Part 2-The Impact of Risk and Compliance on Cross-Border Sales and Franchising Agreements

This is the second in a 2-part series on risk and compliance in cross-border sales and franchising agreements. Find part 1 here.

You have conducted your due diligence in both business and legal matters. But you must also conduct due diligence on your local partner.

Because the local partner is the key to the ongoing success of the franchise in the target country, a background check on the individual local partner and the principal officers of any proposed franchisee entity is a critical part of the franchisor’s due diligence. A background investigation or check delves into an individual’s general reputation and history. When conducting an international background check, the franchisor must ensure that a potential local partner in a target market does not trigger certain national security and anti-bribery legislation. Some important aspects of a background check in the international context are highlighted below:

• U.S. Office of Foreign Assets Control. U.S. persons are barred from engaging in transactions with individuals and entities that are listed on OFAC’s Specially Designated Nationals and Blocked Persons (SDN) list. Franchisors based in the U.S. must conduct searches on the current SDN list to ensure that any potential franchise transaction does not involve these individuals and/or entities.

• Third party. The third-party relationships of local partner candidates could pose a risk for the franchisor. The U.S. federal government is increasingly seeking to impose liability on corporations for the acts of third parties, such as distributors and subsidiaries in the Foreign Corrupt Practices Act and other contexts.

• Anti-money laundering legislation. Many countries in the world,, including New Zealand have anti-money laundering legislation. In New Zealand we have the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT) legislation, which requires lawyers to gather more information from clients. The information includes the following: original passport, driver’s license, bank statement (or power/phone bill) with current address, details of directors/shareholders (if a company), details of source of funds (if a company), and IRD number.

Reputational due diligence

General business reputation. A franchisor should conduct a search of foreign news sources and media associated with the shareholders, principals, and officers of a company under review.

Social media. Searches should be made of the social media accounts of the individual local partner or its franchisee entity as well as its principal shareholders and officers.

Criminal records and civil lawsuits. Each target country has varying laws about the type of criminal records that are publicly available, who is allowed to access them, and how a third party may use the information within a criminal record. To assist in reputational due diligence, a franchisor should be aware that the government of the United Kingdom has compiled a list of target countries and their processes for obtaining a criminal background check on someone who lives or has lived in the target country.

Reference checks. A franchisor should contact each reference that a franchise applicant has listed and ask questions about the applicant’s background character and competency. The franchisor may need to use a translation service if the reference does not speak the same language as the franchisor.

Conducting cross-border due diligence on the business environment of the target market, the proposed local partner, area developer, or joint venture partner, as well as the local legal issues remains a vital part of a franchisor’s decision to enter a new jurisdiction. In conducting international due diligence, the franchisor will likely spend more, take longer, and yield less information than desired. Given the scarcity of resources in many markets, it is prudent to allow for more time to complete the due diligence process, and also to be transparent with the prospects in regard to the process and the expectations of the prospects.

To the extent that public sources are limited, the franchisor should be prepared to ask local partner candidates and local counsel to produce a number of documents related to the due diligence. To the extent a franchisor’s inquiries do not reveal a depth of information, the franchisor may have to cover a broad range of topics in a shallow fashion and make the most of the information provided, recognizing that cross-border due diligence is a difficult exercise that may not yield the same results as a domestic investigation.

Draft clauses and comments

1) Governing law

In a U.S. agreement the governing law clause might read as follows:

3.1 Governing Law. This Agreement shall be governed by the laws of New York and shall be subject to the jurisdiction of the New York Courts.

3.2 Waiver.

(a) General. Waiver of any default or breach of this Agreement shall not be interpreted as a waiver of any subsequent default or breach.

(b) Punitive Damages. Except for Area Developer’s obligation to indemnify [Subway] for third-party claims under Section X.1, and except for punitive damages available to either party under the United States Trademark Act of 1946 (Lanham Act, 15 U.S.C., Sections 1051 et seq.), [Subway] and Area Developer (and Area Developer’s owners) waive to the fullest extent permitted by law any right to or claim for any punitive, exemplary, or consequential damages against the other and agree that in the event of a dispute between [Subway] and Area Developer, the party making a claim will be limited to equitable relief and recovery of any actual damages it sustains.

(c) Jury Trial. [Subway] and Area Developer irrevocably waive trial by jury in any action, proceeding, or counterclaim, whether at law or in equity, brought by either of [Subway] or Area Developer.

In New Zealand the governing law clause could read as follows:

This Agreement shall be governed by the laws of New Zealand and shall be subject to the jurisdiction of the New Zealand Courts.

It is important for due consideration to be undertaken in relation to governing law. In my opinion, it is often better to have the governing law in the jurisdiction of the master franchisee or area developer because if there is a breach and the franchisor needs to seek remedies in court, it is often easier and more expeditious to instruct local counsel to act on behalf of the U.S. franchisor and to abide by the governing law in the local jurisdiction.

2) Social media

In New Zealand the social media clause might read as follows:

The Franchisee acknowledges that in relation to the Business and the Franchisor’s Intellectual Property it will act with care when using any social media, and it shall always do its utmost to look after the best interests of the Franchisor, and anything to be published, circulated, transmitted, or disseminated in any way by or through social media shall be subject to the Franchisor’s prior written approval.

In some international franchise agreements I have seen, the website and social media clause might read as follows:

The Website and Social Media Pages

(a) The franchise system will be listed on our global website (“Website”). You will not have editorial access to the Website, but if you require changes and updates you must notify us in writing and we will implement such changes as soon as is reasonably practicable, subject to our prior approval, not to be unreasonably withheld or delayed. You will not advertise and promote via any other website featuring the Marks without our prior written consent.

(b) You shall not advertise and promote your business via pages featuring the Marks on third-party social media platforms (“Social Media Pages”) without our prior written consent. The franchise system will be featured on our branded Social Media Pages. You will not have editorial access to our Social Media Pages, but if you require changes and updates you must notify us in writing and we will implement such changes as soon as is reasonably practicable, subject to our prior approval, not to be unreasonably withheld or delayed.

(c) We will not use the Website or Social Media Pages to promote any marketing initiatives, promotions, discounts, or loyalty schemes for your franchise system without your prior written consent.”

It is important for all international franchisors or licensors to actively monitor their social media pages. Otherwise, a valuable brand could be destroyed while the parties are sleeping.

Conclusion

When a franchisor is looking to embark on cross-border sales and franchising agreements, there will be considerable impact in relation to the risk and compliance to that franchisor. There are many considerations to take into account, including tax laws, dispute resolution, and serious consideration of the governing law. When you embark upon cross-border transactions great care must be taken in relation to the different jurisdictions, and expert legal advice should always be obtained in the local jurisdiction.

Stewart Germann is a franchising lawyer and partner of Stewart Germann Law Office at Auckland, New Zealand. He is actively involved in international franchising, speaks at international franchising events, and has published articles in the International Journal of Franchising Law. Contact him on +64 9 308 9925 or at stewart@germann.co.nz.