UK: Franchising In Europe – Wind Of Change, Or A Road To Nowhere?

Introduction

The European Parliament recently published a study on the regulatory framework and challenges for franchising in the EU, commissioned by its Internal Market and Consumer Protection Committee (IMCO).

The study considers how the EU regulatory environment impacts upon franchising and suggests that franchising is failing to fulfil its full potential in the EU and this is due, at least in part, to the lack of a homogenous approach to EU regulation, the adverse impact of EU competition law on franchised brands and a failure of self-regulation to adequately promote, educate and support franchising at a member state level.

It concludes that in order to enable franchising to achieve its full potential it is necessary to introduce franchise-focused legislation which would include:

• pre-contractual disclosure obligations on both the franchisor and the franchisee;
• special competition law rules for franchising;
• more clearly defined roles with an element of state funding for national franchise associations, like the British Franchise Association (BFA); and
• mandatory terms in franchise agreements

The European Parliament subsequently organised a workshop to discuss the study, at which representatives from the European Commission (EC) gave a lukewarm reception to the proposal for a new, harmonised EU franchise law.

Is franchising underperforming in the EU?

The study cites evidence that 83.5% of franchise turnover is concentrated in a quarter of member states and only represents just under 2% of EU GDP, compared with almost 6% in the US and 11% in Australia.

If franchising is underperforming in the EU, why is that?

Self-regulation is not working - The study states that the self-regulatory environment in the EU is marked by a lack of consistency in approach and enforcement and a conflict of interest between the interests of franchisors (whose membership fees largely fund the national franchise associations) and franchising as a whole.  The fact that the majority of franchise chains in the EU are not members of any national self-regulatory franchise association is cited as symptom of this dysfunction. The study proposes that national franchise associations need a clearly defined role for promoting franchising within each member state in a consistent and impartial manner, and a degree of state subsidy is therefore appropriate.

The lack of harmonisation in EU regulation - The study states that this creates technical barriers to cross border franchising. A number of member states have specific franchise disclosure laws and a number of others regulate franchising differently through "relational" laws, such as duties of good faith, agency law, consumer protection and unfair competition.

The impact of EU competition law on franchise systems - The study considers the macro-economic impact of EU competition law on franchising, stating that it places franchise chains at a disadvantage compared to corporate chains, preventing franchisors and franchisees, which are mostly SMEs and individuals, from competing effectively with big business.

An infringement of EU competition law can lead to substantial fines on the parties concerned.  The non-financial implications are equally severe, including damage to business reputation, the unenforceability of contracts, the risk of third party damages actions and even personal sanctions (fines, director disqualification and imprisonment) imposed on executives of the parties concerned. The EC takes an absolutist approach to "object" or "hard-core restrictions" in franchise agreements and commercial practices in franchise networks. These restrictions automatically infringe competition law, regardless of the size of the parties, the market coverage of the agreement and its economic realities, or any concrete effects on the market.

Resale price maintenance (RPM) is a "hard-core restriction" under EU competition law, and only the provision of a list of recommended prices or maximum prices by a franchisor to a franchisee is permitted, with the result, so the study says, that vertically-integrated corporate chains have a monopoly over the ability to deliver a price promise.

A ban on "passive selling" (which effectively means any online activity, including e-commerce) is also a hard-core restriction. The study suggests that this is problematic for franchised brands, particularly in the retail sector, which need to exercise a high degree of control over their online channels to ensure brand consistency.

The study concludes that RPM and greater restrictions on a franchisee's freedom to operate online are unlikely to be anti-competitive, and might even have the opposite effect, and it recommends the adoption of a US style "rule of reason" approach which looks at each restriction on its merits.

How has the EC reacted to the study?

The European Parliament's recent workshop was attended by a number of stakeholders, including a Dutch MEP who has strong pro-franchisee views and a representation from the European Franchise Federation (EFF), of which the BFA is a member. Following the workshop, an EFF delegate made the following preliminary observations to the BFA:

• The EC currently has no interest in furthering the case for franchise-focussed legislation. Equally, the EC is currently not in favour of taking any corrective measures in relation to alleged unfair trade practices in franchising, nor is it prepared to countenance special competition law rules for franchising which would allow franchisors to set prices or have greater control over online activity.
• The EFF believes that the study was flawed in its conception and conclusions and failed to assess whether there is any evidence that franchisees are unhappy with franchising. The delegate cited the annual BFA/NatWest survey in the UK which sets out franchisee satisfaction rates, which are consistently high.
• The EFF challenged the link made in the study between jurisdictions which regulate franchising and the growth and success of franchising.
• Franchise failure rates in the EU remain low, and this is a success story for the EU and the existing regulatory regime.

Commentary

The study raises some important issues for the franchising industry in Europe to consider; namely, the patchwork quilt of current franchising laws and the role of member state franchise associations. However, when considering the weight of the various arguments for or against introducing new legislation, it is important to separate out the genuine issues from the personal ambitions and interests of those involved in the study and the workshop.

Everyone involved in the franchising sector would of course like to see franchising increase its share of national and EU wide GDP, and for franchising to be flourishing across the entire single market as opposed to in isolated pockets. The current patchwork quilt of franchising laws in the EU runs counter to the stated aims of the single market. However, is franchising really underperforming and is the current interplay of self-regulation and EU law to blame? The study jumps to its conclusion without considering a number of other mitigating factors and their potential impact. For example:

• The EU is culturally and economically diverse, and a direct comparison with the US or Australia is therefore inappropriate. For example, whilst being a broad generalisation, consumers in northern and western EU member states tend to be more receptive to franchised brands as opposed to their more conservative southern and eastern neighbours. 
• The very fact that the EU is, in theory at least, a single market means that many businesses choose to expand corporately within the EU and not through franchising.
• The direction of travel is no longer one-way, but historically a number of EU brands have used franchising to access distant markets, such as the Middle East and Asia, where there is comparatively easier access to capital, lower costs and a greater demand for the brand. The attraction of "low hanging fruit" has resulted in the EU being overlooked by some brands and, for others, they feel more comfortable taking a risk in a distant foreign market as opposed to closer to home.
• A lack of homogenous regulation can slow down the cross-border deal making process and increase costs, but it is unlikely that this alone can be blamed for deals not being done. For international franchisors, regulatory variations between countries are an unavoidable aspect of doing business.
• EU competition law does already contain a degree of flexibility which assists franchised systems, permitting otherwise anti-competitive restrictions where the franchisor has a legitimate interest to protect, allowing RPM in short term price promotions and allowing consistent quality standards to be imposed on franchisees in relation to online sales. A number of brands do franchise successfully in the EU, and they generally manage to offer a consistent brand experience – including price and online interaction – within the existing framework. Indeed, if franchising is performing well in some EU member states and not in others, EU competition law cannot be blamed for this disparity as it applies ubiquitously.

The fact that so many franchised brands do not participate with their national franchise associations should be a cause for concern. Franchise associations such as the BFA need to broaden their appeal and make a clearer case for engagement. It is perhaps worth looking at other self-regulated industries, such as advertising in the UK, to see if there are lessons to be learnt. Ultimately, franchising might well benefit from some form of targeted statutory intervention, if that could guarantee 100% engagement, impartiality and a greater consistency of approach.

It remains to be seen whether the proposed legislation will gain any traction with the EC. The IMCO deliberations will be concluded with a final committee vote scheduled for April 2017. For businesses which are interested in using franchising as a means to expand into/across the EU, now is the time to make their voices heard.

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.