Overview of the New Saudi Franchise Law
In a very significant move and in line with its commitments under the WTO, to open economic sectors to direct foreign investments and modernize its legal and regulatory frameworks, the Saudi Council of Ministers, after lengthy discussions and deliberations, approved yesterday (8 October 2019 the long-awaited (overdue) text of the New Franchise Law (the “Franchise law”) which was published and posted (in its Arabic version) on the website of the Ministry of Commerce and Investment (www.mci.gov.sa).This is a significant development as franchise agreements were previously governed by the provisions of the Saudi Commercial Agency Law (enacted by virtue of Royal Decree No. M/5 dated 11/06/1389 H (corresponding to 25/08/1969) as amended together with its implementing regulations and hence were inappropriately regulated, as the Commercial Agency Law could not cater for the specific nature and requirements of business format franchises which could not achieve their full commercial potential in the absence of a proper and full-fledged legal framework.
The Franchise Law is intended to fill this gap and to encourage both domestic (only 5% of the total number of franchisors operating in the Kingdom are Saudis) and international franchisors to invest in the Kingdom and help develop its economy (through the creation of much needed jobs) in line with the objectives set in its 2030 vision.
Set out below are some of the most salient aspects of the Franchise Law:
a- Franchising :The Franchise Law defines franchising as “ the system whereby a person called the franchisor grants the right to another person called the franchisee to carry out the activities-subject matter of the franchise- for his own account, using the trade mark or trade name owned by the franchisor or his licensee, including the provision of the technical expertise and know-how to the franchisee and the manner in which the latter shall operate the franchise activities, in return for a financial or other consideration, excluding the amounts paid by the franchisee to the franchisor for goods or services.
b- Franchisor: a natural or juristic person granting a franchise pursuant to a franchise agreement, which includes the master franchisee in his relationship with the sub-franchisee.
c- Franchisee: a natural or juristic person who is granted a franchise pursuant to a franchise agreement, and this definition includes the sub-franchisee in his relationship with the master franchisee.
d- Franchise Agreement: an agreement between the franchisor and the franchisee, whereby the franchise is granted to the latter.e- Franchise Operating Manual: the way in which the franchise operations are managed, as specified by the franchisor, including the way in which the trade mark associated with these activities is to be displayed and which the franchisee is bound to comply with
f- Control: The ability to influence the actions or decisions of another person, directly or indirectly, through any of the following:
1-the ownership of more than fifty percent of the capital of the company or concern.
2-the ownership of more than fifty percent of the voting rights in shareholders or partners (in limited liability companies) meetings, as the case may be.
3- the right to appoint or elect the majority of the members of the board of directors or board of managers (in limited liability companies)-as the case may be- or the executive officers of the company or concern or the right to manage it.
g- Group: a person controlled by the franchisor, or who controls the franchisor or under the common control of a third party, whether directly or indirectly.
h- Franchise Prospectus: a document containing a disclosure of the key rights, obligations and risks pertaining to the franchise prospects.
II- Objectives of the Franchise Law
The Franchise Law is intended to:
1-Encourage franchising operations in the Kingdom, by establishing a legal framework, organizing the relationship between the franchisor and the franchisor, entrenching the principle of contractual freedom, and laying down the foundations of this relationship based on the principle of transparency.
2- Afford the necessary protection to the franchisee and franchisor, particularly upon termination/expiry of the franchise agreement.3-Secure the disclosure of the rights, obligations and risks pertaining to the franchise prospects, to assist the potential franchisee in making proper investment decisions.4-Increase and maintain the quality of goods and services offered in the Kingdom.
III- Scope of Application of the Franchise Law
Article 3 of the Franchise Law defines its scope of application by stating that it shall apply to any franchise agreement implemented within the Kingdom.
The following arrangements and agreements shall be excluded from the scope of its application:
1- Privileges/concessions granted or issued pursuant to Royal Decrees.
2- Agreements or contracts governed by the provisions of the Saudi Commercial Agencies’ Law.
3- Agreements or contracts for the purchase and sale of goods or the provision of services bearing a specific trade mark, or for the use of a trade mark or other intellectual property rights in relation to any goods or services.
4- Arrangements whereby the franchisee is, directly or indirectly, wholly owned by the franchisor.
5- Any other agreements or arrangements specified by the Implementing Regulations (yet to be issued).
IV- Conditions for Granting a Franchise
Article 5 of the Franchise Law specifies the conditions for granting a franchise, as set out below:
1-A franchise opportunity may not be offered or granted except after franchise activities have been carried out in accordance with the franchise operating manual for at least one year, by two persons or at least in two different outlets and one of these persons can be the franchisor or any person within his group.
2-If the franchisor does not carry out the franchise activities in the Kingdom directly, the franchisor-who has the right to grant a sub-franchise- may not offer the franchise opportunity or grant the franchise except after he-or other franchisors-has carried out franchise activities in the Kingdom for at least a period of one year. The Minister (i.e. the Minister of Commerce and Investment) may amend the periods provided for in article 5.
V- Registration and Disclosure
Article 6 of the Franchise Law provides that the franchise agreement and disclosure prospectus shall be registered with the Ministry (i.e. the Ministry of Commerce and Investment) and the Implementing Regulations will specify the registration requirements and the documents and information that should be submitted.
Article 7 of the Franchise Law deals with the requirements that should be met by the disclosure prospectus, as the same are listed below:
1- The franchisor must provide the franchisee with a copy of the disclosure prospectus as per the provisions of the Implementing Regulations (yet to be issued) fourteen (14) days at least prior to the conclusion of the franchise agreement or the payment by the franchisee of any consideration pertaining to the franchise, whichever occurs earlier.
2- The disclosure prospectus must be:• Drawn up in the Arabic language. If it is drafted in a language other than Arabic, it must be translated by a sworn translator.
• Clear and accurate .In the event of submission by the franchisor to the franchisee-who wishes to enter into a contractual relationship with him- information pertaining to the previous or projected financial performance of the franchise operations owned by him or by any entity within his group, he shall include this information in the disclosure prospectus and ensure they meet the requirements and conditions set out in the Implementing Regulations (yet to be issued).
VI- Obligations of the Franchisee and Franchisor
Article 8 of the Franchise Law deals with the obligations of both parties to the franchise agreement. These obligations are as follows:
1- The franchisor must comply with his obligations as provided in the franchise agreement.2- The franchisor-unless otherwise agreed in writing with the franchisee-must comply with the following obligations:
• Specify the rights granted to the franchisee under the franchise agreement.
• Provide a detailed franchise operating manual including the criteria and instructions that must be observed by the franchisee when operating the franchise, in such a way as to enable the latter to carry out the franchise operations, and provide the latter with operating manuals and guides.
• Train the employees of the franchisee.
• Provide the technical, marketing and other expertise required by the nature of the franchise granted.
• Provide the franchisee-either directly or through a third party-with the goods or services pertaining to the franchise, throughout the term of the franchise agreement, except for the goods and services which the franchisee remains free to purchase from other suppliers.
• Preserve the confidentiality of the accounting and financial information and data pertaining to the business activities of the franchisee.
• Respond to the franchisee’s request to obtain details around the financial consideration owed or paid by the latter regarding the carrying out of the franchise activities.
• Refrain from establishing any entity that would undertake activities similar to the franchisee’s activities within the geographic area specified in the franchise agreement, or grant this right to a third party, throughout the term of the franchise agreement.
Moreover, the franchisor is bound to comply with the obligations provided for in Article 9 of the Franchise Law, that is:
• Obtain the franchisee’s approval upon any change to the goods or services or the way in which the franchise activities are operated.• Provide the franchisee with the information and data pertaining to the franchise operations that would allow the latter to improve the franchise operating manual, including the financial and accounting information pertaining to those activities.
• Enable the franchisee or his representatives to inspect the facilities and premises used in the carrying out of the franchise activities, provided that such an inspection does not result in a disruption of the activities of the franchisee or cause any damage to the latter.
• Obtain the franchisee’s approval upon a change to the place where the franchise activities are carried out. The franchisor and the franchisee must perform their contractual obligations in good faith. The Franchise Law remains silent on what would tantamount to a breach of this general obligation of good faith so that, in the event of dispute, it would fall to the competent courts to determine what would or would not fall short of that generic contractual behavior standard.
VII- The Franchise Agreement
Article 11 of the Franchise Law specifies the contents (terms and conditions) of the franchise agreement. It would appear, absent any provisions to the contrary in the law (and pending the publication of the Implementing Regulations which would supplement the list of terms and conditions) that these are de minima requirements and that the parties would be free (in line with the principle of freedom enshrined in the law) to agree additional terms and conditions (always subject to the proviso that they do not conflict with the provisions of the law, the Implementing Regulations and Saudi public policy considerations).
Subject to the above caveats, the franchise agreement should:
1- Be in writing and signed by both parties. If it is drafted in a language other than Arabic, it should be translated into Arabic by a sworn translator.
2- In addition to the terms agreed upon by the parties, include the following provisions:
• A description of the franchise activities, the term of the franchise agreement, the mechanism for amending it and its geographic scope.
• Any consideration to be paid by the franchisee to the franchisor, including the financial consideration for the franchise, the consideration (if any) for training of the franchisee’s employees and for the provision of technical support and the calculation method for any amount paid in return for any goods or services provided by the franchisor or any person within his group to the franchisee.
• Obligations of the parties in relation to the training by the franchisor of the franchisee’s employees.• Obligation of the franchisor to provide the technical, marketing and other expertise required by the nature of the franchise granted.
• Obligation of the franchisee to comply with the instructions, marketing methods, display and preservation of the franchise identity.
• Any obligations of the franchisor to supply any goods or services to the franchisee, and the obligation of the franchisee to obtain these goods or services from the franchisor either directly or through a third party based on the franchisor’s instructions (this obligation might trigger some issues in terms of competition law)
.• The right of the franchisee to use any trade mark or other intellectual property rights relating to the franchise activities and the obligations of the parties in the event of breach of the intellectual property rights and the damages resulting therefrom.
• A mechanism for the resolution of any dispute arising out of or in connection with the franchise agreement (the law remains silent on vital issues such as the governing law and competent court to resolve any such dispute. It is also uncertain whether such a dispute could be arbitrated and whether foreign arbitration would be admitted).
• The extent to which the franchisee has the right to grant a sub-franchise to a third party and the relevant provisions governing the same.
• The consequences of any change in the ownership of the franchisee, franchisor or the entity controlling either of them.
• Any other provisions specified in the Implementing Regulations.
VIII- Assignment of the Franchise Agreement
Save as otherwise provided in the franchise agreement, the franchisee should obtain the franchisor’s prior approval in the event of change of control of the franchisee or the assignment or transfer by the latter of the franchise agreement and activities. The franchisor may not object to the change of control of the franchisee or to the assignment by the franchisee of the franchise agreement and activities to a third party or withdraw his approval after having given it, except in the following circumstances:
1- If it is unlikely that the assignee has sufficient financial resources enabling him to comply with the obligations placed upon the franchisee by the franchise agreement.
2- If the assignee is unable to satisfy the reasonable requirements of the franchisor regarding the assignment of the franchise agreement and activities.
3- If the assignee does not meet the criteria set by the franchisor for the selection of franchisees.
4- If the assignee does not agree-in writing-to assume the franchisee’s obligations under the franchise agreement from the date of its assignment.
5- If the franchisee has failed to pay any fees owed to the franchisor.6- Any other case provided for in the Implementing Regulations (yet to be issued).It is worth noting that, pursuant to Article 14 of the Franchise Law, the franchisor shall (without prejudice to the provisions of Article 13) be deemed, to have consented to the assignment by the franchisee of the franchise agreement and activities to a third party or to a change of control of the franchisee, if he fails to reply-in writing- to the written request submitted by the franchisee in this regard, in accordance with the provisions of the Implementing Regulations (yet to be issued),specifying the time limit within which such response must be made by the franchisor.
IX-Renewal of the Franchise Agreement
Article 15 of the Franchise Law provides that “ unless the franchise agreement provides otherwise, if the franchisee wishes to renew or extend the franchise agreement, he shall notify the franchisor in writing of his intention, within at least one hundred and eighty (180) days prior to the expiry of the agreement. The agreement shall be renewed or extended for a similar term and upon similar conditions, except in the following circumstances:
1-Agreement of the franchisor and franchisee on new terms and conditions.
2-Upon fulfillment of any of the conditions provided for in Article 18 of the Franchise law.
3-Failure by the franchisee to pay the consideration due under the franchise agreement.
4-Consent of the franchisor to the assignment by the franchisee of the franchise agreement and activities before the expiry of the franchise agreement to a third party who meets the criteria for granting the franchise.
5-If the franchisor is no longer willing to undertake franchise activities or to grant a franchise in their respect in the Kingdom.
6-Failure by the franchisee to enter into the renewal or extension agreement according to the reasonable requirements of the franchisor, at least sixty (60) days prior to the expiry of the franchise agreement.
X-Termination or Expiry of the Franchise Agreement
Article 16 of the Franchise Law specifies the circumstances in which the franchise agreement may be terminated by the parties or expires upon the expiry of its term (initial/renewed/extended).Articles 16 provides that: “except as otherwise provided for in the franchise agreement, if the franchisee is a natural person, the franchise agreement shall expire upon the opening of any of the proceedings of liquidation against him pursuant to the bankruptcy law, or upon his death or his losing the legal capacity or the occurring of any health condition precluding him from carrying on the franchise activities. The agreement may also contain provisions to the effect that it may be assigned or transferred in case of death, loss of legal capacity or the occurring of a health condition, to one or several heirs of the franchisee or to a third party”.
Article 16 further provides that “ save as otherwise provided for in the franchise agreement, if the franchisee is a juristic person, the franchise agreement shall expire upon the person being adjudicated liquidated/wound up voluntarily or through the opening of any liquidation proceedings against it pursuant to the bankruptcy law or its dissolution. Its transformation or merger with another juristic person shall not result in the expiry of the agreement”.
Article 17 of the Franchise Law specifies the consequences of a breach by the franchisor of his legal obligations by stipulating that “ in case the franchisor commits a material breach of his disclosure and registration obligations as provided for in the Law and the Implementing Regulations, the franchisee may, before the expiry of a period of one year from the date on which he knew of the breach or before the expiry of three years from the date on which the breach occurred, whichever occurs earlier, terminate the franchise agreement-without being under an obligation to compensate the franchisor therefor.
Article 18 of the Franchise Law provides that “the franchisor may not terminate the franchise agreement prior to the expiry of its term without the franchisee’s written consent unless termination is warranted by a lawful ground (this would surely exclude the possibility of terminating the agreement for convenience, at least on the franchisor’s part, unless of course he manages to secure the franchisee’s approval).There would be a lawful ground for termination if:
1-The franchisee has committed a material breach of his obligations under the franchise agreement and has failed to cure such breach within fourteen (14) days from the date on which the franchisor sends him a written notice to this end.
2-If the franchisee is liquidated or wound up (dissolved),or transfers his franchise business or his interests therein to his creditors, or disposes of the assets used in his franchise business to a third party.
3-If the franchisee leaves or voluntarily quits carrying out the franchise activities for a period of ninety (90) consecutive days.
4-If the franchisee commits repeated breaches of the provisions of the franchise agreement or another agreement entered into with the franchisor or a person within his group in relation to the franchise despite being required in writing by the franchisor to perform his obligations.
5-If the undertaking by the franchisee of the franchise activities represents a danger to public health and safety.
6-If the franchisee loses any of the permits and licenses required for the latter to carry out his business activities.
7-If the franchisee has committed substantial violations of the provisions of the laws applicable in the Kingdom which adversely affect the reputation of the franchisor.
8-If the franchisee has committed any commercial fraud in the course of carrying out the franchise activities.
9-If the franchisee has infringed on the franchisor’s intellectual property rights during the term of the franchise agreement.
10-Any other circumstance provided for in the franchise agreement as being a lawful ground for termination.
Article 19 of the Franchise Law provides that “in the event that the franchisor commits a material breach of his obligations-in terms of disclosure and registration- provided for in the Law and he Implementing Regulations, the franchisee shall be entitled to claim compensation for any (may raise a “measure of damages” issue, concerned with ascertaining whether indirect, special, incidental damages could be recovered, noting that under Shari’a law as applied in Saudi Arabia, only direct and actual damages would be recoverable in application of the principle “la darar wala darrar”).
Article 20 of the Franchise Law deals with the consequences of termination of the franchise agreement by the franchisor in accordance with the provisions of Article 17 or terminates it in breach of the provisions of Article 18 of the Law or refuses to renew or extend the franchise agreement for a reason other than those mentioned in paragraphs (2) to (5) of Article 15 of the Law. In such cases, the franchisor or any entity within his group, is bound to:
1-Repurchase the material assets used exclusively in connection with the franchise activities which the franchisee has purchased from him or from a third party based in his instructions, within sixty (60) days from a request by the franchisee. The assets shall be repurchased at a price no less than the price paid by the franchisee less the depreciation of any machines or equipment being part of these assets. The amount of depreciation shall be calculated in accordance with the GAAP and the previous accounting practices of the franchisee.
2-Save for the case of refusal by the franchisor to renew or extend the franchise agreement for any reason other than the circumstances provided for in paragraphs (2) to (5) of Article 15 of the Law, the franchisor shall compensate the franchisee for any losses incurred by the latter in setting up, acquiring or operating the franchise business activities in the Kingdom, in addition to any other damages sustained by the latter (again, this raises a “measure of damages” issue as indicated above).
Except as otherwise provided in the franchise agreement, if the franchisee terminates the franchise agreement in breach of the provisions of the Law, the franchisor shall be entitled to claim compensation for any damages sustained by him (again, this raises a “measure of damages” issue as indicated above).Article 21 of the Franchise Law clarifies the conditions for bringing suit upon the termination of the franchise agreement.
These conditions are as follows:
1-Lawsuits whereby the franchisee would claim damages as a result of the termination by the franchisor of the franchise agreement in breach of the provisions of Article 18 of the Law may not be heard after the expiry of three years following termination of the franchise agreement.
2-Lawsuits whereby either party would claim damages as a result of the breach by the franchisor or franchisee of their legal or contractual obligations may not be heard after the expiry of one year from the date on which the non-defaulting party knew of the breach or three years after the occurrence of the breach, whichever occurs earlier.
3- The bringing of any suit pursuant to the provisions of the Franchise Law, does not preclude either party from claiming any rights pursuant to the provisions of any other law.
Article 22 of the Law provides that “the assignment of the franchise agreement and activities, its termination, expiry or non-renewal shall entail the expiry of the agreement to use any trade mark or trade name associated with the franchise activities and the Implementing Regulations will specify the relevant details to this end.
Article 23 of the Law provides that “shall be deemed null and void any agreement whereby the franchisee waives any of his rights as provided for in the Law unless this agreement is part of a final settlement agreed upon with the franchised or is authorized pursuant to the provisions of the Law.
Articles 24 of the Law lists the penalties and sanctions applicable in case of violation of its provisions and the provisions of the Implementing Regulations (yet to be issued). These consist in the imposition of a penalty which shall not exceed SAR. 500,000 (equivalent to around $ 133,333).A committee of three members, of whom one at least shall be an expert in commercial laws, shall be formed pursuant to a decision of the Minister of Commerce and Investment to look into violations of the provisions of the Law and the Implementing Regulations and impose the penalty provided for in paragraph (1) of Article 24.
Without prejudice to the provisions of the relevant laws, a party against whom a penalty was imposed may lodge an appeal with the Board of Grievances (one can wonder why the Law did not provide for a right to appeal the decision of the committee before the commercial courts instead of the Board of Grievances which we believe are better equipped to deal with commercial matters surrounding the imposition of a penalty especially following the judicial reform which saw the establishment of these courts).
Article 25 of the Law provides that the parties may agree to refer disputes arising out of the implementation of the franchise agreement or the application of the Law through alternative dispute resolution mechanisms such as arbitration, mediation and conciliation (although important, this article does not clarify whether foreign parties could resort to a foreign body to arbitrate, mediate or conciliate their dispute.
More importantly, the Law remains silent on whether the contract could be governed by a foreign law, although it would be fair to assume, in application of the principle of freedom of contract, entrenched in the Law, that the parties are free to subject the contract to a foreign law. However, from our experience, it would always be possible for the Ministry of Commerce to require that the contract be governed by Saudi law as a pre-requisite for its registration, as is the case with a commercial agency or distributorship agreement.
Moreover, uncertainty remains as to whether a judgment or arbitral award rendered abroad, even under Saudi law, would still be enforceable by Saudi courts, assuming that the judgment or award complies with the Law and the Saudi public policy broadly interpreted).Article 26 of the Law provides that “the Implementing Regulations” shall be issued by the Minister within one hundred and eighty (180) days from the date of publication of the law and shall come into force on the same date as the latter”.
Since the Law was published on October 8th, 2019, it would come into force, along with its Implementing Regulations on April,8th, 2020.The Implementing Regulations will contain provisions to the effect of:
1-allowing the Ministry (i.e. the Ministry of Commerce and Investment) to issue the specimen franchise agreement (it is not specified whether the specimen is mandatory or is provided for guidance purposes only, as is the case with the specimen commercial agency agreement but in application of the principle of freedom of contract, it would be fair to assume that it is provided for guidance only).
2-define the requirements applicable to the disclosure prospectuses submitted by franchisors.
3-determine the applicable fee for the registration of franchise agreements and other services extended by the Ministry.
4-specify the information that should be published by the franchisees.5-determine the authority in charge of enforcing the provisions of the Law, the Implementing Regulations and the rules governing its work.
Although highly anticipated by many investors within and outside the Kingdom of Saudi Arabia and perceived as a landmark legislation (in the sense that it is highly hoped that it will attract a significant amount of foreign direct investment and create many job opportunities for young unemployed Saudis), there remain several aspects that need to be addressed in order for the law to become a true yardstick by which the ambition of the Kingdom to become a major economic player shall be measured. Not least, the Saudi legislator should clarify, as a minimum, the following issues:
1-ability of the parties to subject their franchise arrangement to a law other than Saudi law;
2-ability of the parties to refer their disputes to litigation or arbitration outside of Saudi Arabia.
3-the extent to which any foreign judgments or arbitral awards rendered against a Saudi franchisee or sub-franchisee would be enforced by Saudi courts.
4-the nature of the specimen franchise agreement to be issued buy the Ministry of Commerce and Investment (mandatory or for guidance only).This Article is solely intended to provide an overview of the Franchise Law and not an in-depth analysis that would be impossible before the publication and coming into force of the Implementing Regulations and any Ministerial resolutions clarifying specific aspects (contents of the disclosure prospectus, required documents for the registration of a franchise agreement etc…). Before such texts are published and implemented, and a slate of relevant disputes adjudicated by Saudi courts, it would be near impossible to provide a comprehensive analysis of the implications of the Law.
Disclaimer: this article is for information purposes only. It is not intended to provide any kind of legal advice or opinion and may not be relied upon to this effect. You should seek the opinion of a legal professional before relying upon the views or information contained in this article. The author hereby disclaims any liability whether in contract or tort (or based on a theory of negligence) towards any person or entity who would act upon the information or views provided in this article. The author does not warrant, in any manner whatsoever, that the information or views contained in this article are correct, true, complete or accurate in any respect and the author disclaims any liability should any such information or views prove to be incorrect, untrue, incomplete or inaccurate.