New Saudi Arabia Franchise Law To Take Effect in April 2020
In late October, Saudi Arabia's Ministry of Commerce and Investment (MOCI) issued a new franchise law, the Commercial Franchise Regulation of the Kingdom of Saudi Arabia (the Franchise Law). The Franchise Law will take effect in April 2020.
Among other things, it sets forth a new registration and disclosure regime and regulates the ongoing franchise relationship. Although MOCI previewed a draft of the Franchise Law to the international franchise community in 2017, the Franchise Law contains several ambiguities and gaps -- for example, in the area of registration and pre-sale disclosure requirements -- that are likely to create some uncertainty for franchisors exploring the Saudi franchise market. The Franchise Law is notable in that it features many elements of the most burdensome franchise registration, pre-sale disclosure, and relationship laws, but leaves a number of questions to be addressed by implementing regulations, which we expect to be issued by April 2020. It will take some time before the interpretation and application of these provisions are fully understood. A few of the material provisions of the new Franchise Law are outlined below.
Definition of a franchise
The definitional scope of the Franchise Law is similar to that generally employed by the Federal Trade Commission's Franchise Rule in the U.S. Under the Franchise Law, a "franchise" is defined broadly as the grant by a franchisor to a franchisee "of the right to conduct business - the object of the franchise - for its own account linked to a trademark or trade name that the [f]ranchisor owns or is licensed to use, including providing technical expertise and know-how to the [f]ranchisee and specifying a method for operating the franchised business in exchange for monetary or non-monetary consideration." What is not clear is how much technical expertise and know-how must be provided by the franchisor for the underlying arrangement to fall within the definition of a franchise. Article 1 excludes sums paid by the franchisee to the franchisor in exchange for goods or services, so it presumably does not apply to most traditional distributorship arrangements.
Article 3 provides that the Franchise Law applies to any franchise agreement performed inside the Kingdom of Saudi Arabia (KSA), which likely means that the Franchise Law will apply regardless of where the offer or sale occurs or where the parties are located, so long as the premises of the franchise business or services offered under the franchise arrangement will be provided in the KSA. Article 4 excludes from the purview of the Franchise Law, among other types of arrangements and agreements: (i) concessions issued under royal decrees, (ii) contracts subject to KSA's commercial agency regulation, and (iii) other agreements or arrangements to be addressed by the implementing regulations.
KSA's version of 2+1
A franchisor may not offer or sell a franchise in the KSA unless the franchise has been operated under the franchise system for at least 1 year and by at least 2 persons or in 2 separate outlets. If, however, the franchise opportunity is offered by a master franchisee, the master franchisee may not offer or sell the franchise unless the master franchisee or any other franchisee has operated the franchise in the KSA for at least 1 year.
One area that must be addressed in more detail by the implementing regulations is the Franchise Law's requirement that both the franchise agreement and disclosure document be registered with the MOCI. We assume that registration will be required before the offer and sale of the franchise.
Pursuant to Article 7 of the Franchise Law, the franchisor must provide the franchisee with a copy of the disclosure document at least 14 days before the earlier of franchise agreement signing or the date the franchisee makes any payment "in respect of the franchise." While the franchisee's payment of a deposit would likely trigger the disclosure obligation, it is unclear whether the mere signing of a letter of intent would trigger the disclosure obligation. The disclosure document and franchise agreement need not be written in Arabic, but if they are written in a language other than Arabic, a certified translation of the disclosure document and franchise agreement into Arabic must be prepared. Article 7 also states that the disclosure document must be clear and accurate.
Financial performance representation
If the franchisor provides a prospective franchisee with information relating to previous or projected financial performance for a franchised business that the franchisor or one of its affiliates owns, then the franchisor must include this information in the disclosure document. The Franchise Law does not address whether financial performance representations that the franchisor may provide related to its franchisees' outlets must also be disclosed in the disclosure document, but prudent counsel would likely counsel its franchisor clients doing business in the KSA to include this information in the disclosure document as well.
Franchise relationship obligations
Article 10 of the Franchise Law states that the franchisor and franchisee must perform their respective obligations described in the franchise agreement in good faith. Notably, "good faith" is not defined, which suggests that whether the parties have acted in good faith would be determined by looking at legal precedent under KSA's unique combination of civil law, common law, and religious law. The Franchise Law endeavors to regulate the franchise relationship between the parties in several key areas governing transfer, renewal, or termination of the franchise.
Transfer or assignment
Pursuant to Article 13, the franchisee must obtain the franchisor's approval before changing control of the franchisee or transferring or otherwise assigning the franchise agreement or the franchised business to a third party, but the franchisor may not object to (or revoke its approval of) such a change in control or a transfer or assignment of the franchise agreement or franchised business except under enumerated circumstances including where: (i) the assignee appears unlikely to have sufficient financial resources to enable it to perform the franchisee obligations required under the franchise agreement, (ii) the assignee is unable to satisfy the franchisor's reasonable requirements for assignment, (iii) the assignee does not meet the franchisor's selection criteria for franchisees, (iv) the assignee does not agree in writing to assume the franchisee's obligations under the franchise agreement from the date of assignment, and (v) the franchisee has unpaid monetary debts to the franchisor.
Article 15 of the Franchise Law provides that, unless the franchise agreement states otherwise, the franchisee must send written notice to the franchisor of its intent to renew or extend the franchise agreement no less than 180 days before the franchise agreement's expiration date. Under those circumstances the franchise agreement must be renewed or extended except where, among other things: (i) the franchisor and franchisee have agreed on new conditions, (ii) a terminable event has occurred, (iii) the franchisee has unpaid monetary debts to the franchisor, (iv) the franchisor no longer wishes to conduct the franchised business or grant franchises in the KSA, or (v) the franchisee fails to sign a renewal or extension agreement within 60 days of the franchise agreement's expiration date in accordance with the franchisor's reasonable requirements.
The franchisee may terminate the franchise agreement on written notice if the franchisor commits a material breach of the disclosure or registration requirements, within 1 year after learning of the breach or 3 years after the date of the breach, whichever is sooner. The Franchise Law does not describe what events of breach would be considered "material" thus triggering the franchisee termination right. Alternatively, the franchisor may not terminate the franchise agreement before the term of the franchise agreement expires unless there is a "legitimate reason" for termination. The Franchise Law enumerates reasons for termination, including: (i) the franchisee's breach of material obligations described in the franchise agreement, (ii) liquidation or dissolution of the franchisee or an assignment of the franchised business or its assets for the benefit of creditors, (iii) abandonment or cessation of operation of the franchised business for more than 90 consecutive days, (iv) non-compliance with the franchise agreement after written notice of default from the franchisor, (v) if the franchisee's conduct of the franchised business presents a risk to public health or safety, and (vi) if the franchisee has lost any of its permits necessary to conduct its business.
Compensation to franchisee
Article 19 of the Franchise Law provides that the franchisee may, without terminating the franchise agreement, claim compensation for any harm that it suffers as the result of the franchisor's material breach of its obligations related to disclosure or registration. Under Article 24, the Franchise Law directs the MOCI to establish a committee responsible for reviewing violations of the Franchise Law and implementing regulations. However, we must await the implementing regulations for additional information regarding the committee's duties and obligations.
The Franchise Law does not address whether the registration and disclosure requirements will apply to deals in the pipeline and whether the relationship requirements will apply to franchise agreements that have already been consummated, but we would expect the implementing regulations to address the extent to which the Franchise Law requirements will apply retroactively.
The Franchise Law is a positive step for franchisees operating franchised businesses in the KSA, but it raises many questions for franchisors. Unless the implementing regulations fill in the gaps, it may be left to KSA tribunals to interpret some of its open-ended provisions.
Note: The authors wish to thank Herb Wolfson of the law firm of Emirates Law Network for providing information used in this article.
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