Cross border transactions continue to evolve, and businesses within the Middle East continue to witness substantial growth. Kingdom of Saudi Arabia (KSA) continues to prosper due to foreign investment in addition to its oil revenue business. The business of franchising has helped all kinds of local brands gain an access to the international market while promoting their goods and services.
Understanding a Franchise Agreement
A Franchise agreement is undertaken between two natural/legal persons where one person (franchisor) grants the other (franchisee), the right to conduct his business by yielding the technical know-how and expertise for the same. The franchisee is granted the right to use the trademark affiliated with the franchisor's business in exchange for monetary or non-monetary consideration.
Saudi Arabia's New Franchise Law
Franchising agreements were governed under the Commercial Agency Law (Royal Decree Number 11, 20/02/1382H) of Saudi Arabia up until 2019. However, a new set of executive regulations have been drafted by the Ministry of Commerce and Investment (MOCI) to govern the franchise agreements in the territory. These regulations passed under Royal Decree Number 122, 09/02/1441H (the Law) corresponding to 8 October 2019, shall come into effect on 22 April 2020. The objectives of the legislation are as follows:
- To govern the relationship between a franchisor and franchisee;
- obligate the franchisor to adhere to disclosure requirements for a franchise agreement;
- protect franchisee(s) in the event of termination of the franchise arrangement;
- encourage commercial franchising activities on the principle of transparency and
- maintain continuity of the franchise system in KSA.
Article 3 provides that the Franchise Law applies to any franchise agreement undertaken in the Kingdom of Saudi Arabia; this most likely means that the Franchise Law will apply regardless of where the sale occurs, or where the parties are located, so long as the services offered under the franchise arrangement are provided in the KSA. Article 4 excludes from the purview of the Franchise Law, among other types of arrangements:
- Concessions issued under royal decrees;
- Contracts subject to KSA's commercial agency regulation, and
- Other agreements or arrangements to be addressed by the implementing regulations.
TheLaw has been passed with the aim of making the relationship between a franchisor and franchisee a clear and transparent one. Before the Law came into existence, the arrangements between a franchisor and franchisee fell under the principal and agent relationship, governed by the Saudi Commercial Agencies Law. The Law eliminates this (Article 4) and henceforth, a franchise agreement shall only be governed by the regulations under this.
The Franchising Law: Provision of Regulation at a Granular Level
The overall objective of international franchising and regulations governing it is to enable international companies to enter local markets and to develop a regulatory framework for the relationship between the franchisor and the franchisee. UAE law does not bear a specific legal definition of 'franchise'; the country has no specific laws to exclusively govern franchise either. The main piece of legislation dealing with franchising in Dubai and the United Arab Emirates (the UAE) is the UAE Commercial Agency Law (Federal Law number 18/1981, as amended) (the Agency Law). Pursuant to the Agency Law, an agency has been defined as, ''Any arrangement in which a foreign company is exclusively represented by an agent to distribute, sell, offer, or provide goods or services within geographically defined limits for a commission or profit'' (Article 1 of the Agency Law) and the relationship between a franchisor and franchisee shall be addressed by the same. The franchisor will be treated as the principal and the franchisee shall be treated as an agent for the purposes of the Agency law, therefore, the relationship between a franchisor and franchisee will be that of a principal and agent. The franchisee cannot be treated as an employee of the franchisor. The Commercial Agency law has been governing the relationship between a franchisor and franchisee in the jurisdiction of KSA up until 2019 and the same shall be invalid under the new Law passed in the nation. The Law brings forth a new set of regulations governing the relationship between the franchisor and franchisee and adding obligations of conducting activities in good faith on behalf of both parties. Through this law, the necessary protection for both parties has been laid out; the following are some of the essential points covered under this Law.
- The franchisor's obligations
The franchisor has the obligation to establish the rights of the franchisee; the business model of the franchise model; enable the franchisee to access the knowledge to run such a business; provide employee training and other technical and marketing experience to the franchisee. The franchisor has an obligation to fulfill all disclosure documents (a disclosure document is a document that includes the most prominent disclosure rights, duties and risks related to opportunities pertaining to a franchise) to the franchisee and provide the franchisee with a clean and accurate copy at least 14 days before the signing of a franchise agreement (Article 7). The agreement must be written and signed by both parties and if it is written in any language other than Arabic, then it must be translated to Arabic (Article 11).
- Renewal of the franchise agreement
The franchisee must send written notice to franchisor of its intent to renew or extend the franchise agreement within a period of no less than 180 days before the franchise agreement's expiration date (Article 15). Such a franchise agreement shall be renewed or extended except where the parties have agreed to new terms that state otherwise, in case of a terminable event (agreement coming to an end after a certain time), franchisee owes monetary debts to the franchisor, the franchisor no longer wishes to conduct business with such a franchisee, or in cases where the franchisee fails to sign a renewal or extension agreement within 60 days of the agreement's expiration date. Importantly, unless the franchise agreement categorically stipulates otherwise, the new franchise Law requires that the renewed franchise agreement be under similar conditions, which can be interpreted to mean having similar terms and conditions as the earlier agreement. A franchisee shall have to take approval from the franchisor if and when the franchisee decides to change or transfer the franchise business to a third party (Article 13).
- Termination of the franchise
Article 18 states that the franchisor cannot terminate such an agreement prematurely, except in scenarios bearing 'legitimate' cause to do the same; the Law proceeds to delineate 9 cases that constitute legitimate cause. These include insolvency, failure to obtain license, violation of intellectual property rights of the franchisor, among others (Article 18). In addition to the 9 cases, a catch-all provision imbues a franchisor with the power to terminate for 'any other case stated as legitimate cause for termination in the franchise agreement'. Therefore, franchisors must prudently review the drafting of the termination provisions in their franchise agreements, and ensure additional events that might give rise to a termination, are included in the agreement as a further 'legitimate cause for termination.'
- Compensation and Penalties
The franchisee is entitled to ask for compensation without terminating the franchise agreement for any harm suffered by such a franchisee as a result of the franchisor's material breach of its obligations related to disclosure registration (Article 19).The franchisee can request compensation if it was harmed due to the franchisor's inadequate termination and the franchisee can claim such compensation before a competent court, provided it is done within 3 years of the termination of the franchise agreement. A violation of the franchise agreement can result in a fine not exceeding SAR 500,000 imposed by a committee formed by a ministerial resolution and such decisions shall be subject to appeal (Article 24).
Foreign Investment Laws
Under the current applicable regulations, non-Saudi nationals are proscribed from acting as commercial agents or franchisees. This activity is currently restricted to Saudi nationals, and 100% Saudi-owned companies. Any business owned fully or partially by a foreign investor will be subject to the Saudi Arabian General Investment Authority (SAGIA)- issued foreign investment regulations; it must be noted that the restrictions imposed on non-nationals, with respect to ownership and control, are in relation to trading and wholesale activities.
In light of the vision of 2030, KSA is encouraging foreign direct investment and aims to promote the growth of small and medium enterprises in the country. Franchise businesses help establish more business opportunities which in turn creates more job opportunities and hence, resulting in enhancing the economy of Saudi Arabia. This vision aims to encourage the local brands in Saudi with the ability to manufacture national products, to expand their business worldwide. This will in turn promote the international status of the country and increase diversification and empowerment of the economy. Through the franchise business, the economy of Saudi shall be diversified by placing it on the global franchise map. The vision of 2030 aims to support those wanting to invest in the franchise system as it is an important opportunity to launch entrepreneurial projects and at the same time promote small and medium projects which calls for an establishment of a legislative, cultural and economic structure for its growth. The main purpose of this vision is to increase the contribution of the franchising business sector to increase the Kingdom's GDP (gross domestic product).
Ambiguities and Gaps
This legislation is notable in that it features many elements of the most burdensome franchise registration, pre-sale disclosure, and relationship laws, but leaves an array of questions to be addressed by implementing regulations. For instance, Article 10 of the act imposes an obligation to act in good faith on both the parties of the franchise agreement, without lucidly defining 'good faith'. Another area that has to be addressed is set out in Article 1 of the Law; while it states that the franchisor has an obligation to impart the technical knowledge and expertise to the franchisee, the constitution of 'technical expertise' has been neglected . The term 'technical knowledge and expertise' has not been explained and is subject to interpretation. Article 23 mandates that the parties may agree to settle disputes arising under 'franchise agreements or the application of the law' by alternative dispute resolution. However, the Law under Article 3 clearly states that it shall apply to any franchise agreement that is implemented within KSA. Regardless of the fact, that if parties choose to seek remedy under Article 23 and resolve a dispute arising out of a franchise agreement through arbitration or any other dispute resolution, and in the process, choose any foreign law as being the governing law for the franchise agreement, then a question arises as to whether the aggrieved party can invoke the jurisdiction of the court regarding the governance of the law. It can be interpreted that since Article 3 clearly states that all franchise agreements within KSA shall be governed under this Law, then the aggrieved person can invoke the jurisdiction by demanding the local law to be applied. Hence, there is an ambiguity that has been created between Article 23 and Article 3 and as seen, Article 23 stands in contradiction of Article 3 since the Law does not grant the parties the right to choose the governing law for the given franchise agreement.
There are certain contradictions prevailing in these set of regulations that need to be addressed by the competent authorities in the jurisdiction of Saudi Arabia, for gaining more clarity and understanding about franchise agreements prevailing there.
Originally published 30 April, 2020
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.