which the franchise has achieved its success. As such, these clauses usually stipulate whom and how the manuals can be used.
A key ingredient to the franchise relationship is confidentiality. Therefore franchise agreements usually contain a corresponding clause that specifies that the information and materials passed between the parties are strictly confidential. The further designate who is to have access to confidential information and what the penalties are for breaking the parties’ confidentiality.
Mediation and Arbitration of Franchise Disputes in Ecuador
Since the passage of the Arbitration and Mediation Law in 1997, franchisers and franchisees have been able to submit legal disputes to mediation and arbitration.
A point of great importance to both franchisers and franchisees is the agility in which the parties can reach a total or partial agreement to their legal disputes.
Meditation is a private non-binding intervention between parties with a legal dispute to facilitate specific grievances or issues. Agreements reached under this mechanism, because of its typically non-adversarial nature, often allow the parties to continue their commercial relationship.
It is worth emphasizing that mediation is not a trial. Rather it is an extra-judicial process to which the parties voluntarily submit themselves. If the parties do not reach agreement, they are entirely free to sue each other regarding the legal rights that they believe have been impinged. However, mediation agreements executed by the parties are binding and deemed final decisions that cannot be appealed.
Information divulged in mediation, as well as the final agreement, is confidential. Neither the parties nor the mediator may disclose the content or results of the process. The confidential nature of the process facilitates the parties’ ability to explore a wide range of options and alternatives.
The Constitution of the Republic of Ecuador also allows the parties to negotiate and include mediation and arbitration clauses in their contracts.
Arbitration, in contrast to mediation, is a form of trial or litigation, which is heard by designated arbitrators that can be appointed by the parties by mutual agreement.
Ecuadorian law permits international arbitration when the parties have agreed to it and when certain stipulated requirements have been met.
The innovation of the Arbitration and Mediation Law is that it allows the state to submit itself to domestic or international arbitration. This means that the contract’s participants may distance themselves from the traditional justice system with its overloaded dockets, delays and lengthy appeals.
Arbitration decisions are not subject to appeal but the parties may solicit their amplification or clarification. There also exists the possibility of instigating an action to nullify an arbitration decision if certain specific circumstances have been met.
Because it is a private and single stage proceeding, arbitration in Ecuador is much more agile and expedient than traditional litigation. Franchisers and franchisees doing business in Ecuador also benefit from the transparency of the arbitration process as the certified arbitrators are widely recognized as pillars of moral authority in the country.
Although the above considerations are by no means the only ones to be taken into account when evaluating whether or not to operate a franchise in Ecuador, these items should provide an basic guidelines for both potential franchisers and franchisees. Nonetheless, it is important to point out that prospective investors should obtain qualified local legal and tax counsel before entering into a franchise agreement. For with the proper protections both sides to a franchising contract can reap the great rewards in Ecuador.
Glossary of Terms
A legal agreement that allows one company with an established product, name, idea, or trademark to grant certain rights and information about its business to an independent business owner. In return the independent business owner (franchisee) undertakes to accept certain obligations.
The company that provides an established product, name, idea, or trademark to an independent business owner in return for a fee and/or other business considerations. The franchiser uses sets the conditions for the franchise relationship but does not control or have financial ownership of the new business.
The franchisee is the independent businessman/company that purchases or leases a franchise from the franchiser and operates the franchise using the name, product, and business format provided by the franchiser.
A one-time payment made by the franchisee to the franchiser for the franchise rights and the assistance of franchiser. This fee gives the franchisee the right to open and operate a business using the franchiser’s concepts, products, and/or services.
Ongoing payments from the franchisee to the franchiser for continued support and services. These fees are usually based on a percentage of the business profits earned by the franchisee.
Is the distinctive name or symbol used to distinguish a product or service from others. Trademarks must be registered with the Ecuadorian Intellectual Property Institute is order to receive protection. Only the owner can use registered trademarks unless he/she grants a third party the right to appropriate the name or symbol.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.