Law and Business Review of the Americas

VOLUME 20 WINTER 2014 NUMBER 1

TABLE OF CONTENTS

SYMPOSIUM ISSUE 2014

ARTICLES Franchising in the United States Honey V. Gandhi ...... 3

Franchise Legislation in Canada Jeffrey P. Hoffman ...... 25

Opportunity for US-Based Franchises in Mexico: Legal Overview and Potential Pitfalls Lorelee P. Dodge ...... 55

Franchising in Argentina: Challenges for the Foreign Franchisor Gustavo M. Papeschi ...... 71

Update: Franchising in Brazil Kitty McGahey ...... 95

Franchise Law in Chile: Current Issues and Future Outlook Guillermo Carey, Tim R. Samples, and Paulina Silva ...... 107

CASE NOTE Australia’s Updated Franchise Code of Conduct: Does an Express Obligation of Good Faith Benefit the Franchisor or Franchisee? Natalie Sears ...... 121

UPDATES Two Down, Eleven to Go: Creating a Canadian SEC or Something Like It John J. Kappel ...... 133

Brazil’s Landmark Anti-Corruption Law Michelle Richard ...... 141 American Trade News Highlights for Winter 2013: Costco Cashews-How Much Roasting Makes Them American for Purposes of NAFTA Preferential Tariff Treatment by Canada? Vanessa Humm ...... 149 Editorial and Submission Policies: should ensure that the significance of a contribution would be apparent to readers This journal is a quarterly, professional outside the specific expertise. Special terms peer-reviewed publication produced by the and abbreviations should be clearly defined Southern Methodist University Dedman in the text or notes. School of Law’s International Law Review Accepted manuscripts will be edited, if Association (and its Law Institute of the necessary, to improve the journal’s effec- Americas), as well as the Section of Interna- tiveness of communication. If editing tional Law and Practice of the American should be extensive, with a consequential Bar Association). The journal relies on the danger of altering the meaning, the manu- ongoing cooperation of the SMU School of script will be returned to the author for ap- Business, the SMU Departments of Eco- proval before type is set. Alternatively, the nomics and Political Science, and the manuscript may be returned to the author London Forum of International Economic to address the deficiencies. In all events, the and Financial Law at the Centre for Com- editors reserve the right, after discussion mercial Law Studies at Queen Mary Col- with the author, to change its acceptance de- lege, University of London. cision, or to move a publication from one is- Aims and Publication Policy: sue to a later or earlier issue. The editors will not accept unsolicited student-written This journal addresses the legal, business, submissions, nor will they consider articles economic, political and social dimensions of or reports that have been, or are to be, pub- Western Hemispheric integration efforts lished elsewhere, or materials prepared for (e.g., NAFTA, FTAA, MERCOSUR, etc), one’s clients or business promotion. their implementation, their future evolve- Manuscripts submitted for publication ment and expansion, and their overall im- should be submitted in duplicate with a pact on doing business in the Americas. cover letter summarizing the contents to: The journal will combine practical and policy implications of these integration Editor-in-Chief processes. As such, it will cover not only LAW AND BUSINESS REVIEW OF THE AMERICAS matters of immediate concern and interest, Southern Methodist University but also matters respecting reform of legal, Dedman School of Law business, economic, political and social P.O. Box 750116 structures (including human rights, gender, Dallas, Texas 75275-0116 labor, and environmental issues) within the [email protected]. various countries in the Western Hemi- At the time the manuscript is submitted, sphere. Subject matter concerning other re- written assurance must be given that the ar- gional integration efforts in the world and ticle has not been published, submitted, or various other comparative topics in the in- accepted elsewhere. The author normally ternational trade and investment areas will will be notified of acceptance, rejection or also be addressed, from time to time. need for revision within 8-12 weeks. However, topics of particular concern to Manuscripts may range from 6,000 to the journal will include: (1) free trade, direct 10,000 words (approximately 20-30 pages in investment, licensing, finance, taxation, la- length). However, longer articles are ac- bor, environmental, litigation and dispute cepted based upon topic, quality, and space resolution, and organizational aspects of availability. The title of the article should NAFTA and other specific integration ef- begin with a word useful in indexing and in- forts and their specific implementation. For formation retrieval. Text and endnotes practical reasons, English is used as the lan- should be double-spaced. All endnotes guage of communication; (2) subject matter should be numbered in sequential order, as involving economic, legal, political and so- cited in the text. Unless for good reason ac- cial integration, and reform effects in Latin ceptable to the editors, endnotes for legal and Central America and in the Caribbean articles should conform to The Bluebook, Basin; and (3) FTAA implications. Uniform System of Citation (18th ed, 2005; Article Submission: online version 2008). For non-legal articles, the citations should be internally consistent The editors will consider for publication within the given article. Authors should manuscripts by contributors from any coun- submit short biographical data, including his try. Articles will be subjected to a profes- or her affiliation; an abstract summarizing sional peer-review procedure. Authors the manuscript (not to exceed 150 words). ISSN 1571-9537 THE INTERNATIONAL LAW REVIEW ASSOCIATION An Association of The International Lawyer and Law and Business Review of the Americas SOUTHERN METHODIST UNIVERSITY DEDMAN SCHOOL OF LAW 2013-2014 STUDENT EDITORIAL BOARD

BROOKS CASTON President

The International Lawyer Law and Business Review of the Americas MAX METZLER KENDAL PAYNE SARAH WILSON JOHN FAUBION Editor-in-Chief Managing Editor Editor-in-Chief Managing Editor

Associate Managing Editors JENNIFER ARNEL BRYAN ASSINK ALLIE SHOWALTER ROBINSON SAMMY TRAKHTENBROIT HEATHER VENRICK

Contents Editor Case Note & Comment Editors Senior Note & Comment Editor TYLER HOKANSON RYAN GRANEY JACOB BERGMAN KATY JOHNSON ALEX PRESCOTT ALLIE SHOWALTER ROBINSON

Canada Reporter NAFTA Reporter Year-In-Review Editors JOHN KAPPEL VANESSA HUMM JENNIFER ARNEL BRYAN ASSINK

Latin America Technology Citations Administrative Reporter Editor Editors Managing Editor MICHELLE RICHARD BRAD WILLIAMS BRYAN ASSINK HELEN HUTTON JAKE BROWN RACHEL MICHAELWICZ

Articles Editors MICHAEL ANDREWS MICHAEL HEWITT SOO NAM ZACH BURNETT KIRSTEN JENSEN CODY PERLMETER MOIRA CHAPMAN RACHEL KAKURES KELSEY POLLARD LAUREN CHASE KAITLIN KAUFMANN PHILLIP POOL FIDAA ELAYDI LYNDA MAJOR NICOLAS SHEMIK COURTNEY EUDY ANNE MORETTI RACHEL THEBEAU JAMES ‘JT’ GAGE ADAM TUNNELL

Staff Editors ALEX ALLEN MICHAEL HANSON AUSTIN MERCER DARYOUSH BEHBOOD ANDREW HATCH ANNABEL PEDRAZA JAMIE BROOKS JODY LYNN HOLM IAN ROSS PHILLIPS CHRISTOPHER CORNELL KRISTEN JACKSON SAM PONDROM LAUREN CROUCH JACOB JOHNSON LEV PRICHARD JACOB CRUMRINE CHRISTINA KEARNEY NATALIE SEARS KATHLEEN CRUZ BRYANNA KROUGH CLAYTON SMITH JASMINE CULPEPPER DIVYESH LALLOOBHAI JOHN SMITHEE JERI LANE D’AURELIO JANET LANDRY BARBARA STAFFORD GREGORY FIJOLEK SAMER LAWAND BEN STEPHENS COURTNEY FLOYD JUSTIN LEE ANGEL TORRES MASHHOOD GHASSEMI TYLER LIVINGSTON MAI TRAN NEERAJ GILANI DANIEL LUNSFORD JEFFREY VETETO ANTHONY GODFREY ANN MARTIN STEPHANIE VITIELLO ROXANNE HAJIKHANI LESLIE MCCOMBS JORDAN WYNN DAMIEN HAKERT JIBRAEEL ZAIDI

TALIBRA FERGUSON Administrative Assistant —Editorial Base— Southern Methodist University Dedman School of Law Dallas Law and Business Review of the Americas

Honorable Editor-in-Chief PROFESSOR ROBERTO MACLEAN President, SMU – LIA

Co-Editors-in-Chief JOSEPH J. NORTON DIEGO C. BUNGE SMU-Dallas UBA-Buenos Aires

Associate Editors-in-Chief MAURICIO BAQUERO-HERRERA MARTIN L. CAMP MARCOS AURELIO´ P. VALADAO˜ Colombia SMU-Dallas Brasil

—BOARD OF SENIOR PROFESSIONAL EDITORS—

RODRIGO OLIVARES-CAMINAL OMAR GARCIA-BOLIVAR JORGE A. GONZALEZ London Washington D.C.-Caracas Dallas

ROSARIO SEGOVIA-HEPPE GABRIEL GARI ANTONIO PENA˜ LAWRENCE B. PASCAL SMU-Dallas London-Montevideo Miami SMU-Dallas

CHRISTOPHER MALCOLM VIRGINIA TORRIE GERARDO VASQUEZ´ COMEZ´ West Indies Toronto Mexico City

NARA PORTO CLAUDIA CARBALLAL-BENAGLIO Dallas-Brasil Mexico-Dallas

—SMU FACULTY ADVISORY BOARD—

Chair LUIGI MANZETTI (POLI.SCI.)

GAIL M. DALY (LAW) GEORGE MARTINEZ (LAW) THOMAS OSANG (ECON.) CHRISTOPHER H. HANNA (LAW) MICHAEL LUSTIG (POL.SCI.) MARC I. STEINBERG (LAW) JOHN S. LOWE (LAW) DANIEL J. SLOTTJIE (ECON.) PETER WINSHIP (LAW) —ADVISORY BOARD—

—ABA Representatives—

Chair GLENN P. HENDRIX

Canadian International Investment & International Trade Committee Development Committee Committee JOHN W. BOSCARIOLI JEAN PAUL CHABANEIX KRISTY L. BALSONEK MARCELA B. STRAS DANIEL MARIN MORENO MATTHEW ROBERT NICELY AMY STANLEY

Latin American & Caribbean International Corporate Counsel Mexico Committee Committee Committee JEAN PAUL CHABANEIX CAROL BASRI PATRICK DEL DUCA MARCOS RIOS RICHARD T WALSH ALEJANDRO SUREZ

—External Representatives—

DR. ERNESTO AGUIRRE DR. CARLOS GERSCOVICH PROF. ANA MACLEAN Washington D.C. Buenos Aires Lima

MR. LEE BUCHEIT PROF. BENJAMIN GEVA DR. HECTOR MAIRAL New York Toronto Buenos Aires

ALBERTO SALAZAR VALLE PROF. MICHAEL W. GORDON PROF. ANTONIO BORGES Toronto Gainesville Brasilia

LOUIS CAPIN PROF. LUIS MEJAN´ PROF. RICARDO OLIVERA-GARCIA Mexico City Mexico City Montevideo

PROF. EM. BEVERLY MAE CARL DR. EVA HOLZ DANA G. NAHLEN Santa Fe Montevideo Dallas

PROF. MARSHA ECHOLS HON. MIGUEL OTERO PROF. JULIO FAUNDEZ Washington D.C. Santiago Warwick

ANTONIO FRANCK PROF. BORIS KOZOLCHYK PROF. JOEL P. TRACHTMAN Mexico City Tucson Boston

MANUEL GALICIA PROF. ROSA LASTRA PROF. STEVEN T. ZAMORA Mexico City London Houston

DR. ALEJANDRO M. GARRO PROF. RAUL VINUESA New York Buenos Aires OFFICIAL CITATION LAW & BUS. REV. AM. WINTER 2014 Nothing herein shall be construed as representing the opinions, views or actions of the American Bar Association unless the same shall have been first approved by the House of Delegates or the Board of Governors or of the Section of International Law and Practice of the Association unless first approved by the Section or its Council. Southern Methodist University Dedman School of Law’s Law Institute of the Americas

(formerly SMU Centre for NAFTA and Latin American Legal Studies)*

Established in 1952, the LAW INSTITUTE OF THE AMERICAS at Southern Methodist University Dedman School of Law was originally designed to promote good will and to improve relations among the people of the Americas through the study of comparative laws, institutions and governments respecting the American Republics, and to train lawyers in handling legal matters pertaining to the nations of the Western Hemisphere. Today, in reviving the institution, the Law Institute of the Americas comprises meaningful academic research, teaching and programs pertaining to the “NAFTA/FTAA processes” and other Western Hemispheric integration efforts; to Latin and Central American law and judicial reform, particularly focusing on Argentina, Brazil, Chile, Guatemala, Mexico, Peru and Venezuela; and to a more limited extent, to Canadian legal issues, particularly as they interrelate to the NAFTA/FTAA. The Law Institute of the Americas also is concerned with increasing (regional and hemispheric) legal and economic interconnections between the “NAFTA/FTAA processes” and European and Asia-Pacific integration activities.

The officers of the Institute are as follows: the Honorable Roberto MacLean, President; Professor Joseph J. Norton, Executive Director; and Professor George Martinez, Associate Executive Director. The Institute is also supported by distinguished group of Professorial Fellows, Senior Research Scholars, Professional Fellows, and Student Research Fellows.

As the Institute focuses primarily on issues pertaining to the North American Free Trade Agreement and the pending Free Trade Area of the Americas, and the broader economic, political, legal, and social integration processes underway in the Western Hemisphere, Law and Business Review of the Americas is one of the International Law Review Association of SMU. Other parties of the journal are the Cox School of Business, the SMU Departments of Economics and Political Science, the London Forum, and the American Bar Association Section of International Law and Practice.

* From 1952 through the early 1970’s, the name was the Law Institute of the Americas: in 1993, it was reactivated as the Centre for NAFTA and Latin American Legal Studies; and in 1998, it returned to its original name. For further detailed historical information on the Law Institute of the Americas, please refer to the Law Institute of the Americas’ website at http://www.law.smu.edu/lia.

Articles

FRANCHISING IN THE UNITED STATES

Honey V. Gandhi*

INTRODUCTION

ENERALLY, most people associate franchising with fast food restaurants such as Subway, McDonald’s, and Burger King. This Gis not surprising, because the restaurant industry is among the oldest and the most successful trades still operating under the franchising format. While restaurants and other food-related businesses represent a large segment of the total franchised businesses in America, the franchising model has become common and widespread in a diverse array of business services and industries.1 Today, franchises span many areas of the U.S. economy, including but not limited to, hotel, automotive, real estate, personal and business services, convenience and retail businesses, education and children development activities, maintenance and domestic services, and fitness and health services.2 The Washington, D.C.-based International Franchise Association (IFA), the world’s oldest and largest organization representing franchising worldwide, foresees a positive outlook for the U.S. franchising industry.3 The IFA reports that in 2000, the franchising sector had accounted for more than 40 percent of all U.S. retail sales, with revenue collection of more than a trillion dollars per year from seventy-five different industries.4 The industry analysts further reported that the franchising industry has witnessed rapid growth, with a new franchise opening in the country every eight minutes.5 Even with the harsh economy and skeptical business climate of the past few years, the franchising model continues to be a very strong and resilient business format that generates jobs and contrib-

* Bachelor of Commerce, Mumbai University, India, distinction, 2000; B.S., Mem- ber, Institute of Company Secretaries of India; Texas Wesleyan University, cum laude, 2006; SMU Dedman School of Law, cum laude, 2013. Associate, Stutzman, Bromberg, Esserman & Plifka, a Professional Corporation, Dallas, Texas. 1. Tracy Stapp Herold, Top Food Franchises, ENTREPRENEUR (July 5, 2013), available at http://www.entrepreneur.com/article/226750#. 2. See id. 3. The Entrepreneur’s Source-Answers to the IFA’s 21 Most Frequently Asked Ques- tions about Franchising, INT’L FRANCHISE ASS’N, 1, 9–11, available at http:// www.nextaff.com/resource_centers/business/Franchising%20FAQs.pdf (last visited Feb. 24, 2014). 4. Id. at 2. 5. Id.

3 4 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 utes positively to North America’s GDP.6 The franchise sector contrib- uted approximately $472 billion to the U.S. GDP in 2013 and is estimated to contribute even more in 2014.7 Moreover, it also accounted for approximately 8.3 million jobs in the United States in 2013 and is estimated to create an additional 192,000 new jobs in 2014.8 According to the Inter- national Franchise Association, the outlook for the franchise sector in 2014 not only looks positive, but the industry is also predicted to outpace growth in other business sectors this year as well.9 This article surveys the various laws applicable for franchising in the United States. Part I provides a brief understanding of the meaning and history of franchising. Part II examines the statutory franchising laws, both at the federal and the state level. Part III explores the interplay between franchising and other laws, such as antitrust and intellectual property laws. Part IV discusses an emerging issue about whether franchisees are independent contractors or employees of the franchisor. Fi- nally, Part V presents an overview of the termination and post- termination issues arising in the franchising context.

I. FRANCHISING–MEANING & HISTORY

A. WHAT IS FRANCHISING?

With the explosive growth of franchised businesses and the evolving practice of franchise law, franchising can be categorized as an industry in all respects. Franchising is technically not an industry, but a business format—a tried and tested method of distributing goods and services. The International Franchise Association defines franchising as: [A] method of distributing products or services. At least two levels of people are involved in a franchise system: (1) the franchisor, who lends his trademark or trade name and a business system; and (2) the franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.10 Usually, a franchising arrangement is stipulated by way of an agreement whereby the franchisor provides the franchisee the right to use his business format, operating methods, and intellectual property, such as signs, logos, trademarks or trade names, to distribute a product or service

6. See 2014 Franchise Business Economic Outlook, INT’L FRANCHISE ASS’N, Jan. 2014, available at http://franchiseeconomy.com/wp-content/uploads/2014/01/ Franchise_Business_Outlook_January_2014-1-13-13.pdf; Slow, Steady Growth to Continue for Franchise Businesses in 2013, INT’L FRANCHISE ASS’N (Dec. 20, 2013), http://www.franchise.org/Franchise-News-Detail.aspx?id=5891. 7. 2014 Franchise Business Economic Outlook, supra note 6. 8. Id. 9. Id. 10. See Frequently Asked Questions About Franchising-Answers To The 19 Most Com- monly Asked Questions About Franchising, INT’L FRANCHISE ASS’N, http:// www.franchise.org/franchiseesecondary.aspx?id=10008 (last visited Feb. 24, 2013). 2014] FRANCHISING IN THE UNITED STATES 5 in exchange for fees and royalties.11 Various styles of business franchising exist. The more common type of franchising involves using the franchisor’s business format.12 But franchising also includes product distribution.13 Under the business format franchising, as the name suggests, the franchisee adopts the complete method to operate the business, including its format, operations manuals, marketing plans, and distribution techniques. For example, Taco Bell sells its complete business operations format to its franchisees.14 On the other hand, the product distribution franchisor does not provide the franchisee with the complete business format to run it, but rather the franchisor licenses his trademark and logo to the franchisee for distribution of the product. For example, Coca Cola licenses with bottlers to manufacture the drink using its secret formula and distribute it under its trademark.15 Further, a franchisor can restrict the franchisee’s operational activity to that of either a single-unit franchise or a multi-unit franchise.16 Single-unit franchise agreements grant the franchisee the right to open and operate one franchise unit versus a multi-unit agreement, which allows the franchisee to open and operate more than one unit within a specified area.17

B. HISTORY OF FRANCHISING

The franchising concept came into existence in mid-1800s with the distribution techniques adopted by Isaac Singer, the founder of Singer Sew- ing Company.18 Singer, widely considered to be the father of modern- day franchising, was one of the first to develop franchise contracts with the aim to distribute his sewing machines over a widespread geographic area. He contracted with local salesmen, granting them the right to sell his machines within a specifically defined region in exchange for a licensing fee.19 With the economic and infrastructural growth and the increase in the mobility of Americans in the early to mid-1900s, a wide variety of retail establishments and restaurants picked up on this licensing concept and started to formally develop franchises—for example, Kentucky Fried Chicken in 1952, Burger King in 1954, McDonald’s in 1955, and Pizza Hut

11. Howard Yale Lederman, Franchising and the Franchise Law–An Introduction, 92 MICH. BAR J., 34, 34 (Jan. 2013) available at http://www.michbar.org/journal/pdf/ pdf4article2150.pdf. 12. See BARBARA BESHEL, AN INTRODUCTION TO FRANCHISING 2 (2001), available at http://www.franchise.org/uploadedFiles/Franchise_Industry/Resources/Education_ Foundation/Intro%20to%20Franchising%20Student%20Guide.pdf. 13. Id. 14. Id. at 2-3. 15. See id. at 2; JAMES H. AMOS, JR., THE COMPLETE IDIOT’S GUIDE TO FRANCHISING 5 (2005). 16. BESHEL, supra note 12, at 3. 17. Id. 18. AMOS, supra note 15, at 15. 19. Id. at 5-6. 6 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 in 1958.20 Since then, the franchising model has not only become more popular, but has also posed new problems with the sophistication of players, legislative growth in antitrust, competition, and contract laws, and the increasing influence of technology and intellectual property rights. Franchising is now regulated both at the state and federal level, but this was not the case until the 1970s.21 The explosive growth of franchising, which really began gaining momentum in the 1950s and 1960s, experienced several ups and downs, and consequentially led to important legal and regulatory developments in the franchise industry.22 The industry had a very impressive and steady growth chart during the 1950s and 1960s, and reported that its revenue growth over the fifteen-year period from 1955–1970 was at a striking 3,600 percent.23 However, by the end of the 1960s, the franchising system and protocols adopted by the players started to show some weaknesses and flaws.24 Several lawsuits, big and small, including class actions, were filed against the franchisors, and most cases pointed to the “pervasive power of [franchisor] control” over the disclosure of information; ease of entry into the franchise industry, cou- pled with the lack of adequate capital and/or experience among franchisees; undefined franchise relationship terms regarding termination, cancellation, and renewal of the contract; or simply the widespread ex- ploitative practices adopted by the franchisor.25 While the federal legislators showed reluctance in legislating concrete disclosure requirements and business practices for franchising, some of the state legislators re- acted positively to the urgent need for franchise regulation.26 In 1971, California became one of the first states to enact a franchise disclosure law, and several other states followed its lead.27 Finally, in 1979, the Fed- eral Trade Commission (FTC) enacted the federal franchise regulation titled “Disclosure Requirements and Prohibitions Concerning Franchis-

20. DAVID JOHN COLE ET AL., ENCYCLOPEDIA OF MODERN EVERYDAY INVENTIONS 13 (2003). 21. See William L. Killion, The Modern Myth of the Vulnerable Franchisee: The Case for a More Balanced View of the Franchisor-Franchisee Relationship, 28 FRANCHISE L.J. 23, 27 (Summer 2008). 22. See id. at 25–26. 23. Id. at 25. 24. See id. 25. Id. at 26. Many experts analyzed the franchise market, and criticized the franchisors’ operations and the bargaining inequality between the franchisors and the uninformed franchisees. See id. at 23. New York Attorney General Louis Lef- kowitz’s investigations into the franchising trend discovered that in most of the franchise arrangements, franchisees were investing their life savings in franchises, which were actually “fly-by-night operations.” Id. at 26. News articles also pointed out that the franchisors used skillful pressure tactics to convince inexperi- enced persons to invest monies, without much disclosure of business operation details. Sylvia Porter, Franchising Frauds’ Flood Post Office, SARASOTA-HERALD TRIBUNE, May 10, 1971, at 11A. There were also class actions filed by the franchisees, the most publicized being Siegel v. Chicken Delight, Inc., where the Court found the franchisor engaged in an illegal tying arrangement. 448 F.2d 43 (9th Cir. 1971). 26. See Killion, supra note 21, at 27. 27. California Franchise Investment Law, CAL. CORP. CODE § 31000 (1971). 2014] FRANCHISING IN THE UNITED STATES 7 ing and Business Opportunity Ventures,” commonly known as the “FTC Rule,” to regulate the franchise industry and protect the franchisees’ interests.28

II. FEDERAL & STATE LAWS ON FRANCHISING

A. FEDERAL FRANCHISING LAW Currently, the franchising laws regulate two areas of franchise practice: (1) the disclosure requirements prescribed at the federal level and the registration, notice, and additional disclosure requirements prescribed at the state level for the offer and sale of the franchise; and (2) the relationship laws adopted by some states that govern the on-going relationship between the franchisor and franchisee.29 To offer a franchising opportunity to a prospective franchisee, the franchisor generally has to comply with both federal and state laws, in addition to any industry-specific regulations.30 The FTC Rule, promulgated in 1979, required the franchisor of a franchise operation to make disclosures of twenty-three items to the franchisee by way of the Uniform Franchise Offering Circular (UFOC) at the first face-to-face meeting or at least ten days prior to signing the franchise agreement with the franchisee.31 Among other pertinent information, the disclosure items included information on the franchised business and its operations, the franchisor’s litigation history, the franchisor’s financial representation, and past and present franchisees.32 The FTC Rule was enacted in response to widespread fraudulent, deceptive, and unfair trade practices adopted by several franchisors across the country.33 The primary purpose of mandating the timely disclosures was (1) to ensure that the prospective franchisee has all the available information and resources needed to make an informed decision about investing in a particular franchise; and (2) to discourage the franchisor from engaging in high- pressure tactics and provide the franchisee with a “cooling-off” period before signing the franchise agreement.34 The franchisors continued to make the mandated disclosures under the UFOC until July 1, 2008, when the Amended FTC Rule of 2007 came into effect.35 Under the Amended FTC Rule, the FTC modified its original rule to align the disclosure requirements with those of the states.36

28. Killion, supra note 21, at 28. 29. See id. 30. Lederman, supra note 11, at 37. Some industries such as automotive, petroleum, soft drinks, alcohol may be subject to industry-specific state and federal laws, in addition, to the franchise statutes. Id. 31. 16 C.F.R. § 436 (1979); Lederman, supra note 11, at 36. 32. Id. 33. See Lederman, supra note 11, at 35–36. 34. Franchise Rule, 64 Fed. Reg. 57,294, 57,301 (proposed Oct. 22, 1999). 35. Disclosure Requirements and Prohibitions Concerning Franchising, 16 C.F.R. § 436 (2007); Lederman, supra note 11, at 36. 36. 16 C.F.R. § 436–37. 8 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

The Amended FTC rule requires disclosure of information in twenty- three specific categories under a disclosure document called the “Franchise Disclosure Document” (FDD).37 Such disclosures are required to be made fourteen days prior to signing any agreement or paying any consideration.38 In addition, the franchisor is required to furnish executed copies of the agreement at least seven days before signing where the franchisor has made changes to the agreement not initiated by the franchisee.39 Further, the franchisor is also required to make supplemen- tal disclosures to update his disclosure within 120 days after the close of the franchisor’s fiscal year and quarterly, where there have been any material changes to the information disclosed under the FDD.40 The FDD calls for information on the following: • Background on the franchisor, its parents, predecessors, and affili- ates; business experience; and litigation and bankruptcy history (Items 1–4) • Fees to be paid to the franchisor and estimate of initial investment (Items 5–7) • Restrictions on sources of products & services and territorial restrictions; franchisor’s obligations; assistance by franchisor, training, advertising; financing (Items 9–12) • Intellectual property: trademarks, copyrights, and patents (Items 13–14) • Franchisee’s obligations, restrictions on sales; provisions regarding renewal, termination, transfer, and dispute resolution; and public figures (Items 15–18) • Financial performance representations (Item 19) • Franchisee information (Item 20) • Financial statements (Item 21) • Contracts (Item 22) • Receipts (Item 23)41 Of all the disclosure items, one of the most notably disputed items is Item 19, financial performance representations.42 Financial performance representations usually deal with the sales or earnings projections made by the franchisor with respect to the franchised business.43 The franchisor is not required to make performance representations in the FDD, and if it chooses not to, then the franchisor is strictly prohibited from making these representations in any other place or form—be it ne-

37. Id. § 436. 38. Id. § 436.2(a). 39. Id. at 436.2(b). 40. Id. at 436.7. 41. Id. at 436.5. 42. See Disclosure Requirements and Prohibitions Concerning Franchising, 72 Fed. Reg. 15444 (Mar. 30, 2007). 43. See 16 C.F.R. § 436.5(s)(3). 2014] FRANCHISING IN THE UNITED STATES 9 gotiations, marketing materials or even sales discussions.44 Moreover, if no representations are made under Item 19 of the FDD, then the franchisor is even prohibited from discussing actual sales or revenues.45 On the other hand, if the franchisor does elect to make any financial performance representations, the franchisor is required to have made them on a “reasonable basis,” and corroborate with written substantiations for such representation upon request.46 While this standard makes Item 19 disclosure complicated, the legislators wanted to make sure that the franchisors do not relay any misleading information, which includes misrepresentations, overstatements, or false promises that attempt to portray untrue prospects of the franchise to the franchisees. The disclosure responsibility and the protections under the FTC rule are only applicable to a business relationship that falls within the definition of a “franchise” under the rule.47 A “franchise” under the rule is defined as a business or commercial relationship that has the following three elements: (1) Trademark: the franchisor grants the franchisee the right to operate a business identified by the franchisor’s trademark and to use the trademark in conducting the franchisee’s business operations; (2) Control: the franchisor exerts or has the right to exert a significant degree of control over or provide significant assistance to the franchisee’s business operations; and (3) Consideration: the franchisee promises to pay the franchisor $500 or more in exchange for the right to operate the franchise.48 All franchisors offering franchises in the United States have to comply with the Amended FTC Rule and make the mandated disclosures to the prospective franchisee before the sale is consummated. Failure to comply with the Amended FTC disclosure requirements could result in civil penalties of up to $16,000 per violation.49 However, the federal law does not call for registration of the franchise or the filing of the FDD.50

B. STATES ON FRANCHISING REGULATION As for the pre-sale requirements, most states have disclosure, registration, and/or notice requirements. The Amended FTC Rule does not pre- empt the stricter state disclosure laws, meaning that depending upon the regulations of the states having jurisdiction over a particular franchising offering, the franchisor may have to make additional disclosures and comply with other formalities beyond the requirements under the

44. See N. AM. SEC. ADM’RS ASS’N, INC., 2008 FRANCHISE REGISTRATION AND DIS- CLOSURE GUIDELINES 58 (Aug. 6, 2011), available at http://www.nasaa.org/wp- content/uploads/2011/08/6-2008UFOC.pdf [hereinafter NASAA]. 45. See id. at 57–58. 46. Id. at 58. 47. See 16 C.F.R. § 436; Lederman, supra note 11, at 36–37. 48. 16 C.F.R. § 436.1(h). 49. 16 C.F.R. § 1.98. 50. See 16 C.F.R. § 436; NASSA, supra note 44, at 1. 10 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

Amended FTC Rule.51 Registration states typically require a pre-offer review and approval process of a registration application.52 All registration states require the registration application form in the FDD format as prescribed under the Amended FTC Rule discussed above.53 Some states have prescribed further disclosures, in addition to those mandated under the Amended FTC Rule.54 The examiners of the governing state authority conduct a merit review of the application and advise the franchisor of their approval or need for amending the application.55 The following states require registration of the offering: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, and Washington.56 In most of these states, the franchisor is prohibited from selling or offering the franchise for sale until the registration application has been approved or the franchisor has been granted exemption.57 The franchisor is also required to pay a registration fee at the time of application.58 On the other hand, the notice states prescribe a less time-consuming and simpler process. These states typically require the franchisor to complete and file the respective state’s notice application form, however, they do not call for the filing of the FDD prepared under the Amended FTC Rule.59 Also, there is no merit review of these applications and hence, the process is very straightforward.60 States that follow this approach include Connecticut, Florida, Kentucky, Nebraska, Texas, and Utah.61 While the filing is usually a one-time filing, some states such as Florida and Utah require annual filings.62 Until the notice application forms are filed properly, the franchisor in these states is prohibited from selling or offering for sale any franchise offering.63 Whether a business relationship or business model constitutes a franchise largely depends upon the applicable state’s definition of a “franchise.” Similar to the Amended FTC Rule definition of a “franchise,” most states typically have the three elements within their

51. 16 C.F.R. § 436.10. 52. JOEL R. BUCKBERG & DAVID J. KAUFMAN, FRANCHISE SALES AND DISCLOSURE LAW S A T 49TH ANNUAL CONVENTION OF THE INTERNATIONAL FRANCHISING AS- SOCIATION 6 (Feb. 14–17, 2009), available at http://www.franchise.org/uploaded Files/Franchise_Industry/Events/Sales%20Compliance%20Summit.pdf. 53. NASAA, supra note 44, at 1. 54. See generally BUCKBERG &KAUFMAN, supra note 52. 55. Id. at 25. 56. Id. at 5. 57. Id. at 6. 58. Id. at 41. 59. Id. at 7. 60. Id. 61. Id. 62. Id. 63. Id. 2014] FRANCHISING IN THE UNITED STATES 11 definition of the term.64 The definition usually involves a written or oral agreement under which: (1) the franchisor grants the franchisee the right to engage in the business of offering, selling or distributing goods or services under the franchisor’s marketing plan or business format; (2) the franchisee’s operation of such business or marketing plan is associated with the franchisor’s trademark or other commercial symbol; and (3) in exchange, the franchisee is required to pay consideration in the form of fee and/or royalties.65 As under the federal law, the states also require that all elements of the definition be present for the business to constitute a franchise under state law.66 To determine what disclosure laws the franchisor is required to comply with, the franchisor would need to inquire which states have jurisdiction over the franchise offering.67 Whether a franchise sales activity triggers a particular state’s franchise regulations may depend on several factors such as whether: (1) The offer to sell originates in the state (2) The offer to sell is directed to the state (3) The acceptance of the offer is made in the state (4) The franchisor domiciles in the state (5) The franchisee resides in the state (6) The proposed franchise will be located or operated in the state or the sales territory granted to the franchisee will fall within the state.68 Considering these factors, there may be scenarios where the franchisor would come within the purview of more than one state and would be responsible for complying with registration, disclosure, and/or notice requirements of multiple states to avoid penalties.69

C. EXEMPTIONS FROM DISCLOSURES While the rule of thumb is that a franchisor is obligated to make disclosures under the Amended FTC Rule and the applicable state’s registration and notice regulations, exemptions from these disclosures have been promulgated both at the federal and the state level.70 But there may be situations where the franchisor is able to seek exemption at the state level but would still have to comply with the FTC disclosure requirements, or

64. See Thomas M. Pitegoff & W. Michael Garner, Brief History and Overview of Franchise Relationship Laws, in FUNDAMENTALS OF FRANCHISING 188 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008). 65. Id. at 188–89. 66. Id. 67. Rochelle B. Spandorf & Mark B. Forseth, Franchise Registration, in FUNDAMEN- TALS OF FRANCHISING 133 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008). 68. Id. 69. Id. 70. Judith M. Bailey & Dennis E. Wieczorek, Franchise Disclosure Issues, in FUNDA- MENTALS OF FRANCHISING 97–98 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008). 12 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 vice versa.71 The Amended FTC Rule provides exemptions primarily for three types of franchisee sales: (1) sale to a large franchisee that has a net worth of at least $5 million and has been in the business for at least five years; (2) sale to a party related to franchisors, i.e., where the franchisee has been part of the franchisor’s management for at least two years, and either owns at least fifty percent interest in the franchise and/or twenty- five percent equity interest in the franchisor; and (3) sales in which the franchisee has a large initial investment of $1 million or more.72 The states also offer exemptions to large, experienced franchisors, franchisees that are part of the franchisor’s management, and sophisticated franchisees, such as financial institutions or high net worth or net income individuals.73 Also, some states exempt transactions for sale, renewal, or extension of an existing franchise, where there are no material changes in the agreement terms or where the franchisee sells on his account.74

D. FRANCHISING RELATIONSHIP LAW S

The “state relationship laws govern post-sale relationship and franchise contract issues.”75 Several states and U.S. territories, such as Arkansas, California, Connecticut, Delaware, Hawaii, Idaho, Illinois, Indiana, Iowa, Kansas, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, North Dakota, Rhode Island, South Dakota, Virginia, Washing- ton, Wisconsin, Puerto Rico and the Virgin Islands, have enacted relationship laws.76 These states have created better protection for franchisees against the abuse of the franchisor, who is usually the party represented by counsel that often drafts the franchise agreement.77 The relationship laws typically deal with various facets of issues arising during the term of a franchise agreement, such as termination and renewal provisions, assignment and transfer of a franchise, restriction of free association of franchisees, repurchase of the remaining inventory by the franchisor upon the termination of the franchise, encroachment by the franchisor, and termination only with good cause.78 To avoid future disputes and participation in unfair practices, it is imperative that the franchisors comply with their relationship obligations to the franchisee in accordance with the applicable state relationship laws.

71. Id. at 98–99. 72. 16 C.F.R. § 436.8. 73. BUCKBERG & KAUFMANN, supra note 52, at 35–38. 74. Id. at 38. 75. Id. at 3. 76. Pitegoff & Garner, supra note 64 at 187 n.7. 77. Id. at 186–87. 78. Id. at 187. 2014] FRANCHISING IN THE UNITED STATES 13

III. FRANCHISING & INTERPLAY WITH OTHER LAWS

A. INTELLECTUAL PROPERTY & FRANCHISING Intellectual property, particularly in the form of trademark, trade dress, and copyright, plays a very important role in replicating successful business models through franchising. In a franchising transaction, a major part of what the franchisor is selling and what the franchisee is buying is “the brand,” or the so-called goodwill of the franchisor.79 The brand most prominently involves the franchisor’s name—the trademark—but it may also have various other intellectual property assets that support and nurture the brand, such as use of the trade dress (the exterior or interior appearance of a restaurant), copyrights (the manuals and brochure materials), business systems, logos, patents, and designs.80 These assets are essential for the franchisor in selling its brand to the franchisee and for the franchisee in selling the brand to the public. Therefore, it is imperative that the intellectual property assets associated with the franchise are properly identified, created, owned, protected, and commercialized for the success of all—the franchise, the franchisor, and the franchisee.

1. Trademarks A trademark may be a word, symbol, name, device or a combination of these, which a merchant uses to identify and distinguish his products from the products sold by the other merchants in the market.81 The scope of what features of a product could be termed as its trademark is not restric- tive—it could be phrases, color, or any other characteristic, provided the mark identifies the source of the product and sufficiently distinguishes it from the other brands.82 For example, the phrase “Just Do It” is a slogan that is commonly associated with Nike and distinguishes it from its other competitors such as Reebok or Puma. Trademark protection works for the benefit of the consumers and society—it promotes competition and maintains product quality. Where the brand uses distinctive design features in the appearance or image of the product, for example, the use of colors in product packaging or the design of a store, to distinguish itself from the rest of the brands, these features typically falls under the definition of trade dress.83 Trade dress is often an important asset in franchising business, especially in restaurant franchising, where the brand is associated with the interior and exterior decor ´ and appearance of the restaurant, the design of the menu, and the packaging of the food items.84

79. Steward Hershman & Andrew A. Caffey, Structuring a Unit Franchise Relation- ship, in FUNDAMENTALS OF FRANCHISING 62 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008). 80. Id. at 67. 81. 15 U.S.C. § 1127. 82. William A. Finkelstein & Christopher P. Bussert, Trademark Law Fundamentals and Related Franchising Issues, in FUNDAMENTALS OF FRANCHISING 3 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008). 83. RESTATEMENT (THIRD) OF UNFAIR COMPETITION § 16 cmt. a (1995). 84. Finkelstein & Bussert, supra note 82, at 47. 14 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

Trademarks are regulated both at the state and federal level. At the federal level, the most prominent statute that governs trademarks is the Lanham Act.85 Franchisors who wish to obtain federal registration of their trademarks have to submit their application to the United States Patent and Trademark Office (USPTO).86 To be eligible for registration, the registrant has to show that the mark is distinctive and used or intended to be used in commerce.87 Also, the Lanham Act lays down statutory restrictions and refuses registration of marks that may be immoral, scandalous, deceptive, or falsely suggest connection with persons, living or dead, institutions, beliefs, or national symbols, or bring them into con- tempt or disrepute.88 Also, the marks, which are merely descriptive, i.e., describe the products rather than say what they are, are not eligible for registration until they attain secondary meaning by gaining market recognition.89 Although registration of a trademark is not essential to protect the right in itself, it is the preferred practice among most franchisors.90 The right to a trademark can also be obtained without registration, provided the owner is the first to use the distinctive mark in commerce.91 Unregis- tered trademarks may be eligible to receive protection under state common law.92 However, this protection is limited to the specific geographic area in which the trademark was first put to use in commerce.93 On the other hand, registration of a trademark with the USPTO gives the owner the right to use the mark nationwide, except in the specific geographic area where it was already being used by another entity.94 Further, registration of the trademark stands as nationwide constructive notice of the owner’s right to the trademark and also makes the trademark owner eligible to file suit in case of infringement in the federal court and claim treble damages and other remedies under the Lanham Act.95 Because trademarks are typically the most important asset of a franchising unit, it is imperative that franchisors as well as the franchisees ensure that the rights to the trademark are intact. Sometimes, the rights to a trademark can be lost due to discontinued use for a prolonged period (three years or more), abandonment, improper licensing or loss of origi-

85. Lanham Act, 15 U.S.C. §§ 1051–72 (2008). 86. Id. § 1051(a)(1). 87. Id. § 1052. 88. Id. 89. Kellogg Co. v. Nat’l Biscuit Co., 305 U.S. 111, 113-14 (1938). Secondary meaning is acquired distinctiveness, where the mark “has become distinctive, in that, as a result of its use, prospective purchasers have come to perceive it as a designation that identifies goods, services, businesses, or members . . .” RESTATEMENT (THIRD) OF UNFAIR COMPETITION § 13(b). 90. Finkelstein & Bussert, supra note 82, at 5–6. 91. 15 USC § 1151(b)(5); ADAM L. BROOKMAN, TRADEMARK LAW : PROTECTION, EN- FORCEMENT, AND LICENSING § 10.02[A] (1999). 92. Finkelstein & Bussert, supra note 82, at 22–23. 93. Id. 94. Id. at 25. 95. 15 U.S.C. §§ 1072, 1117, 1121. 2014] FRANCHISING IN THE UNITED STATES 15 nal distinctiveness of the mark.96 To avoid losing the trademark, it is particularly important in the franchising arena for the franchisor to properly grant the license to use trademark to the licensor.97 This entails exercising adequate quality control of the products distributed by the franchisee to ensure that the distinctive quality and image of the product matches that of the brand.98

2. Copyrights Copyright is an expression of idea or ideas in a tangible form that can be perceived, reproduced or communicated through a device or ma- chine.99 Copyright protects vast variety of original works of authorship— literary works, musical works, dramatic works, pictorial and graphic works, motion pictures, audiovisual works, sound recordings, and architectural works.100 In a franchising model, copyright protection could be sought in many operational aspects—in the operations and training manuals, program or advertising brochures, menu cards, proprietary business systems, or a musical advertising jingle. It is to be noted that copyright only protects the expression of ideas, not the ideas.101 Hence, a right in the copyright of the franchisor’s training manual, for example, protects the duplication of the expression of those training systems and not the systems themselves. To prevent competitors from copying his system, the franchisor would have to protect it as a trade secret. In franchising, the franchisor grants copyright licenses to the franchisee as a part of the business model.102 A franchisee receiving a copyright license could receive the right to reproduce the copyrighted work, create derivative works, or perform the work.103 Such licenses could either be exclusive or non-exclusive, however an exclusive license to use the copyright must be in writing and signed by the owner.104 Copyright protection is afforded to unregistered copyrights or even where the copyright notice is not provided on the copyrighted work.105 Basically, copyright protection is available to all works of authorship, provided they are original.106 All copyrighted works are afforded protection for the term of the author’s life plus an additional seventy years after

96. Agreement on Trade-Related Aspects of Intellectual Property Rights, art. 19, Apr. 15, 1994, Marrakesh Agreement Establishing the World Trade Organization, An- nex 1C, 1869 U.N.T.S. 299, 33 I.L.M. 1197. 97. Finkelstein & Bussert, supra note 82, at 41. 98. Id. at 42. 99. 17 USC § 102 (1976). 100. Id. 101. Id. 102. Ian Cockburn, Franchising & Licensing — What Are They and How Can You Ben- efit from Them?, WORLD INTELLECTUAL PROP. ORG., www.wipo.int/export/sites/ www/sme/en/documents/pdf/franchising.pdf (last visited Feb. 26, 2014). 103. 17 USC § 201(d) (1976). 104. Id. § 204(a). 105. Id. §§ 405, 408. 106. See id. § 102. 16 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 the death of the author.107 While registration of copyright is optional, a franchisor and franchisee may choose to register the copyright with the Copyright Office.108 Regis- tration establishes a public record of the copyright claim.109 Moreover, registration is required before the owner can file an infringement suit.110 Further, registration of the copyright will also allow the owner to claim additional remedies such as statutory damages and attorney fees in case of an infringement lawsuit.111

B. FRANCHISING & ANTITRUST LAW S Antitrust law regulates all relationships among competitors and between the businesses and the consumers, with the primary purpose of promoting competition for the benefit of the consumers.112 In franchising, the antitrust laws commonly regulate three broad categories of conduct:

1. Tying Agreements In a franchising transaction, the franchisors primarily sell to the franchisor the right to distribute its products using the associated trademark and the business model of the franchisor. The franchisee believes in the competitive strength of the franchisor’s trademark, and thus elects to invest his resources in running the franchised business. The consumers possibly buy the product from the franchise for the quality offered under the franchisor’s trademark.113 Given that, it becomes imperative to maintain the original brand image of the trademark. To maintain his trademark’s brand image and receive the consumers’ continued business, the franchisor puts in place quality controls. One such quality control effort is known as a tying arrangement, where the franchisor mandates that the franchisee buy certain supplies and materials required in the franchise’s operations from the franchisor or designated suppliers.114 While the franchisor may reason that this control is necessary to maintain consis- tency in quality of the final product brought to the market, the franchisor may have ulterior motives through this tying arrangement. It would have the benefit of having a ready market and opportunity to charge marked- up prices for the tied products to the franchisee, who is now obligated to pay the higher price. Alternatively, the franchisor may earn kickbacks

107. Id. § 302. 108. Id. § 408. 109. U.S. COPYRIGHT OFFICE, COPYRIGHT BASICS CIRCULAR 7 (2012), available at http://www.copyright.gov/circs/circ1.pdf. 110. Id. 111. Id. 112. Sherman Antitrust Act, 15 U.S.C. §§ 1–7 (1890; Clayton Antitrust Act, 15 U.S.C. §§ 12–27 (1914); Federal Trade Commission Act, 15 U.S.C. § 45 (1914). 113. See Siegel v. Chicken Delight, Inc., 448 F.2d 43 (9th Cir. 1971), cert. denied, 405 U.S. 955 (1972). 114. Robert T. Joseph & Lee N. Abrams, Antitrust Law, in FUNDAMENTALS OF FRANCHISING 259 (Rupert M. Barkoff & Andrew C. Selden eds., 3d ed. 2008). 2014] FRANCHISING IN THE UNITED STATES 17 from the designated suppliers for having his franchisee buy the supplies from them. In both scenarios, the franchisor places restraints on trade and competition. It places restrictions on the franchisee’s right to choose as to who he could buy the supplies from and also obstructs market entry for new suppliers, thereby suppressing competition. While tying arrangements are not per se illegal, federal courts have found tying arrangements illegal in some scenarios.115 The statutes that prohibit tie-ins are Section 1 of the Sherman Act and Section 3 of the Clayton Act.116 The Sherman Act provision focuses on regulating any actions “in restraint of trade” and the Clayton Act provision prohibits any conduct that substantially lessens competition.117 To state a tying claim, the franchisee would have to show that (1) the tied products are two distinct products and the franchisor has tied the sale of these two products; (2) the franchisor has “appreciable economical power” in the tying market such that the franchisor has the power to force the franchisee to make the purchase of the tied product; and (3) the arrangement has an effect on the substantial volume of commerce in the tied product market.118 If the trademark of the product is only remotely related to the alleged tied products, the courts, as in the case Siegel v. Chicken Delight, Inc., are bound to find that the two products tied together are distinct and separate.119 In Siegel, the court found an illegal tying arrangement where some miscellaneous items, which did not have any special design nor uniquely supported the franchise brand, were tied to the licensing of trademark.120 On the other hand, the franchisor Baskin-Robbins’ policy of requiring the franchisee to buy the ice cream to be sold at the franchise from the franchisor itself was not found to be an illegal tying arrangement because the court found that the quality of the ice cream and the brand image of Baskin-Robbins trademark was so “inextricably interrelated” in the consumer’s minds.121 Also, whether a trademark was separate from the alleged tied product depends upon the type of franchising. For example, under a business format system, the franchisor merely provides the business format and the franchisee is usually responsible for manufacturing and distributing the product. Under this system, the franchisee could use a component of his choice, provided the quality of the end product correctly reflects the franchisor’s trademark. For example, in Siegel, the court found that the franchisor could not coerce the franchisee to buy cooking equipment, paper packaging and food mixes that were purchased from the market and resold to the franchisee.122 But, in a distribution format, the goods are

115. Siegel v. Chicken Delight, Inc., 448 F.2d 43 (9th Cir. 1971), cert. denied, 405 U.S. 955 (1972). 116. Sherman Antitrust Act, 15 U.S.C. § 1; Clayton Antitrust Act, 15 U.S.C § 14. 117. Id. 118. Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 461–62 (1992). 119. 448 F.2d 43. 120. Id. at 46. 121. Krehl v. Baskin-Robbins Ice Cream Co., 664 F.2d 1348, 1354 (9th Cir. 1982). 122. Siegel, 448 F.2d at 47–49. 18 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 either manufactured by the franchisor or by the franchisee as per the franchisor’s secret formula or specifications, as is the case with brands such as Coca-Cola. Under this format, it is undeniably important for the franchisor to have the franchisee distribute the exact product to maintain the goodwill and value of the attached trademark, and courts are therefore reluctant to find tying arrangements illegal. As for proving the franchisor’s market power, uniqueness of a distinctive trademark is not sufficient evidence. But, courts have held that market power can be inferred in a lock-in case under the Kodak lock-in theory, where upon purchasing one product, the franchisee is locked-in to buying another.123 Sometimes, the franchisor allows the franchisee, under the franchise agreement, the liberty to purchase from a list of approved suppliers. Subsequently, post-contract the franchisor changes its policy and designates a specific supplier for the franchisee to purchase the necessary supplies from. A similar situation arose in a rather recent case, Burda v. Wendy’s Int’l, Inc.124 In Burda, Wendy’s International, the fast- food franchisor, initially had a list of approved suppliers from whom the franchisee could request bids for purchase of food products.125 Post-contract, Wendy’s changed its purchase policy, and coerced the franchisee, under the threat of termination, to purchase from the designated supplier or be charged a surcharge fee.126 Relying on the Kodak lock-in theory, the franchisee brought an illegal tying claim against the franchisor, and the court agreed with the franchisee.127 Distinguishing the franchise agreement in Burda from the one in Queen City Pizza, Inc. v. Domino’s Pizza, Inc., where the franchisor had informed the franchisee about the potential exclusive purchasing agreements prior to getting locked-in the contract, the court in Burda found that the franchise agreement did not give notice of the exclusive purchase arrangements prior to contracting, but instead misled the franchisee into thinking that competition was open.128

2. Resale Price Maintenance Can franchisors control the resale prices of the products sold by the franchisee? Prior to the Supreme Court’s decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., it was per se illegal for franchisors to set resale prices for their own products.129 However, the Supreme Court in Leegin held that vertical price controls are not per se illegal and would have to be analyzed under the rule of reason, i.e. the vertical price controls should not unreasonably restrain trade nor substantially harm com-

123. Kodak, 504 U.S. at 477–78. 124. 659 F.Supp.2d 928 (S.D. Ohio 2009). 125. Id. at 931. 126. Id. 127. Id. at 935. 128. Burda, 659 F.Supp.2d 935-37; Queen City Pizza, Inc. v. Domino’s Pizza, Inc., 124 F.3d 430 (3d Cir. 1997). 129. 551 U.S. 877, 877 (2007). 2014] FRANCHISING IN THE UNITED STATES 19 petition in the market.130 Hence, in a franchising context, the franchisor would have to show that the price controls do not substantially hinder competition and possibly show that the price controls in fact have a pro- competition effect. Moreover, the vertical price controls may require further analysis where the franchisor is involved in dual distribution, i.e., where the franchisor has company-owned outlets and competes against the franchisee.131 In such scenarios, any resale price agreements between franchisor and franchisee may be considered to be horizontal agreements among competitors to fix prices and would be illegal.132

3. Exclusive Dealings Exclusive dealings arrangements are entered in a franchising set-up to ensure that the franchisee does not sell products of competing brands. While it seems obvious that a franchisor’s demand for the franchisee’s loyalty to his trademark is an important business consideration, sometimes a franchisor goes beyond what is necessary, often stifling competition. Exclusive dealings stand in violation of Section 1 of the Sherman Act and Section 3 of the Clayton Act, where the franchisor imposing the exclusive dealing restriction has a significant market share or control to impede businesses to enter or exist in the market, and thereby forecloses the consumer’s access to competitive products.133 The key inquiry is whether the exclusivity provision in the franchise agreement in fact substantially forecloses competition in the market.

IV. FRANCHISEE—AN INDEPENDENT CONTRACTOR OR AN EMPLOYEE? Franchisor and franchisee are generally presumed to be two independent work units. But recent court decisions have attacked this presumption and challenged the franchising model in general.134 The question that has sent chills down the spines of several franchisors is whether franchisees are independent contractors or the franchisor’s employees. Sev- eral courts have found that they are in fact employees.135 If the franchisor is found to be a putative employer of the franchisee, the effect on the franchisor can be extremely devastating and expensive. The

130. Id. at 877–78. 131. Quentin R. Wittrock & Jeremy L. Johnson, Can Franchisors Control Franchisee Prices?, 28 FRANCHISE L.J. 199, 199 (Spring 2009). 132. Id. Horizontal price agreements are per se illegal. Leegin 551 U.S. at 877. 133. 15 U.S.C. §§ 1, 14. 134. See, e.g., Awuah v. Coverall N. Am. Inc., 707 F. Supp. 2d 80, 83–84 (D. Mass. 2010); De Giovanni v. Jani-King, Int’l, Inc., 262 F.R.D. 71, 84–86 (D. Mass. 2009); Patterson v. Domino’s Pizza LLC, 143 Cal. Rptr. 3d 396, 399 (Ct. App. 2012) (rev. granted). 135. See, e.g., De Giovanni, 262 F.R.D. at 85 (holding that the franchisees were employees because the franchisee was found to be conducting the same business as the franchisor); Patterson, 143 Cal. Rptr. 3d at 399 (holding that the franchisee was deemed franchisor’s agent and the franchisor was also vicariously liable for franchisee’s employee’s actions of sexual harassment against another co-worker). 20 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 franchisor would not only be responsible for paying back the franchise fees paid by the franchisee under the franchise agreement and would be liable to pay worker’s compensation, insurance benefits, overtime, employment tax, but the franchisor could also be held vicariously liable under the principles of agency law for any acts done by the franchisee or its agents under this newly found relationship.136 Moreover, the franchisors could also be made liable to pay attorney’s fees and treble damages. There is a growing anxiety among franchisors about the worker status of the franchisee, as the courts across the nation wrestle with this question. A recent decision from a Massachusetts court, which was highly discussed and publicized, ruled against the franchisor, finding that the franchisees were employees.137 In Awuah v. Coverall North America Inc., the Supreme Judicial Court of Massachusetts held that the franchisor, a commercial cleaning company, had misclassified its franchisees as independent contractors.138 The court used the infamous “ABC” three-prong test for its analysis.139 Under this test, to prove that a worker was an independent contractor, the defendant must show that: (1) the worker performs his services free from control of the defendant; (2) the services performed are outside the usual course of business of the defendant or outside the overall business of the defendant; and (3) the worker is customarily engaged in independently-run trade or business of the same nature as the services provided.140 The Coverall court relied only on the second prong and found that Coverall was involved in the same business as the franchisee.141 According to the court findings, Coverall provided employee training, identification badges, and uniforms to the franchisees.142 Moreover, Coverall and not the franchisees was the one directly contracting with the customers and collecting the bills.143 Based on these facts, the court held that Coverall was involved in the same business as the franchisees and the franchisees were in fact employees of Coverall.144 Following the Coverall decision, several other cases have been filed against franchisors claiming misclassification of the franchisees as independent contractors.145 It seems that the primary focus of the courts evaluating these claims has been on the amount of control the franchisor has over the franchisee’s operations and the means used to exercise it.146

136. De Giovanni, 262 F.R.D at 84; Patterson, 143 Cal. Rptr. 3d at 399. 137. Awuah v. Coverall N. Am. Inc., 707 F.Supp.2d 80, 85 (2010). 138. Id. 139. Id. at 82. 140. Id. 141. Id. at 82–83, 85. 142. Id. at 84. 143. Id. 144. Id. 145. Juarez v. Jani-King of Cal., Inc., No. 09-3495 SC, 2012 WL 177564, at *4 (N.D. Cal. Jan. 23, 2012); Hayes v. Enmon Enters. LLC, No. 3:10-CV-00382-CWR-LRA, 2011 WL 2491375, at *3 (S.D. Miss. June 22, 2011). 146. Juarez, 2012 WL 177564, at *4; Hayes, 2011 WL 2491375, at *3. 2014] FRANCHISING IN THE UNITED STATES 21

For example, California courts used the control test which, among other factors, looks at whether the principal has the authority to terminate, the level of skill required, the supplier of tools and other instrumentalities, the length of time for which services are to be performed, the discretion to hire or fire, and the amount of supervision required.147 The District Court of Mississippi also applied a similar ten-factor control test in Hayes v. Enmon Enterprises, LLC, finding that while the franchise agreement termed the franchisee as an independent contractor, the terms of the agreement were akin to an employee-employer relationship.148 The IFA argues that the Coverall court’s ABC test, which is followed by many states across the nation, does not account for the “symbiotic relationship” shared in a franchising relationship and has appealed to states across the nation for legislative changes.149 The IFA argues that most franchising arrangements would fail on all three prongs of the test.150 It contends that franchisors are legally required to enforce adequate controls over the franchisees’ operations to maintain its trademark.151 Moreover, the franchisor is often involved in the same business in which it has corporate-owned units as well.152 Finally, the nature of franchising arrangement is such that the franchisee is dependent upon the franchisor’s trademark to continue its operations and would not be able to operate if the trademark is withdrawn upon the termination of the franchise relationship.153 To protect the franchising industry, the IFA has appealed to several states, including Georgia, Delaware, Indiana, Massa- chusetts and Nebraska for legislative changes. Of these states, Georgia and Delaware have more recently passed legislation specifically announc- ing that franchisees are independent contractors and not franchisor’s employees.154 There certainly is a tug of war between the franchisor’s concern to maintain enough control to protect its trademark and his concern to cross the line and form an employee-employer relationship. But for genuine business franchisors, where that line could be drawn is a little uncertain. The recent analysis of this issue suggests that the franchisor should care-

147. Juarez, 2012 WL 177564, at *4. 148. Hayes, 2011 WL 2491375, at *3 (finding that there was a genuine issue of material fact for the jury to decide on the relationship between the franchisor and franchisee, as there were conflicting factors in the franchise agreement). 149. Dean Heyl, Franchisees are Independent Contractors, But Not as Easy as “ABC” in Some States, FRANCHISING WORLD (Oct. 2012), available at http://www.franchise .org/Franchise-Industry-News-Detail.aspx?id=58705. 150. Id. 151. Id. (noting that franchisors, as trademark owners, have a fiduciary duty to protect their trademark and enforce quality controls). 152. Id. 153. Id. 154. See, e.g., H.B. 55, 147th Gen. Assemb. (Del. 2011) available at http://openstates .org/de/bills/147/HB55/documents/DED00003458/ (last visited Feb. 26, 2014); H.B. 548, 2011-2012 Reg. Sess. (Ga. 2011) available at http://www.legis.ga.gov/ Legislation/20112012/126994.pdf (last visited Feb. 26, 2014). 22 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 fully provide adequate control to the franchisees both under the agreement and in practice.

V. PRE- & POST-TERMINATION ISSUES Termination of a franchising arrangement can be carried out under a mutual agreement or at the choice of one of the parties. If under the latter scenario, this could raise either a pre- or post-termination dispute, or both. Franchising arrangements are usually governed by franchise agreements. Most of the time, the reason for termination could be due to breach of the contract provisions, failure to make royalty payments, non- adherence to the quality standards, failure to meet reasonable sales goals, damage to franchisor’s trademark or reputation, sale of competitor products, encroachment over franchisee’s exclusive territory or discrimination by franchisor, non-renewal of franchise agreements, or breach of the implied covenant of good faith and fair dealing.155 Upon a breach, the aggrieved party may proceed with a default or termination.156 But many times the agreements do not address all the issues. The party should then investigate if any state relationship laws would apply and provide a remedy.157 At present, there are nineteen states, other than Puerto Rico and the U.S. Virgin Islands, that have enacted laws addressing franchise terminations.158 To determine which state’s law applies, the franchisor must identify if there is any choice-of-forum or choice-of-law clause governing state law.159 In the absence of such a clause, the party shall determine the jurisdiction based on the states’ jurisdictional laws, if any, or otherwise if the franchise outlet is located in that state.160 Prior to termination of the franchise relationship, the terminating party should conform to the mandated procedures. The party would have to comply with the all formalities under the franchise agreement provisions and/or state relationship laws. In this regard, some states require that franchisors have good cause before terminating, send notices of default to franchise, provide cure periods, and send notice of terminations.161 To

155. CHRISTINE E. CONNELLY, ROBERT LICHTENSTEIN, & M. ELIZABETH MOORE, INT’L FRANCHISE ASS’N, FRANCHISE DEFAULT AND TERMINATION–BEST PRAC- TICES TO ENFORCE THE CONTRACT AND PROTECT THE SYSTEM, 3 (2012), available at http://www.franchise.org/uploadedFiles/IFA_Events/SecondaryPages/Franchise_ default.pdf. 156. Id. 157. Id. 158. Id. at 11. 159. It should be noted that choice-of-forum clauses are more readily enforced by many jurisdictions versus choice-of-law clauses, where the court commonly requires that the parties establish connections with the designated state. See Jonathan Klick, Bruce Kobayashi, & Larry Ribstein, Federalism, Variation, and State Regulation of Franchise Termination, 3 ENTREPRENEURIAL BUS. L.J. 355, 367–68 (2009), available at https://www.law.upenn.edu/cf/faculty/jklick/workingpapers/3Entrepreneurial BusLJ355(2009).pdf. 160. CONNELLY, LICHTENSTEIN, & MOORE, supra note 155, at 12. 161. Id. at 13. 2014] FRANCHISING IN THE UNITED STATES 23 avoid any penalties, the terminating party will have to review and comply with the applicable obligations. One of the more common post-termination issues arises with regard to non-compete covenants. Non-compete covenants protect the franchisor’s legitimate business interest in preserving its goodwill and stopping competition. These covenants gain more importance, especially in reference to post-termination period and are incorporated in most franchising agreements. By including non-competition clauses, a franchisor can protect its trademarks, trade secrets, goodwill, market share, and protect itself and its other franchisees from unfair competition. While assessing the non-compete covenants, courts usually enquire if the covenant is “reasonable.”162 Reasonableness, in this context, refers to the length of time or the coverage of the restricted area, and is determined on a case- by-case basis.163 If the non-compete is found to be reasonable, it can be enforced not only against the signatory but sometimes also against non- signatories, who are operating the competing business. In such cases, the non-signatory is usually a family member of the signatory, who acts in concert with, aids, or abets the breaching franchisee.164

CONCLUSION Franchising offers franchisors, as well as franchisees, a mechanism to access opportunities of success. Moreover, the franchising model has proven successful even in the tough economic market, and has probably shown that it is a rather secure technique of running a business. But the parties to a franchise agreement often struggle to strike the right balance between the somewhat conflicting desires of the franchisor and the franchisee. While the franchisor wants to adopt standardization and quality control to maintain its goodwill and brand recognition in the market, the franchisee is hungry for autonomy and self-control. As each party is responsible in the success and failure of the relationship, the franchisor seems to bear the greater onus to comply with the statutory regulations as well as maintain a fair paradigm to ensure a successful and rewarding venture for both the parties.

162. RESTATEMENT (SECOND) OF CONTRACTS §§ 186, 188 (1981). 163. Id. 164. See, e.g., McCart v. H & R Block, Inc., 470 N.E.2d 756, 761 (Ind. Ct. App. 1984) (enforcing the non-compete against the non-signatory spouse because he was found to have conspired with the franchisee in operating a competitive business); Michael R. Gray & Jason M. Murray, Covenants Not to Compete and Nonsignato- ries: Enjoining Unfair Conspiracies, 25 FRANCHISE L.J. 3, 9 (Winter 2006). 24 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 FRANCHISE LEGISLATION IN CANADA

Jeffrey P. Hoffman*

ABSTRACT This paper examines the regulation of franchising in Canada with a focus on those provinces that have enacted franchise disclosure and relationship legislation; the business arrangements to which this legislation applies; the obligation to provide pre-sale disclosure in the form of a franchise disclosure document; the remedies available to franchisees where there was no disclosure or deficient disclosure; the duty of fair dealing; the right of franchisees to associate; and the right to seek damages for a breach of the duty of fair dealing and the right to associate.

I. PROVINCIAL FRANCHISE LEGISLATION

A. INTRODUCTION

NDER the Canadian Constitution Act of 1867,1 there is a division of powers between the federal government and the prov- Uinces. Matters of contract, including franchise agreements, are considered to be matters of “property and civil rights” and within exclusive provincial jurisdiction.2 However, not all provinces have chosen to enact franchise legislation. Franchise disclosure and relationship statutes exist in five of the ten provinces of Canada: Alberta, Ontario, New Brunswick, Prince Edward Island (PEI) and Manitoba.3 There is cur-

* Partner, Gowling Lafleur Henderson LLP, Toronto, Canada. 1. Constitution Act, 1867, 30 & 31 Vict., c. 3 (U.K.), reprinted in R.S.C. 1985, app. II, no. 5 (Can.). 2. Larry Weinberg & Geoffrey B. Shaw, A Practical Road Map to Entering the Cana- dian Market, 24 FRANCHISE L.J. 63, 63 (2004). 3. Franchises Act, R.S.A. 2000, c. F-23 (Alta.) [hereinafter Alberta Statute]; The Franchises Act, C.C.S.M. c. F-156 (Man.) (in force since October 1, 2012) [hereinafter Manitoba Statute]; Franchises Act, S.N.B. 2007, c. F-23.5 (N.B.) [hereinafter New Brunswick Statute]; Arthur Wishart Act (Franchise Disclosure), 2000, S.O. 2000, c. 3 (Ont.) [hereinafter Ontario Statute]; Franchises Act, R.S.P.E.I. 1988, c. F-14.1 (P.E.I.) [hereinafter PEI Statute]. These statues may be viewed online at www.canlii.org. The British Columbia Law Institute published a consultation paper in March 2013 requesting input on proposed franchise legislation for the province of British Columba (BC). See CONSULTATION PAPER ON A FRANCHISE ACT FOR BRITISH COLUMBIA, B.C. LAW INST. (2013), available at http://papers.ssrn .com/sol3/papers.cfm?abstract_id=2251456. On March 31, 2014, the Institute released a report that recommended the enactment of franchise legislation in that province. See THE REPORT ON A FRANCHISE ACT FOR BRITISH COLUMBIA, B.C. LAW INST. (2014), available at http://www.bcli.org/wordpress/wp-content/uploads/ 2014/03/report-76_BC-Franchise-Act_with_Cover.pdf. As of the date of this pa-

25 26 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 rently no franchise-specific legislation, and thus no obligation to prepare and deliver a franchise disclosure document (FDD) to franchisee candidates in British Columbia, Saskatchewan, Quebec, Newfoundland and Labrador, or Nova Scotia.4 Franchisors can prepare FDDs for use in each province or prepare a single FDD for use across the country, provided that where a single FDD is used, it addresses the requirements of each of the provincial statutes and their respective disclosure regulations. The disclosure regulations under the Alberta, Manitoba, PEI, and New Brunswick statutes expressly permit the use of an FDD prepared and used to comply with the disclosure requirements under the laws of another jurisdiction if the franchisor includes such additional or supplemen- tary information with that document as is necessary to comply with the disclosure requirements of these statutes and their respective disclosure regulations.5 The practice of using a foreign FDD and supplementing it with the documents and information required by provincial legislation is discour- aged as, unless the FDD is carefully prepared, there is the potential for errors and inconsistencies between the information provided in the foreign FDD and the information to be provided in the domestic FDD, particularly with respect to the base information used to create earnings projections, if any, and the cost of establishing and operating the franchised business which information may differ between countries. Us- ing a foreign FDD as the base for a Canadian FDD may also result in a lengthy and cumbersome document and make it difficult to meet the requirement of the laws of Ontario, PEI, Manitoba, and New Brunswick that all of the information in the FDD be “accurately, clearly, and con- cisely set out.”6 There is no obligation to register an FDD with a governmental authority and, indeed, there is no law compelling a franchisor to deliver an FDD, even where it is apparent that one ought to be provided. Though the statutes set out obligations of disclosure, the only remedies available where one is not delivered is to seek rescission and, in some provinces,

per, the author anticipates that a franchise statute will come into force in British Columbia sometime over the next two years. 4. There is also no such legislation in the Yukon, Northwest or Nunavut Territories in Northern Canada. In Quebec, ´ while there is no franchise-specific legislation, the Civil Code of Quebec ´ (CCQ) has provisions governing standard form contracts (contracts of adhesion) including provisions that impose a duty of good faith (art. 1375) both at the time an obligation is created and at the time it is performed or extinguished. Contracts of adhesion that are illegible or incomprehensible to a reasonable person (art. 1436) or that contain clauses that are determined to be “abusive” (art. 1437) are not enforceable. Civil Code of Quebec, ´ S.Q. 1991, arts. 1375, 1436, 1437 (Can.). 5. Franchises Regulation, Alta. Reg. 240/1995 s. 2(2); Franchises Regulation, Man. Reg. 29/2012 s. 2(2); Franchise Act Regulations, P.E.I. Reg. EC232/06 s. 4; Disclo- sure Document Regulation, N.B. Reg. 2010-92 s. 4. 6. Manitoba Statute, s. 5(9); New Brunswick Statute, s. 5(7); Ontario Statute, s. 5(6); PEI Statute, s. 5(6). 2014] FRANCHISE LEGISLATION IN CANADA 27 damages for the failure to disclose.7

B. THE PURPOSE OF THE LEGISLATION

The rights and obligations under the law are similar in each province with franchise legislation and their object is the same: “to assist prospective franchisees in making informed investment decisions by requiring the timely disclosure of necessary information”;8 to impose on each party to a franchise agreement a duty of fair dealing in its performance and enforcement;9 to protect the rights of franchisees to associate;10 and to provide statutory and civil remedies, including (in some provinces) the right to bring an action for damages for a breach of these obligations.11 Franchise legislation in Canada is remedial and, as such, is given “such fair, large and liberal interpretation as best ensures the attainment of its objects.”12 The legislation arose from an imbalance of power between franchisors and franchisees, both in the negotiations that led to the entering into of a franchise agreement and during the course of the franchisor-franchisee relationship. As a member of the Ontario legislature put it during the debates that led to the creation of the Ontario statute: It’s very important that we take a serious look at and take to heart that which we might do, and make every effort to go as far as we can to put in place things that will create a level playing field, that will present to people the opportunity they felt they were getting into when they signed agreements to go into business in Ontario.13 The Ontario Court of Appeal has made a number of statements regarding the purpose of the Ontario statute, gleaned from its reading of the Act and the debates that led to its passing. For example: One of the prime purposes of the Act is to obligate a franchisor to make full and accurate disclosure to a potential franchisee so that the latter can make a properly informed decision about whether or not

7. Pointts Advisory Ltd. v. 754974 Ontario, Inc., [2006] O.J. No. 3504, para. 59 (Can. Ont. Sup. Ct. J.). 8. Alberta Statute, s. 2(a). 9. Alberta Statute, s. 7; Manitoba Statute, s. 3(1); New Brunswick Statute, s. 3(1); Ontario Statute, s. 3(1); PEI Statute, s. 3(1). 10. Alberta Statute, s. 8; Manitoba Statute, s. 4; New Brunswick Statute, s. 4; Ontario Statute, s. 4; PEI Statute, s. 4. 11. All such legislation provides a statutory rescission remedy for the failure to properly disclose material facts and all such legislation, except Alberta’s statute, provides a right of action in damages for breach of the duty of fair dealing and interference with the right to associate. 12. Legislation Act, S.O. 2006 c. 21, sch. F, s. 64 (Ont.); Interpretation Act, R.S.A. 2000, c. I-8, s. 10 (Alta.); Interpretation Act, R.S.N.B. 1973, c. I-13, s. 17 (N.B.); The Interpretation Act, C.C.S.M., c. I-80, s. 6 (Man.); Interpretation Act, R.S.P.E.I. 1988, c. I-8, s. 9 (P.E.I.). 13. Ontario, Legislative Assembly, Official Report of Debates (Hansard), L060A (17 May 2000) at 1520 (Tony Martin, MPP Sault Ste Marie). 28 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

to invest in a franchise.14 It is clear, therefore, that the focus of the Act is on protecting the interests of franchisees. The mechanism for doing so is the imposition of rigorous disclosure requirements and strict penalties for non- compliance. For that reason, any suggestion that these disclosure requirements or the penalties imposed for non-disclosure should be narrowly construed, must be met with scepticism.15 The purpose of the statute is clear: it is intended to redress the imbalance of power as between franchisor and franchisee; it is also intended to provide a remedy for abuses stemming from this imbalance.16 These judicial pronouncements make it sound like these statutes are to be read in a way that favors the interests of franchisees over franchisors, but that is not the case. The statutes do impose “fairly onerous disclosure requirements on franchisors” but the Court of Appeal for Ontario has clarified that the statute is “not entirely one-sided” as it imposes a duty of fair dealing on “each party” to a franchise agreement with respect to performance and enforcement and thus “obliges both the franchisor and the franchisee to deal fairly with one another.”17 It has also stated that “a fair interpretation of the [Ontario] Act is one that balances the rights of both franchisees and franchisors.”18

C. NO DEROGATION OF RIGHTS The rights and remedies conferred by these statutes are in addition to and do not derogate from any other right or remedy that a franchisee or franchisor may have at law.19 For example, a claim by a franchisee for a remedy available to it under a statute does not prevent a franchisor from commencing a claim (or counterclaim) for, say, breach of contract.20

D. APPLICATION TO INITIAL GRANT, RENEWAL AND EXTENSION These statutes apply to the initial grant of a franchise. These statutes also apply to existing franchise agreements with respect to imposing a duty of fair dealing on the parties to a franchise agreement and protecting

14. 1490664 Ont. Ltd. v. Dig This Garden Retailers Ltd., [2005] 256 D.L.R. 4th 451, para. 16 (Can. Ont. C.A.). 15. Personal Serv. Coffee Corp. v. Beer (c.o.b. Elite Coffee Newcastle), [2005] O.J. No. 3043, para. 28 (Can. Ont. C.A.). 16. Salah v. Timothy’s Coffees of the World Inc., [2010] O.J. No. 385, para. 26 (Can. Ont. Sup. Ct. J.), aff’d, [2010] O.J. No. 4336 (Can. Ont. C.A.). 17. Beer, [2005] O.J. No. 3043, para. 29. 18. 4287975 Canada Inc. v. Imvescor Restaurants Inc., [2009] O.J. No. 1508, para. 40 (Can. Ont. C.A.), leave to appeal dismissed [2009] S.C.C.A. No. 244. 19. Alberta Statute, s. 15; Manitoba Statute, s. 9; New Brunswick Statute, s. 10; Onta- rio Statute, s. 9; PEI Statute, s. 10. 20. In the Beer case, the franchisee’s rescission claim was granted, but the franchisor was permitted to continue its counterclaim to pursue Mr. Beer for improperly ap- propriating its business and carrying on the same business in competition with PSCC using the know-how, suppliers, customers, and equipment provided by PSCC during the course of their relationship. Beer, [2005] O.J. No. 3043, para. 24. 2014] FRANCHISE LEGISLATION IN CANADA 29 the right of franchisees to associate.21 In Ontario, Manitoba, PEI, and New Brunswick they also apply, subject to certain exemptions, to the renewal or extension of a franchise agreement.22 Most franchise agreements list conditions that must be met before the franchisee is able to extend or renew its franchise agreement, such as the payment of a renewal fee, execution of the franchisor’s current form of franchise agreement and the execution and delivery of a general release in favor of the franchisor. If the language of either the renewal clause in the franchise agreement or the release to be signed by the franchisee is broad enough to include a release or waiver of the franchisee’s rights under a franchise statute, then the renewal clause is void and unenforceable. The statutes provide that any purported waiver or release by a franchisee of a right given under the statutes or of an obligation or requirement imposed on a franchisor is void.23 In 405341 Ontario Ltd. v. Midas Canada Inc., Mr. Justice Cullity considered terms of the Midas standard form franchise agreement that required a franchisee to provide Midas with a general release as a condition of renewal or assignment of the franchise agreement.24 Justice Cullity declared the requirement to provide a general release void.25 His decision was upheld by the Court of Appeal for Ontario where Madam Jus- tice MacFarland wrote “[i]f you include a term in your franchise agreement that purports to be a waiver or release of any rights a franchisee has under the Act, it will be void.”26 “Requiring franchisees to give up any claims they might have against a franchisor for purported breaches of the Act in order to renew their franchise agreement, unequiv-

21. Alberta Statute, s. 3(2); Manitoba Statute, s. 2(2); New Brunswick Statute, s. 2(3); Ontario Statute, s. 2(2); PEI Statute, s. 2(2). 22. Manitoba Statute, s. 2(1); New Brunswick Statute, s. 2(2); Ontario Statute, s. 2(1); PEI Statute, s. 2(1). In Alberta, there is an exception from the obligation to disclose in respect of the renewal or extension of an existing franchise agreement. Alberta Statute, s. 5(1)(d). In order for a franchisor to be exempt from the obligation to disclose on a renewal or extension of an existing franchise agreement in Ontario, Prince Edward Island, Manitoba and New Brunswick, there must be (a) no interruption in the operation of the business operated by the franchisee under the franchise agreement and (b) no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into. Mani- toba Statute, s. 5(11)(f); New Brunswick Statute, s. 5(8)(f) (where “most recent renewal” is used in place of “latest renewal”); Ontario Statute, s. 5(7)(f); PEI Stat- ute, s. 5(7)(f). 23. Alberta Statute, s. 18; Manitoba Statute, s. 11; New Brunswick Statute, s. 12; Onta- rio Statute, s. 11; PEI Statute, s. 12. 24. See 405341 Ontario Ltd. v. Midas Canada Inc., [2009] O.J. No. 4354 (Can. Ont. Sup. Ct. J.) aff’d, [2010] O.J. No. 2845 (Can. Ont. C.A.) (the author was one of the lawyers representing Midas on this motion and the appeal from the order made on the motion). 25. Id. para. 8. 26. 405341 Ontario Ltd. v. Midas Canada Inc., [2010] O.J. No. 2845, para. 26 (Can. Ont. C.A.). 30 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 ocally runs afoul of the Act.”27 Franchisors should, therefore, take care to ensure that any requirement in a franchise agreement for a release of the franchisor on renewal, extension, transfer or assignment of the franchise agreement is limited to those things capable of being released at law.

E. CHOICE OF LAW AND CHOICE OF VENUE Franchisors should give careful consideration to the choice of law and venue provisions of their franchise agreements. If the franchise agreement is governed by a law other than the law of the province in which the franchisee carries on business or if it requires disputes to be resolved in a province or state other than the province in which the franchisee carries on business, the choice of law and choice of venue provisions will be void to the extent that they purport to restrict the application of the law of the province that governs the relationship or to the extent they restrict venue to a forum outside of that province with respect to a claim otherwise enforceable under the applicable provincial franchise statute.28 If a franchise is granted in a province without a franchise statute and the franchise agreement is governed by the laws of a province with a franchise statute, then the parties will have contracted into the laws of the province with the franchise statute and be bound by its statutory obligations. In the Midas case, franchise agreements for shops located across Ca- nada uniformly provided that they were to be construed, performed, and enforced in accordance with the laws of the Province of Ontario. The court held that “the intention of the parties was that their rights and obligations—including the reciprocal and inviolable rights and duties of fair dealing—are to be the same as if the business of the franchise was operated in Ontario”.29 It does not necessarily follow that by contracting into the laws of a province with franchise legislation that a franchisor must provide a franchisee candidate with an FDD (unless there is disclosure legislation in the province where the franchise is to be operated). This is because the obligation to disclose is a pre-contractual obligation and the parties do not contract into the laws of a province with disclosure legislation until such time as they enter into a franchise agreement with such a choice of law provision.

27. Id. para. 30. Where the franchise agreement calls for the execution of a general release in favor of the franchisor, one that includes a release or waiver of rights under a franchise statute, the provision cannot be saved by presenting the franchisee with a form of release that preserves the franchisee’s right to advance a claim under the statute. See 2176693 Ontario Inc. v. Cora Franchise Group Inc., [2014] O.J. No. 550, para. 14 (Can. Ont. Sup. Ct. J.). This decision is under appeal. 28. Alberta Statute, s. 17; Manitoba Statute, s. 10; New Brunswick Statute, s. 11; Onta- rio Statute, s. 10; PEI Statute, s. 11. 29. Midas, [2009] O.J. No. 4354, para. 35. 2014] FRANCHISE LEGISLATION IN CANADA 31

II. NON-APPLICATION OF FRANCHISE STATUTES The Ontario, Manitoba, New Brunswick, and PEI statutes expressly provide that they do not apply to a number of business relationships,30 including an employer-employee relationship, a partnership, membership in a co-operative association, a relationship or arrangement arising out of an oral agreement where there is no writing which evidences any material term or aspect of the relationship or arrangement, and a service contract or franchise-like arrangement with the government or an agent of the government.31 The Ontario, Manitoba, New Brunswick, and PEI statutes also expressly state that they do not apply to an arrangement arising from an agreement between a licensor and a single licensee to license a specific trade-mark, where the license is the only one of its general nature or type to be granted by the licensor with respect to that trade-mark. The Ontario statute is silent as to the geographic scope of the “single license” to be granted, but it is presumed to mean a single license within Canada as trade-marks registration and regulation is a matter of federal jurisdiction and the statutes in Manitoba, New Brunswick, and PEI expressly provide that their statutes do not apply to a single license granted “in Canada.” A distinction must be drawn between the “non-application” of the statutes and the availability of an “exemption” from the obligation to disclose.32 When acting for a trade-mark owner who is looking to license its trade-mark in Canada, it is essential for the licensor to consider, in the following order: (a) Whether provincial franchise disclosure legislation applies to the arrangement; (b) Whether the arrangement is a “franchise;” and (c) If the arrangement is a “franchise,” whether it is exempt from disclosure Special attention must be given to such arrangements made in the Province of Alberta, where the franchise statute does not have a “non- application” provision. In Alberta, where a licensor is seeking to license a specific trade-mark to a single licensee, the licensor must determine, in the following order: (a) Whether the licensee’s business is to be operated either partly or wholly in Alberta, and whether the purchaser of the business is an Alberta resident or has a permanent establishment in Alberta for the purposes of the Alberta Corporate Tax Act,33 in which case the Alberta statute applies;

30. Manitoba Statute, s. 2(3); New Brunswick Statute, s. 2(4); Ontario Statute, s. 2(3); PEI Statute, s. 2(3). 31. Except in New Brunswick and Manitoba, where the statutes bind the Crown. New Brunswick Statute, s. 2(1); Manitoba Statute, s. 13. 32. Exemptions are discussed in Part IV(D), infra. 33. Alberta Statute, s. 3(1). 32 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

(b) Whether the arrangement is a “franchise;” and (c) If the arrangement is a “franchise,” whether it is exempt from disclosure

III. “FRANCHISE” DEFINED

A. ONTARIO, NEW BRUNSWICK, PEI, AND MANITOBA The definition of “franchise” under the statutes of Ontario, New Brunswick, PEI, and Manitoba are virtually identical. There are two definitions of “franchise” under the statutes of these provinces, each of which require fact-based inquiries. The first definition of “franchise” has been described as the “classic” definition or “business format” franchise.34 The test is divided into three parts: (1) a payment or continuing payments, whether direct or indirect, or a commitment to make such payment or payments, to the franchisor, in the course of operating the business or as a condition of acquiring the franchise or commencing operations; (2) the grant of the right to sell, offer for sale or distribute goods or services that are substantially associated with the franchisor’s trade-mark; and (3) the franchisor exercises “significant control” over or offers “significant assistance” in the franchisee’s method of operation, including building design and furnishings, locations, business organization, marketing techniques, or training.35 The second definition of “franchise” has been described as the “alternative” definition or “product distribution” franchise. It too consists of a three-part test: (1) a payment or continuing payment, whether direct or indirect, or a commitment to make such payment or payments, to the franchisor, in the course of operating the business or as a condition of acquiring the franchise or commencing operations; (2) a grant of repre- sentational or distribution rights, whether or not a trade-mark is involved, to sell, offer for sale or distribute goods or services supplied by the franchisor or a supplier designated by the franchisor; and (3) the franchisor or a third person designated by the franchisor provides “location assistance,” including securing retail outlets or accounts for the goods or services to be sold, offered for sale or distributed or securing locations or sites for vending machines, display racks or other product sales displays used by the franchisee. In Di Stefano v. Energy Automated Systems Inc., Mr. Justice Code stayed an action commenced in Ontario in favor of Tennessee because the contract between the parties provided that Tennessee was the forum in which any disputes regarding the agreement were to be determined.36

34. Weinberg & Shaw, supra note 2, at 67. 35. See Manitoba Statute (the Manitoba statute adds the words “under a business plan” after “method of operation” but does not define “business plan” other than to include the phrase in the definition of “franchise system.” It also substitutes the word “strategies” for “techniques”). 36. See Di Stefano v. Energy Automated Systems Inc., [2010] O.J. No. 385 (Can. Ont. Sup. Ct. J.). 2014] FRANCHISE LEGISLATION IN CANADA 33

The plaintiffs, a group of ten dealers, argued that they were “franchises” and, as a result, the dispute had to be determined in Ontario.37 Justice Code held that they were not “franchises.” The plaintiffs paid the defendant manufacturer for a five-day training course and planned to sell products associated with its trademarks.38 There was no evidence that the manufacturer exercised “significant control” over or offered “significant assistance” in the plaintiffs’ method of operation.39 The only evidence of assistance was the five-day training program taken prior to obtaining a dealership. Justice Code held that this assistance was not “significant” and that this “slender thread” was not a “reasonable basis” to assert that the contracts were franchise agreements.40 First, the five day training program was a condition precedent to obtaining a dealership. It was not “ongoing assistance during the pendency of the agreement.”41 The Ontario statute uses the verbs “exercises” and “offers,” in the present tense, in relation to the elements of “control” and “assistance.”42 It does not refer to a one time training program under- taken and completed in the past. Second, the offer of assistance did not relate to the business’s “method of operation.”43 Learning about products was not the same as learning about any particular “method of operation.” Last, the legislature did not intend that by merely teaching nascent dis- tributors about sophisticated products, a manufacturer would become, in law, a “franchisor.”44 Contrast the result in the Di Stefano case with the decision in 1706228 Ontario Ltd. v. Grill It Up Holdings Inc., where Mr. Justice Corbett held that the business being sold to the plaintiff was a “franchise.”45 Grill It Up granted the plaintiff the right to sell and offer for sale food that was “substantially associated with the Grill It Up name and trademarks.”46 Grill It Up “did not exercise control over the plaintiffs, but did ‘offer significant assistance’ respecting the store construction, design, equipment, location, menu, training and branding.”47 The court held that there was more than enough “substantial assistance” to bring the relationship within the meaning of “franchise.”48 The court, in determining whether a business is a “franchise,” will ex- amine the entirety of the relationship, including any and all agreements that govern the relationship.

37. Id. paras. 7–14. 38. Id. paras. 6, 8. 39. Id. para. 26. 40. Id. para. 27. 41. Id. 42. See Ontario Statute. 43. Di Stefano, [2010] O.J. No. 385, para. 27. 44. Id. paras. 26–27. 45. See 1706228 Ontario Ltd. v. Grill It Up Holdings Inc., [2011] O.J. No. 2206 (Can. Ont. Sup. Ct. J.). 46. Id. para. 27. 47. Id. 48. Id. 34 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

B. ALBERTA The definition of “franchise” under the Alberta statute differs from the definition of the term under the other provincial statutes. The right to engage in a business in Alberta is not a “franchise” unless there is a plan or system in place that specifies a material aspect of conducting business. Section 1(1)(d) of the Alberta statute reads: (d) “franchise” means a right to engage in a business (i) in which goods or services are sold or offered for sale or are distributed under a marketing or business plan prescribed in substantial part by the franchisor or its associate, (ii) that is substantially associated with a trademark, service mark, trade name, logotype or advertising of the franchisor or its associate or designating the franchisor or its associate, and (iii) that involves (A) a continuing financial obligation to the franchisor or its associate by the franchisee and significant continuing operational controls by the franchisor or its associate on the operations of the franchised business, or (B) the payment of a franchise fee, and includes a master franchise and a subfranchise.49 Section 1(1)(l) of the Alberta Franchises Act defines “marketing or business plan” as meaning: (l) . . . a plan or system that specifies a material aspect of conducting business, including, without limitation, any one or more of the following: (i) price specification, special pricing systems or discount plans; (ii) sales or display equipment or merchandising devices; (iii) equipment to be used to perform services; (iv) sales techniques; (v) promotional or advertising materials or cooperative advertising; (vi) training relating to the promotion, operation or management of the business; (vii) operational, managerial, technical or financial guidelines or assistance.50

IV. THE OBLIGATION TO DISCLOSE Once it is determined that what is being granted is the right to engage in a franchised business, the obligation to provide an FDD is triggered.

A. TIMING A franchisor is required to provide a prospective franchisee with an FDD no less than fourteen days before the earlier of:

49. Alberta Statute, s. 1(1)(d). 50. Alberta Statute, s. 1(1)(l). 2014] FRANCHISE LEGISLATION IN CANADA 35

(a) The signing by the prospective franchisee of the franchise agreement or any other agreement relating to the franchise; and (b) The payment of any consideration by or on behalf of the prospective franchisee to the franchisor or franchisor’s associate relating the franchise.51 An FDD must be one document delivered at one time,52 except in Manitoba where piecemeal disclosure is permitted.53

B. CONTENTS The courts have variously described the need to provide disclosure that is “full,”54 “accurate,”55 “comprehensive,”56 and “complete.”57 An FDD must contain: (a) all material facts, including material facts as prescribed; (b) financial statements as prescribed; (c) copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the franchisee; (d) other information and copies of documents as prescribed.58 In Ontario, Manitoba, New Brunswick, and PEI, an FDD must also contain mandatory statements encouraging franchisees to conduct their own due diligence by obtaining commercial credit reports regarding the franchisor, by contacting current or previous franchisees prior to entering into the franchise agreement, and by obtaining independent legal and financial advice.59 In Ontario, the FDD must also include language warning franchisees that the cost of goods and services acquired under the franchise agreement may not correspond to the lowest cost of the good and services

51. Alberta Statute, s. 4; Manitoba Statute, s. 5; New Brunswick Statute, s. 5; Ontario Statute, s. 5; PEI Statute, s. 5. 52. 1490664 Ont. Ltd. v. Dig This Garden Retailers Ltd., [2005] 256 D.L.R. 4th 451, para. 15 (Can. Ont. C.A.). 53. Manitoba Statute, s. 5(3) (“If the disclosure document is not delivered as one document, the requirement [of a franchisee to receive an FDD] under subsection (2) is not met until the date of the delivery of the last document”). 54. Dig This Garden, [2005] 256 D.L.R. 4th 451, para. 16. 55. Id. 56. 578115 Ontario Inc. (c.o.b. McKee’s Carpet Zone) v. Sears Canada Inc., [2010] O.J. No. 3921, para. 19 (Can. Ont. Sup. Ct. J.); MAA Diners Inc. v. 3 for 1 Pizza & Wings (Canada) Inc., [2003] O.J. No. 430 para. 33, aff’d, [2004] O.J. No. 297 (Can. Ont. C.A). 57. Hi Hotel Ltd. P’ship v. Holiday Hospitality Franchising Inc., [2008] A.J. No. 892 (Can. Alta. C.A.). The regulations require certification of the FDD. In Ontario, the certificate must state that the FDD includes “every material fact, financial statement, statement and other information required by the Act and this Regula- tion.” Arthur Wishart Act (Franchise Disclosure), 2000, O. Reg. 581/00, s. 7 (Can.). 58. Manitoba Statute, s. 5(5); New Brunswick Statute, s. 5(4); Ontario Statute, s. 5(4); PEI Statute, s. 5(4); Franchises Regulation, Alta. Reg. 240/95, s. 2(1). 59. Franchise Regulation, Man. Reg. 29/2012, s. 3; Disclosure Document Regulation, N.B. Reg. 2010-92, s. 5; Arthur Wishart Act (Franchise Disclosure), 2000, O. Reg. 581/00, s. 3; Franchise Act Regulations, P.E.I. Reg. EC232/06, s. 3. 36 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 available in the marketplace.60 The Alberta, Manitoba, and PEI statutes require that an FDD be “substantially complete”61 whereas the Ontario statute has been interpreted by the courts to require “strict compliance” with the disclosure provision of its statute.62 “Substantially complete” under the Alberta statute has been interpreted to mean that “each one of the requirements for the disclosure document must be met, however technical defects in any of the required elements will not invalidate the disclosure so long as each required element is substantially complied with.”63 For example, an FDD is not substantially complete if the officers or directors of the franchisor failed to certify that the FDD contains no untrue information of a material fact, does not omit to state a material fact that is required to be stated, and does not omit to state a material fact that needs to be stated in order for the information not to be misleading.64

C. THE REQUIREMENT TO DISCLOSE ALL MATERIAL FACTS

The FDD must contain all of the information and documents described in the statutes and prescribed by regulation including all “material facts.” This requirement was discussed in 1518628 Ontario Inc. v. Tutor Time Learning Centres, LLC. where Mr. Justice Cumming, as he then was, wrote: Under Canadian common law, a franchiser, so long as it does not make a misrepresentation, has no legal duty to disclose material facts within its knowledge but which are unknown to a prospective franchisee, even if the franchiser knows that the prospective franchisee has formed an incorrect impression that would be corrected by disclosure. The disclosure requirement of the Act has the purpose of overcoming this failure of the common law. Disclosure of all material facts is required.65

60. Arthur Wishart Act (Franchise Disclosure), 2000, O. Reg. 581/00, s. 4. 61. Alberta Statute, s. 4(3)(a); Franchises Regulation, Alta. Reg. 240/95, s. 2(4) (“A disclosure document is properly given for the purposes of section 13 of the Act if the document is substantially complete.”). See also Manitoba Statute, s. 5(1)); Franchise Act Regulations, P.E.I. Reg. EC232/06, s. 3(3). 62. 6792341 Canada Inc. v. Dollar It Ltd., [2009] O.J. No. 1881 (Can. Ont. C.A.); 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., [2010] O.J. No. 3071, para. 18 (Can. Ont. Sup. Ct. J.); 2189205 Ontario Inc. v. Springdale Pizza Depot Ltd., [2011] O.J. No. 2921, paras. 24–25 (Can. Ont. C.A.) (aff’g [2010] O.J. No. 3071). 63. Hi Hotel Ltd. P’ship v. Holiday Hospitality Franchising Inc., [2007] A.J. No. 1465, para. 138 (Can. Alta. Q.B.). 64. An FDD must be certified by two officers or directors of the franchisor where the franchisor has two or more directors and by one officer or director where the franchisor has only one officer or director. Hi Hotel Ltd. P’ship v. Holiday Hospi- tality Franchising Inc., [2008] A.J. No. 892, paras. 130–31 (Can. Alta. C.A.). 65. 1518628 Ontario Inc. v. Tutor Time Learning Centres, LLC, [2006] O.J. No. 3011, para. 55 (Can. Ont. Sup. Ct. J.); leave to appeal granted [2006] O.J. No. 4992, appeal dismissed, April 12, 2007, unreported, handwritten endorsement (Div. Ct). 2014] FRANCHISE LEGISLATION IN CANADA 37

“Material fact” is broadly defined in each statute, except Ontario’s statute, as meaning any information about the business, operations, capital, or control of the franchisor or its associate, or about the franchise system, that would reasonably be expected to have a significant effect on the value or price of the franchise to be sold or the decision to purchase the franchise.66 In Ontario, the definition of “material fact” is open-ended. It is defined as “including” the information about the franchisor and the system described above.67 The broad and open-ended definition of “material fact” in Ontario has given rise to an obligation to disclose not only the information that is prescribed, but information about the specific opportunity, including site- specific information, where it exists.68 For example, even though the On- tario statute requires the FDD to include copies of all proposed franchise agreements and other agreements relating to the franchise to be signed by the prospective franchisee, the courts have interpreted the obligation to disclose “all material facts” as including the obligation to include a copy of any head lease in the FDD, even though a head lease is not typically signed by a franchisee.69 A practice has developed among franchisors to provide a generic disclosure document to franchisee candidates when they first express an interest in a franchise opportunity and, once a site is selected, to then provide either a second FDD or a statement of material change that includes a copy of any lease and other site-specific information. Franchisors should not face any difficulty in disclosing information or providing documents that are expressly set out in the statutes or regulations as being “material.” The challenge for franchisors is to determine what other “material facts” exist and to ensure that all of them are disclosed.70

D. DISCLOSURE EXEMPTIONS

The burden of proving an exemption from a requirement or provision

66. Alberta Statute, s. 1(1)(o); Manitoba Statute, s. 1(l); New Brunswick Statute, s. 1(1); PEI Statute, s. 1(1)(l). 67. Ontario Statute, s. 1(1). 68. Leonard H. Polsky, Location-Specific Deficiencies in Disclosure Documents–Case Comment: Melnychuk v. Blitz Ltd., 16 FRANCHISE & DISTRIBUTION 3, 1352 (2010). 69. Id. 70. Jeffrey P. Hoffman “The Increasing Difficulty of Preparing and Using Disclosure Documents”, 2011, Ontario Bar Association, Annual Franchise Law Conference, at p. 9. Not every fact is a “material fact” that must be disclosed. In Caff´e Deme- tre Franchising Corp. v. 2249027 Ontario Inc., et al. the court granted partial summary judgment dismissing the franchisee’s counterclaim for rescission. See id. [2014] O.J. No. 1614, paras. 24–27 (Can. Ont. Sup. Ct. J.). The court held, for example, that the fact that the franchisor commenced a lawsuit (a month after the delivery of the FDD) against a former franchisee in order to protect the franchise system from unlawful competition was not a “material fact” that needed to be disclosed. Id. 38 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 of one of the statutes is on the person claiming it.71 A franchisor ought to err on the side of caution and provide an FDD to the candidate, unless it is absolutely clear that the transaction is exempt from the obligation to disclose. There is no obligation to provide an FDD to a franchisee candidate where: (a) the grant of a franchise is by a franchisee if: (i) the franchisee is not the franchisor or an associate of the franchisor or a director, officer, or employee of the franchisor or of the franchisor’s associate, (ii) the grant of the franchise is for the franchisee’s own account, (iii) in the case of a master franchise, the entire franchise is granted, and (iv) the grant of the franchise is not effected by or through the franchisor; (b) the grant of a franchise to a person who has been an officer or director of the franchisor or of the franchisor’s associate for at least six months . . . for that person’s own account; (c) the grant of an additional franchise to an existing franchisee if that additional franchise is substantially the same as the existing franchise that the franchisee is operating [and, in Ontario, PEI, Manitoba, and New Brunswick], if there has been no material change since the existing franchise agreement or latest renewal or extension of the existing franchise agreement was entered into; (d) the grant [or sale] of a franchise by an executor, administrator, sheriff, receiver, trustee, trustee in bankruptcy, or guardian on behalf of a person other than the franchisor or the estate of the franchisor; (e) the grant of a franchise to a person to sell goods or services within a business in which that person has an interest, if the sales arising from those goods or services, as anticipated by the parties or that should be anticipated by the parties at the time the franchise agreement is entered into will not exceed [20 percent] of the total sales of the business [expressly defined, in the Alberta statute as a “fractional franchise”]; (f) the renewal or extension of a franchise agreement [and, in Ontario, PEI, Manitoba, and New Brunswick,] where there has been no interruption in the operation of the business operated by the franchisee under the franchise agreement and there has been no material change since the franchise agreement or latest renewal or extension of the franchise agreement was entered into;72

71. Alberta Statute, s. 19; Manitoba Statute, s. 12; New Brunswick Statute, s. 13; Onta- rio Statute, s. 12; PEI Statute, s. 13. 72. Alberta Statute, s. 5(1); Manitoba Statute, s. 5(11); New Brunswick Statute, s. 5(8); Ontario Statute, s. 5(7); PEI Statute, s. 5(7); Arthur Wishart Act (Franchise Dis- closure), 2000, O. Reg. 581/00, s. 8; Franchises Regulation, Alta. Reg. 240/1995, s. 4. 2014] FRANCHISE LEGISLATION IN CANADA 39

(g) the grant of a franchise if: (i) the prospective franchisee is required to make a total annual investment to acquire and operate the franchise in an amount that does not exceed [$5,000];73 The following is added to (g) in Ontario: (ii) the franchise agreement is not valid for longer than one year and does not involve the payment of a non-refundable franchise fee, or (iii) the franchisor is governed by section 55 of the Competition Act (Canada), which section governs multi-level marketing plans which has its own disclosure requirements; and74 (h) In Alberta only, “the sale of a right to a person to sell goods or services within or adjacent to a retail establishment as a department or division of the establishment, if the person is not required to purchase goods or services from the operator of the retail establishment.”75

E. ADDITIONAL DISCLOSURE EXEMPTION AVAILABLE ONLY IN ONTARIO Under the Ontario statute, the obligation to disclose does not apply to the grant of a franchise where the prospective franchisee is investing in the acquisition and operation of the franchise, over a prescribed period, and for an amount greater than the prescribed amount.76 Under the regulation made under the Ontario statute, the prescribed amount of the investment is $5,000,000 CDN and the prescribed period is one year.77 While there are no cases that have interpreted this exemption, it would appear that the intention of the legislature was to exempt the franchisor from having to provide an FDD to a franchisee where the franchise was being purchased by a wealthy, sophisticated investor.

V. STATUTORY RESCISSION

A. TIME WITHIN WHICH TO GIVE NOTICE OF RESCISSION OR CANCELLATION In Alberta: if a franchisor fails to give a prospective franchisee [an FDD within the time required by the statute], the prospective franchisee may re-

73. Manitoba Statute, s. 5(11)(g); Arthur Wishart Act (Franchise Disclosure), 2000, O. Reg. 581/00, s. 6(1); Arthur Wishart Act (Franchise Disclosure), 2000, O. Reg. 581/ 00, s. 9. 74. In Manitoba, New Brunswick and Prince Edward Island, this exemption requires the agreement to not be longer than one year and the franchisor must provide locational assistance or the grant is subject to section 55 of the Competition Act (Canada). In Manitoba there is an added condition that the agreement does not involve the payment of a non-refundable fee. Manitoba Statute, s. 5(8)(h); New Brunswick Statute, s. 5(8)(h)–(i); PEI Statute, s. 5(7)(h). 75. Alberta Statute, s. 5(1)(g). 76. Ontario Statute, s. 5(7)(h). 77. Arthur Wishart Act (Franchise Disclosure), 2000, O. Reg. 581/00, s. 10. 40 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

scind the franchise agreement by giving a notice of cancellation to the franchisor or its associate, as the case may be, (a) no later than sixty days after receiving the disclosure document, or (b) no later than two years after the franchisee is granted the franchise, whichever occurs first.78 In Ontario, Manitoba, PEI, and New Brunswick, a franchisee may rescind the franchise agreement, without penalty or obligation: (a) no later than sixty days after receiving the disclosure document, if the franchisor failed to provide the disclosure document or statement of material change within the time required by the applicable statute, or if the contents of the disclosure document did not meet the requirements of the disclosure section of the applicable statute;79 or (b) no later than two years after entering into the franchise agreement if the franchisor never provided the disclosure document.80

B. ERROR IN TIMING OF DELIVERY OF FDD NOT FATAL In 4287975 Canada Inc. v. Imvescor Restaurants Inc., the franchisee sought to rescind a franchise agreement just shy of two years after it entered into the franchise agreement on the grounds that disclosure was late, the franchisee having paid a deposit two months prior to receiving an FDD.81 The franchisee signed the franchise agreement about six months after receiving the FDD.82 The Court of Appeal for Ontario upheld the lower court’s ruling denying the franchisee’s rescission claim.83 It held that, as there was disclosure in that case, the franchisee could not seek to rescind the franchise agreement within the two-year rescission period.84 The Court held that if the franchisee wanted to rescind its franchise agreement it had only sixty days from the date of receipt of the FDD to do so (even though it did not sign a franchise agreement for some six months after receiving the disclosure document).85 How could a franchisee rescind an agreement that it had not yet entered into? Was it just to require it to rescind within sixty days of receipt of the FDD in such circumstances? The Court of Appeal answered these questions by holding that rescission within the two-year period was reserved for cases where there was no disclosure or disclosure that was so deficient that it did not amount to disclosure and that the

78. Alberta Statute, s. 13. 79. Manitoba Statute s. 6(1); New Brunswick Statute s. 6(1); Ontario Statute s. 6(1); PEI Statute s. 6(1). 80. Manitoba Statute s. 6(2); New Brunswick Statute s. 6(2); Ontario Statute s. 6(2); PEI Statute s. 6(2). 81. 4287975 Canada Inc. v. Imvescor Restaurants Inc., [2009] O.J. No. 1508, para. 3 (Can. Ont. C.A.). 82. Id. 83. Id. para. 12. 84. Id. 85. Id. para. 26. 2014] FRANCHISE LEGISLATION IN CANADA 41 shorter sixty-day rescission period was reserved for situations where the FDD did not meet the timing and/or content requirements of the statute.86 The Court of Appeal held that its ruling did not result in an injustice to the franchisee because “the franchisee has sufficient time—at least [sixty] days—to make an informed decision as to whether or not to enter into the franchise agreement.”87

C. ERROR IN METHOD OF DELIVERY OF FDD NOT FATAL The decision in the Imvescor case was followed by Mr. Justice Belobaba in Vijh v. Mediterranean Franchise Inc.88 There, the only alleged deficiency with the FDD was its method of delivery. The FDD was delivered by e-mail, a method not permitted by the Ontario statute.89 The court held that where the FDD was complete and only the method of delivery was incorrect, the franchisee did not have two years within which to rescind the franchise agreement.90 Following the Court of Appeal’s ruling in the Imvescor case, Justice Belobaba wrote that “the two-year right of rescission is only available where there is ‘a complete failure to provide a disclosure document’ or where the disclosure document provided was ‘materially deficient’ but not where it was ‘merely late.’”91

D. FATAL DISCLOSURE ERRORS In Sovereignty Investment Holdings, Inc. v. 9127-6907 Quebec Inc., Mr. Justice Wilton-Siegel of the Ontario Superior Court of Justice held that there were at least four deficiencies in the FDD provided by the franchisor to Sovereignty, each of which, on its own, was “fatal to 9187’s assertion that the Franchisor complied with the requirement of the [Onta- rio] Act to deliver a ‘disclosure document’”:92 (a) The failure to provide disclosure in a single document at one time;

86. Id. paras. 27, 32. 87. Id. para. 39. 88. Vijh et al. v. Mediterranean Franchise Inc. et al., [2012] O.J. No. 3119 (Can. Ont. Sup. Ct. J.). 89. Id. para. 3. At present, only personal delivery or registered mail are permitted methods of delivery in Ontario, PEI and NB. Ontario Statute, s. 5(2); PEI Statute, s. 5(2); New Brunswick Statute, s. 5(2). Manitoba also permits delivery by fax. Manitoba Statute, s. 5(4). The Alberta statute is silent on the method of delivery. It simply provides that “[a] franchisor must give every prospective franchisee a copy of the franchisor’s disclosure document.” Alberta Statute, s. 4(1). 90. Vijh, [2012] O.J. No. 3119, paras. 5–7. 91. Id. para. 7. 92. Sovereignty Inv. Holdings, Inc. v. 9127-6907 Que. Inc., [2008] O.J. No. 4450, paras. 15–19 (Can. Ont. Sup. Ct. J.). These deficiencies were described as sufficiently material so as not to comply with the substantive provisions of the Act. This case also stands for the proposition that an assignee of a franchise agreement accepts both the benefits and obligations of the agreement and is responsible for rescission claims where it is held that the franchisor/assignor breached its disclosure obligations. 42 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

(b) The failure to provide the franchisor’s financial statements, as prescribed; (c) The failure to include a statement specifying the basis for the earnings projections (where such projections are provided); or (d) The absence of a signed and dated certificate. The following are further examples of where the courts have granted a rescission remedy for the failure to disclose information that was material and that ought to have been disclosed: (a) The failure to provide an FDD from the company that entered into the franchise agreement as “franchisor;”93 (b) The failure to disclose the location where information was available for inspection to substantiate financial projections;94 (c) The failure to have a certificate signed by the correct number of officers and directors;95 (d) “[T]he absence of notice of a pending law suit against the franchisor by one of its franchisees;”96 (e) “[T]he absence of a copy of the existing Offer to Lease . . . [when] the final Lease had not yet been executed when the disclosure document was given to the franchisee” candidate;97 (f) “[T]he lawyer stipulated on the disclosure document as being the person authorized to receive service of process in Canada on behalf of the franchisor was in fact not so authorized and declined service of litigation documents;”98 (g) The failure to include the head lease, where it exists;99 (h) Financial statements were not prepared to the correct standard of reporting required by regulation;100 (i) Information about the advertising fund, including “the percentage of the fund spent on national or local advertising campaigns pre- ceding the date of the disclosure document; . . . the percentage of the fund retained by the franchisor; . . . the projected amount of the contribution, a projection of the percentage of the fund to be spent on national or local advertising campaigns for the current fiscal year . . . [or a] projection of the percentage of the fund to be retained by the franchisor . . . [and] whether reports on advertising activities financed by the fund would be made available to the

93. Apblouin Imps. Ltd. v Global Diaper Servs. Inc., [2013] O.J. No. 1968, para. 27 (Can. Ont. Sup. Ct. J.). 94. Id. paras. 31–32. 95. Id. para. 44; 1448244 Alta. Inc. v. Asian Concepts Franchising Corp., [2013] A.J. No. 350, para. 23 (Can. Alta. Q.B.). 96. 6862829 Can. Ltd. v. Dollar It Ltd., [2008] O.J. No. 4687, para. 27(c) (Can. Ont. Sup. Ct. J.), rev’d, [2010] O.J. No. 214 (Can. Ont. C.A.) (reversed with respect to the finding that there was no liability on the part of franchisor’s associates). 97. Id. para. 27(d). 98. Id. para. 27(e). 99. 2189205 Ont. Inc. v. Springdale Pizza Depot Ltd., [2010] O.J. No. 3071, para. 16 (Can. Ont. Sup. Ct. J.), appeal dismissed, [2011] O.J. No. 2821 (Can. Ont. C.A.); Melnychuk v. Blitz Ltd., [2010] O.J. No. 306, paras. 11, 23 (Can. Ont. Sup. Ct. J.). 100. Melnychuk, [2010] O.J. No. 306, para. 23. 2014] FRANCHISE LEGISLATION IN CANADA 43

franchisees;”101 (j) A description of the exclusive territory to be granted to the franchisee;102 (k) A policy on the proximity between franchisees, where such a policy exists;103 (l) A description of the franchisor’s policy, if any, regarding volume rebates, and whether or not the franchisor or the franchisor’s associate receives a rebate, commission, payment or other benefit as result of purchases of goods and services by a franchisee and, if so, whether rebates, commissions, payments or other benefits are shared with franchisees, either directly or indirectly;104 (m) A copy of an indemnity agreement to be signed by the franchisee;105 (n) A copy of a General Security Agreement to be signed by the franchisee;106 and (o) The failure to accurately summarize a provision of the franchise agreement, for example the length of time during which competition is to be restrained following the expiry or termination of the franchise agreement.107

E. WITHOUT PENALTY OR OBLIGATION

Where a franchisee rescinds the franchise agreement, it rescinds “without penalty or obligation.”108 It has no further obligation to perform the agreement or to make payments due and owing to the franchisor under the agreement. If such payments were made, they would only add to the amount that the franchisee would seek to recover from the franchisee as

101. 6792341 Canada Inc. v. Dollar It Ltd., [2009] O.J. No. 1881, para. 49 (Can. Ont. C.A.). 102. Id. para. 52; Melnychuk, [2010] O.J. No. 306, para. 23. 103. 679 Dollar It, [2009] O.J. No. 1881, para. 62. 104. Id. para. 65. 105. Melnychuk, [2010] O.J. No. 306, para. 23. 106. Id. 107. Mapleleaf Franchise Concepts, Inc. v Nassus Frameworks Ltd., [2011] A.J. No. 1034, paras. 2, 20 (Can. Alta. Q.B.). The fact is that while the Plaintiff was not required to make a summary of what the various portions of the agreement contained, if it chose to summarize those provisions, it must summarize them accurately. There is a mistake made with respect to the reference to three kilometres as opposed to ten kilometres. There is an omission with respect to the agreement containing a prohibition from carrying on business at the same location and a radius of ten kilometres from that location for a period of two years upon termination of the franchise. The summary contained in the disclosure document is not correct. It was, by definition, a misrepresentation. In my view, it constituted a material fact that would reasonably be expected to a have significant effect upon the value or price of the franchise or the decision to purchase it. Id. 108. 1490664 Ont. Ltd. v. Dig This Garden Retailers Ltd., [2005] 256 D.L.R. 4th 451, para. 28 (Can. Ont. C.A.). 44 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 part of its rescission claim.109 Often, it takes time for the franchisee to wind down its operations, to negotiate its way out of a lease, or to sell off remaining inventory (where the franchisor has refused to repurchase it). The court has held that it is reasonable for franchisees to take these steps and that by continuing to carry on business the franchisee has not affirmed the franchise agreement.110 The moment the franchisee delivers a notice of rescission there is “no longer any contract in existence capable of affirmation.”111

F. FRANCHISOR’S OBLIGATION ON RESCISSION Under the Ontario, PEI, New Brunswick, and Manitoba statutes, within sixty days of delivery of a valid notice of rescission, a “franchisor or franchisor’s associate, as the case may be,” is required to: (a) refund to the franchisee any money received from or on behalf of the franchisee, other than money for inventory, supplies or equipment; (b) purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee; (c) purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee; and (d) compensate the franchisee for any losses that the franchisee incurred in acquiring, setting up and operating the franchise, less the amounts set out in clauses (a) to (c).112 The obligation to compensate a franchisee on rescission of the franchise agreement includes the obligation to repay, among other things, initial franchise fees,113 advertising and service fees,114 royalties, the amount paid for the business,115 and rent.116 The franchisee is entitled to recover these amounts even if it did not suffer a loss in the acquiring, setting up, and operating the franchise.117

109. Id. para. 38. 110. Id. para. 39. 111. Id. para. 28. 112. Ontario Statute, s. 6(6); PEI Statute, s. 6(6); New Brunswick Statute, s. 6(6); Mani- toba Statute, s. 6(5). 113. Melnychuk v. Blitz Ltd., [2010] O.J. No. 306, para. 25 (Can. Ont. Sup. Ct. J.); Payne Envtl. Inc. v. Lord and Partners Ltd., [2006] O.J. No. 273 (Can. Ont. Sup. Ct. J.); Rocha v. Panda Flowers (1999) Ltd., [2005] A.J. No. 1098 (Can. Alta. Q.B.). 114. 1159607 Ont. Inc. v. Country Style Food Servs. Inc., [2012] O.J. No. 1241, paras. 114–18 (Can. Ont. Sup. Ct. J.). 115. Id. para. 118; MAA Diners Inc. v. 3 for 1 Pizza & Wings (Canada) Inc., [2003] O.J. No. 430 para. 33 (Can. Ont. Sup. Ct. J.); Sovereignty Inv. Holdings, Inc. v. 9127- 6907 Que. Inc., [2008] O.J. No. 4450, paras. 5, 66 (Can. Ont. Sup. Ct. J.). 116. Melnychuk, [2010] O.J. No. 306, para. 25. 117. Payne, [2006] O.J. No. 273, para. 14; 2189205 Ont. Inc. v. Springdale Pizza Depot Ltd., [2013] O.J. No. 1080, paras. 5, 30 (Can. Ont. Sup. Ct. J.) (on motion to op- 2014] FRANCHISE LEGISLATION IN CANADA 45

Under the Alberta statute, the term “cancellation” is used in place of “rescission.”118 The franchisor or its associate, as the case may be, must, within thirty days after receiving a notice of cancellation, “compensate the franchisee for any net losses that the franchisee has incurred in acquiring, setting up and operating the franchised business.”119

VI. DAMAGES FOR MISREPRESENTATION OR A FAILURE TO COMPLY WITH THE DISCLOSURE OBLIGATION

A franchisee has a right of action in damages where it suffered a loss because of a misrepresentation contained in a disclosure document.120 In Ontario, PEI, New Brunswick, and Manitoba, a franchisee also has a right of action in damages if it suffers a loss as a result of the franchisor’s failure to comply, in any way, with the disclosure section of the applicable statute.121 These damages for misrepresentation or failure to comply with the disclosure obligation are in addition to the compensation available to franchisees that have rescinded or cancelled their franchise agreements.122 If a franchisee purports to rescind its franchise agreement and the franchisor refuses to repurchase the franchisees’ supplies, equipment, and inventory or to pay the compensation required to be paid under the statutes, then the franchisee can seek damages for the failure on the part of the franchisor to comply, in any way, with its obligation to disclose.123 These damages may be equal to the amounts that the franchisee sought to be paid when it rescinded its franchise agreement or in addition to those amounts.124 Implicit in the language of this damages section of the statutes is the need to prove a causal connection between the loss suffered and the misrepresentation or failure to disclose, unlike the rescission section which provides the franchisee with an automatic right to compensation where a valid notice of rescission is delivered. The statutes define “‘misrepresentation’ [as including]: (a) An untrue statement of a material fact, or (b) An omission to state a material fact that is required to be stated or that is necessary to make a statement not misleading in the light of

pose confirmation of a reference as to damages); aff’d, [2013] O.J. No. 4664 (Can. Ont. C.A.). 118. Alberta Statute, ss. 9–19. 119. Alberta Statute, s. 14(2); 1448244 Alta. Inc. v. Asian Concepts Franchising Corp., [2013] A.J. No. 350, para. 1 (Can. Alta. Q.B.). 120. Alberta Statute, s. 9(1); Manitoba Statute, s. 7(1); New Brunswick Statute, s. 7(1); Ontario Statute, s. 7(1); PEI Statute, s. 7(1). 121. Manitoba Statute, s. 7(1); New Brunswick Statute, s. 7(1); Ontario Statute, s. 7(1); PEI Statute, s. 7(1). 122. 1490664 Ont. Ltd. v. Dig This Garden Retailers Ltd., [2005] 256 D.L.R. 4th 451, paras. 36–40 (Can. Ont. C.A.). 123. Id. paras. 38–39. 124. 6862829 Can. Ltd. v. Dollar It Ltd., [2010] O.J. No. 214, para. 7 (Can. Ont. C.A.). 46 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

the circumstances in which it was made.”125 “If a disclosure document or statement of material change contains a misrepresentation, a franchisee who acquired a franchise to which the disclosure document or statement of material change relates [is] deemed to have relied on the misrepresentation.”126 “A person is not liable in an action . . . for misrepresentation if the person proves that the franchisee acquired the franchise with knowledge of the misrepresentation”127 or, in the case of the provinces other than Alberta, with knowledge of the material change.128

VII. JOINT AND SEVERAL LIABILIITY The damages described in the previous section of this paper may be sought against the franchisor129 and anyone who signed the disclosure document.130 In Ontario, PEI, New Brunswick, and Manitoba, such a claim can also be made against a “franchisor’s associate” or “franchisor’s broker”131 and, in the case of Ontario only, against a “franchisor’s agent” as well.132 The franchisor, franchisor’s associate, franchisor’s broker, and franchisor’s agent, as the case may be, are jointly and severally liable for any such damages.133 A “franchisor’s associate” means a person who: (a) directly or indirectly, controls the franchisor and (b)(i) was involved in the grant of the franchise “by being involved in reviewing or approving the grant of the franchise” or “by making representations to the prospective franchisee on behalf of the franchisor for the purpose of granting the franchise, marketing the franchise or otherwise offering to grant the franchise” or (ii) “exercises significant operational control over the franchisee and to whom the franchisee has a continuing financial obligation in respect of the

125. Alberta Statute, s. 1(1)(q); Manitoba Statute, s. 1(1); New Brunswick Statute, s. 1(1); Ontario Statute, s. 1(1); PEI Statute, s. 1(1)(n). 126. Alberta Statute, s. 9(2); Manitoba Statute, s. 7(2); New Brunswick Statute, s. 7(2); Ontario Statute, s. 7(2); PEI Statute, s. 7(2). 127. Alberta Statute, s. 10(1); Manitoba Statute, s. 7(4); New Brunswick Statute, s. 7(4); Ontario Statute, s. 7(4); PEI Statute, s. 7(4). 128. Manitoba Statute, s. 7(4); New Brunswick Statute, s. 7(4); Ontario Statute, s. 7(4); PEI Statute, s. 7(4). 129. Alberta Statute, s. 9(1)(a); Manitoba Statute, s. 7(1)(a); New Brunswick Statute, s. 7(1)(a); Ontario Statute, s. 7(1)(a); PEI Statute, s. 7(1)(a). 130. Alberta Statute, s. 9(1)(b); Manitoba Statute, s. 7(1)(d); New Brunswick Statute, s. 7(1)(d); Ontario Statute, s. 7(1)(e); PEI Statute, s. 7(1)(d). 131. Manitoba Statute, s. 7(1)(b)–(c); New Brunswick Statute, s. 7(1)(b)–(c); Ontario Statute, s. 7(1)(c)–(d); PEI Statute, s. 7(1)(b)–(c). A “franchisor’s broker” is defined in these statutes as “a person other than the franchisor, franchisor’s associate, franchisor’s agent or franchisee, who grants, markets or otherwise offers to grant a franchise, or who arranges for the grant of a franchise.” Id. 132. Ontario Statute, s. 7(1)(b). In Ontario, “franchisor’s agent” is defined as “a sales agent of the franchisor who is engaged by the franchisor’s broker and who is directly involved in the granting of a franchise.” Arthur Wishart Act (Franchise Dis- closure), 2000, O. Reg. 581/00, s. 0.1. 133. Alberta Statute, s. 12; Manitoba Statute, s. 8(1); New Brunswick Statute, s. 9(1); Ontario Statute, s. 8(1); PEI Statute, s. 9(1). 2014] FRANCHISE LEGISLATION IN CANADA 47 franchise.”134 In the Dig This Garden case, the individual defendants argued that neither of them “controlled” the franchisor because they owned the shares of the franchisor company equally.135 The court rejected this argument as did a higher court, on appeal: In my view, both Mr. Harper and Ms. Burton meet the statutory definition of “franchisor’s associate.” First, they each admit to holding 50 per cent of the shares of Dig This Garden, they are both officers and directors of Dig This Garden, and both were directly involved in granting the franchise to the respondents by making representations to the respondents on behalf of Dig This Garden. On these facts, it was open to the trial judge to find that Mr. Harper and Ms. Burton directly controlled Dig This Garden. Together they held 100 per cent of its shares and ran all aspects of the company. In such circumstances it would be difficult to come to any other reasonable conclusion.136 In MBCO Summerhill Inc. v MBCO Associates Ontario Inc.,137 the Court of Appeal for Ontario held that an individual who owned “50 [percent] of the shares of the franchisor, ran the day-to-day business of the franchisor in Ontario, acted for the franchisor in negotiating the franchise agreement and executing the agreement on behalf of the franchisor” was a “franchisor’s associate.”138 The provincial legislatures that enacted this legislation, by imposing civil liability for breaches of the statutes on individuals who control the franchisor, who sign the FDD, or who are involved in the marketing and granting of franchises, were bringing home a message to these individuals that they have a responsibility to ensure that the disclosure requirements of the legislation are fulfilled and that the preparation, certification, and delivery of an FDD is not a mere formality or a duty to be delegated without oversight. As the Court of Appeal for Alberta wrote: In a large organization, information does not always reach every person it should. Where factual statements come (or should come) to outsiders from a number of people in the organization, sometimes there are omissions or misstatements. Often no one person in the organization is insincere or even careless; but the net result is misstatements or non-disclosures by the organization. How can one prevent that? By legislation requiring that two (or more) people personally investigate and then certify correctness and completeness. Requiring that they be directors or officers, ensures that they have

134. Manitoba Statute, s. 1(1); New Brunswick Statute, s. 1(1); Ontario Statute, s. 1(1); PEI Statute, s. 1(1). 135. 1490664 Ont. Ltd. v. Dig This Garden Retailers Ltd., [2005] 256 D.L.R. 4th 451, para. 27 (Can. Ont. C.A.). 136. 1490664 Ont. Ltd. v. Dig This Garden Retailers Ltd., [2005] 256 D.L.R. 4th 451, para. 43 (Can. Ont. C.A.) (quoting MacFarland, J.A.). 137. MBCO Summerhill Inc. v. MBCO Assocs. Ont. Inc., [2011] O.J. No. 1289 (Can. Ont. C.A.). 138. Id. para. 2. 48 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

enough legal power to get access to all information and enforce compliance with their instructions.139 It is incumbent on the officers and directors of franchisors to ensure that the FDD is prepared and delivered in accordance with the legislation and that proper receipts are maintained that set out what was delivered to each franchisee candidate and when in order to enable the franchisor to be in a position to be able to respond to a claim for rescission and/or damages. The franchisor has the onus of demonstrating that a proper FDD was delivered to and received by the franchisee.140

VIII. GOOD FAITH AND FAIR DEALING

A. STATUTORY PROVISIONS The franchise statutes impose on each party to a franchise agreement a duty of fair dealing in its performance and enforcement.141 The statutes in Ontario, Manitoba, PEI, and New Brunswick provide that “the duty of fair dealing includes the duty to act in good faith and in accordance with reasonable commercial standards.”142 In Manitoba, PEI, and New Brunswick, this duty is expressly extended to include “the exercise of a right under the agreement.”143 A party to a franchise agreement in Ontario, Manitoba, PEI, or New Brunswick “has a right of action for damages against another party to the franchise agreement who breaches the duty of fair dealing.”144 There is no such statutory right in Alberta, though a party to a franchise agreement there or anywhere else in Canada is not prevented from commencing a proceeding at common law for breach of the implied contractual duty of good faith.

B. WHAT DOES THE DUTY ENTAIL? The duty of fair dealing arises from the agreement between the parties.145

139. Hi Hotel Ltd. P’ship v. Holiday Hospitality Franchising Inc., [2008] A.J. No. 892, para. 77 (Can. Alta. C.A.). 140. MAA Diners Inc. v. 3 for 1 Pizza & Wings (Canada) Inc., [2003] O.J. No. 430 paras. 33–34 (Can. Ont. Sup. Ct. J.) aff’d, [2004] O.J. No. 297 (Can. Ont. C.A). (“Non-compliance with the disclosure requirement under the Act exposes franchisors to significant consequences, including rescission of franchise agreements. One would therefore expect franchisors to be very careful to keep records of their disclosure documentation, and to be able to produce these records when called upon to do so, such as in an action contesting a notice of rescission under the Act.”) (Speigel, J.) (The author represented the applicant in this case). 141. Alberta Statute, s. 7; Manitoba Statute, s. 3; New Brunswick Statute, s. 3; Ontario Statute, s. 3; PEI Statute, s. 3. 142. Manitoba Statute, s. 3(3); New Brunswick Statute, s. 3(3); Ontario Statute, s. 3(3); PEI Statute, s. 3(3). 143. Manitoba Statute, s. 3(3); New Brunswick Statute, s. 3(3); PEI Statute, s. 3(1). 144. Manitoba Statute, s. 3(2); New Brunswick Statute, s. 3(2); Ontario Statute, s. 3(2); PEI Statute, s. 3(2). 145. Personal Serv. Coffee Corp. v. Beer (c.o.b. Elite Coffee Newcastle), [2005] O.J. No. 3043, para. 37 (Can. Ont. Sup. Ct. J.). 2014] FRANCHISE LEGISLATION IN CANADA 49

Canadian courts have not recognized a stand-alone duty of good faith that is independent from the terms expressed in a contract or from the objectives that emerge from those provisions. The implication of a duty of good faith has not gone so far as to create new, unbargained-for rights and obligations. Nor has it been used to alter the express terms of the contract reached by the parties. Rather, courts have implied a duty of good faith with a view to securing the performance and enforcement of the contract made by the parties, or as it is sometimes put, to ensure that parties do not act in a way that eviscerates or defeats the objectives of the agreement that they have entered into.146 The duty of good faith requires that a party to a contract “act fairly and take all reasonable steps to achieve the objectives of the agreement”147 It cannot act in such a way as to undermine or defeat the objectives of the agreement.148 The duty of good faith permits a party to act self-interestedly, but in doing so they must also have regard to the interests of the other party.149 “Good faith is a two-way street. Whether a party under a duty of good faith has breached that duty will depend, in part, on whether the other party conducted itself fairly.”150 Whenever a contract grants discretion- ary powers to a party, that discretion must be exercised in good faith.151 A discretion under a contract must be exercised reasonably, fairly, and with regard to how the other party’s interests are affected.152 The statutory duty of fair dealing simply codified the duty of good faith at common law.153 “Fair dealing” was not a concept that existed at common law.154 Because the duty of fair dealing arises from the franchise agreement, a party that conducts itself strictly in accordance with the agreement should not face a claim for breach of the duty of fair dealing. But the duty addresses an issue that is different from a breach of a contractual term. It addresses whether the term was performed or enforced in a manner that was honest, reasonable, fair, and in good faith.

146. Transamerica Life Can. Inc. v ING Can. Inc., [2003] O.J. No. 4656, para. 53 (Can. Ont. C.A.). 147. CivicLife.com Inc. v. Canada (Att’y Gen.), [2006] O.J. No. 2474, para. 24 (Can. Ont. C.A.). 148. Id. para. 48. 149. 1117304 Ont. Inc. v. Cara Operations Ltd., [2008] O.J. No. 4370, para. 68 (Can. Ont. Sup. Ct. J.). 150. Id. 151. CivicLife.com, [2006] O.J. No. 2474, paras. 49–50. 152. Shelanu Inc. v. Print Three Franchising Corp., [2003] O.J. No. 1919, para. 96 (Can. Ont. C.A.) (citing J.D. McCamus, The Duty of Good Faith Contractual Perform- ance, N.J.I.: Civil Law Seminar, Contract Law: From Form to Remedies, Osgoode Hall Law School (2000)). 153. Machias v. Mr. Submarine Ltd., [2002] O.J. No. 1261, paras. 110, 113 (Can. Ont. Sup. Ct. J.). 154. See Amaren Corp. v. Cara Operations Ltd., [1999] O.J. No. 365, para. 7 (Can. Ont. Gen. Div.). 50 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

C. EXAMPLES OF BAD FAITH CONDUCT A franchisor was held to have acted in breach of the duty of fair dealing when it deliberately concealed a fundamental piece of information from the franchisee regarding the length of the term of the lease that would have had an impact on the franchisee’s decision to renew the franchise agreement.155 Similarly, a franchisor was held to have breached the duty of fair dealing when it “actively misled” the franchisee about an opportunity to renew a lease at a mall location.156 The franchisor deliberately kept the franchisee in the dark about its intention to renew the lease albeit at another location within the same mall and gave the opportunity to operate that business to someone else when it had a contractual obligation to give it to the plaintiff.157

D. EXAMPLES OF GOOD FAITH CONDUCT The refusal to renew or extend an agreement, where there was no contractual obligation to do so, has been held not to be a breach of the duty of good faith.158 A class proceeding commenced by franchisees of the Tim Hortons donut chain159 was dismissed on a motion for summary judgment on the grounds that the franchisor’s changes to the franchise system were permitted by the franchise agreement and carried out in good faith.160 The franchisees had complained that Tim Hortons’ conversion from in- store baking to a central baking/distribution system called “Always Fresh,” where goods were par-baked to be baked to completion in-store,

155. 1159607 Ont. Inc. v. Country Style Food Servs. Inc., [2012] O.J. No. 1241, paras. 107 (Can. Ont. Sup. Ct. J.). 156. Salah v. Timothy’s Coffees of the World, Inc., [2010] O.J. No. 385, para. 122 (Can. Ont. Sup. Ct. J.), aff’d, [2010] O.J. No. 4336 (Can. Ont. C.A.). 157. Id. 158. TDL Group Ltd. v. 1060284 Ont. Ltd., [2000] O.J. No. 1239, para. 17 (Can. Ont. Sup. Ct. J.); 530888 Ont. Ltd. v. Sobeys Inc., [2001] O.J. No. 723, para. 10 (Can. Ont. Sup. Ct. J.). This issue is currently under consideration by the Supreme Court of Canada which recently granted leave to appeal from a decision of the Court of Appeal for Alberta. Bhasin v. Hrynew, [2013] A.J. No. 639, paras. 32-35, app. for leave granted, [2013] S.C.C.A. No. 242. In the Bhasin case, the Court of Appeal ruled that the corporate defendant did not have to act in good faith in exercising a right to give notice to end a contract. Id. para. 31. The contract provided for an initial term of three years that automatically renewed for successive three year periods, unless either party notified the other at least six months prior to the end of the current term that it wanted to end the agreement. Id. para. 11. The Court refused to imply a term in the agreement that a party seeking to terminate it must have good reason for doing so. Id. para. 32. As the Court wrote: “[t]he parties did not intend or presume a perpetual contract, as they contracted that either party could unilaterally cause it to expire on any third anniversary.” Id. 159. Tim Hortons is an iconic brand with over 3,000 locations in Canada. About Us, TIM HORTONS, http://www.timhortons.com/ca/en/about/index.html (last visited Apr. 13, 2014). 160. Fairview Donut Inc. v. TDL Group Corp., [2012] O.J. No. 834, paras. 366, 516, 527 (Can. Ont. Sup. Ct. J.), aff’d, [2012] O.J. No. 5775 (Can. Ont. C.A.), app. for leave to appeal dismissed, [2013] S.C.C.A. No. 47(Can.). 2014] FRANCHISE LEGISLATION IN CANADA 51 increased costs to franchisees.161 They also complained that the cost of goods used to prepare the Lunch Menu were too high with the result that they only broke even or lost money on the Lunch Menu.162 The plaintiffs’ suggestion that every new concept introduced by Tim Hortons had to be profitable was held to be wrong, as “[t]he franchisor is entitled to consider the profitability and prosperity of this system as a whole.”163 In order to keep the system healthy and competitive, the franchisor must be permitted to introduce new products, new methods of production or sale, new techniques or systems during the life of a franchise agreement. The franchisees have an expectation that this will be done. The franchise agreement contemplates this and allows this. It is done for the benefit of both the franchisor and the franchisee. It would not be commercially reasonable to require that the franchisor can only implement system-wide changes over the life of a particular franchise agreement if the proposed change is demonstrated to be an improvement that benefits that particular franchisee. Nor would it be commercially reasonable to require the franchisor to demonstrate that every such change will be a financial benefit for every franchisee.164 The Court held that the Always Fresh Conversion and the Lunch Menu were operational changes permitted by the franchise agreement. They neither took away legal rights nor imposed new legal obligations.165 Tim Hortons was not limited to making changes that only benefited the franchisees financially. The Court further concluded that it was commercially reasonable for Tim Hortons to have implemented the Always Fresh Con- version and the Lunch Menu and that these were decisions that Tim Hortons was entitled to make, having regard to its own interests and to the interests of its franchisees.166 Franchisors generally include provisions in their franchise agreements that allow them to make system or operational changes in order to keep pace with changing consumer demands and competitive forces. Tim Hortons was no exception. Its franchise agreement and operations manual permitted it to make the changes it made to its system. Tim Hortons did not need to demonstrate that the changes it proposed would be necessarily profitable to its franchisees or that the proposed improvements would benefit a particular franchisee. It was not for franchisees or their experts to tell Tim Hortons how it should manage its franchise system. The evidence demonstrated that the franchisor had taken the interests of its franchisees into account in making these system changes.

161. Id. para. 425. 162. Id. para. 515. 163. Id. para. 425. 164. Id. 427. 165. Id. para. 435. 166. Id. para. 427–29. 52 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

E. DAMAGES FOR BREACH OF THE DUTY OF FAIR DEALING Damages for breach of the duty of fair dealing need not be compensatory. The courts in Ontario have awarded general damages for breach of this duty.167 The purpose of the statute is clear: it is intended to redress the imbalance of power as between franchisor and franchisee; it is also intended to provide a remedy for abuses stemming from this imbalance. An interpretation of the statute which restricts damages to compensatory damages related solely to proven pecuniary losses would fly in the face of this policy initiative.

The right of action provided under s. 3(2) of the [Ontario] Act against a party that has breached the duty of good faith and fair dealing is meant to ensure that franchisors observe their obligations in dealing with franchisees. In that regard, the conduct that the trial judge found egregious in the present case is precisely the mischief that this legislation was enacted to remedy.168 A trier of fact may take into account the bad faith conduct of one party in assessing (and reducing) damages for the breach of this duty by the party opposite.169

IX. RIGHT TO ASSOCIATE The Ontario, Manitoba, PEI, and New Brunswick statutes protect the right of franchisees to associate with other franchisees and to enable them to form or join an organization of franchisees.170 Though the language of the provincial statutes differ somewhat, all of them prohibit a franchisor or its associate from interfering with, prohibiting, or restricting a franchisee from forming or joining an organization of franchisees, from associating with other franchisees,171 or from penalizing a franchisee for exercising its right to associate.172 The Ontario, Manitoba, PEI, and New Brunswick statutes provide that “any provision in a franchise agreement or other agreement relating to a franchise which purports to interfere with, prohibit, or restrict a fran-

167. Salah v. Timothy’s Coffees of the World, Inc., [2010] O.J. No. 385, para. 160 (Can. Ont. Sup. Ct. J.) (“$50,000 for breach of the duty of good faith and mental dis- tress”); 1159607 Ont. Inc. v. Country Style Food Servs. Inc., [2012] O.J. No. 1241, para. 131 (Can. Ont. Sup. Ct. J.) ($25,000). 168. Salah, [2010] O.J. No. 385, paras. 26–27. 169. Healy v. Canadian Tire Corp., [2012] O.J. No. 263, para. 63 (Can. Ont. Sup Ct. J.) (affirming an arbitral award). 170. Manitoba Statute, s. 4(1); New Brunswick Statute, s. 4(1); Ontario Statute, s. 4(1); PEI Statute, s. 4(1). 171. Alberta Statute, s. 8(1); Manitoba Statute, s. 4(2); New Brunswick Statute, s. 4(2); Ontario Statute, s. 4(2); PEI Statute, s. 4(2) (all except Alberta add the words “shall not” or “must not” “interfere with”). 172. Alberta Statute, s. 8(2); Manitoba Statute, s. 4(3); New Brunswick Statute, s. 4(3); Ontario Statute, s. 4(3); PEI Statute, s. 4(3) 2014] FRANCHISE LEGISLATION IN CANADA 53 chisee from exercising any right under this section is void.”173 In the Midas case, the same provision of the franchise agreement that required franchisees to release Midas on renewal or transfer of a franchise agreement, discussed above, was declared void to the extent that it interfered with the franchisees’ right to associate as members of a class proceeding. The court held that the right to associate encompassed the right to participate in a class proceeding and enforce their rights through collective action.174 Requiring franchisees to provide Midas with releases on renewal or transfer of their franchise agreements would, over time, erode the class and prevent the franchisees from pursuing their statutory remedies.175 If a franchisor or franchisor’s associate contravenes the sections of the statutes that protect the right to associate, a franchisee has a right of action for damages against the franchisor or franchisor’s associate, as the case may be, in Ontario, Manitoba, PEI, and New Brunswick, though there have been no decided cases that have considered such a claim.176

173. Manitoba Statute, s. 4(4); New Brunswick Statute, s. 4(4); Ontario Statute, s. 4(4); PEI Statute, s. 4(4) 174. See 405341 Ontario Ltd. v. Midas Canada Inc., [2009] O.J. No. 4354, para. 17, 28 (Can. Ont. Sup. Ct. J.); 405341 Ontario Ltd. v. Midas Canada Inc., [2010] O.J. No. 2845, para. 39 (Can. Ont. C.A.). 175. Settlement of the Midas claim was approved by the Court on September 12, 2013. 405341 Ont. Ltd. v. Midas Can. Inc., [2013] O.J. No. 4107 (Can. Ont. Sup. Ct. J.). 176. Manitoba Statute, s. 4(5); New Brunswick Statute, s. 4(5); Ontario Statute, s. 4(5); PEI Statute, s. 4(5) 54 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 OPPORTUNITY FOR US-BASED FRANCHISES IN MEXICO: LEGAL OVERVIEW AND POTENTIAL PITFALLS

Lorelee P. Dodge*

I. INTRODUCTION

RANCHISES represent a growth engine for the Mexican economy. Over the past two years, the gross domestic product of Mex- ico grew 4 percent annually.1 But franchises grew almost three F 2 times that rate, posting a 9–12 percent increase in 2011. The largest sector among these franchises is the food and beverage sector, with approximately one-third of the market.3 Underpinning this franchise industry is a set of industrial property laws and improvements in the administration of industrial property rights, such as trademarks. In 2012, for example, applications to register a trademark in Mexico increased 6 percent, and the number of registered trademarks grew by 20 percent.4 Headlines also highlight the growth of franchises in Mexico. For instance, Burger King recently formed a joint venture in Mexico with Al- sea, a leading restaurant operator in Latin America.5 The joint venture

* Lorelee Dodge is an attorney who practices law in the Dallas office of Patton Boggs. She concentrates her practice in private investment funds, business organization, and mezzanine financing. Previous to her legal practice, Lorelee advised senior management teams for eight years as a strategy consultant with McKinsey & Company. She worked with financial institutional, retail, and technology companies. Lorelee holds a J.D. from SMU Dedman School of Law, magna cum laude, an M.B.A. with distinction from the Harvard Graduate School of business, and a M.Phil. in international relations from Oxford University, U.K. 1. GDP Growth (Annual %), THE WORLD BANK, http://data.worldbank.org/ indicator/NY.GDP.MKTP.KD.ZG (last visited Feb. 27, 2014) (growth of Mexico’s GDP was 3.9% in 2012 and 3.88% in 2011). 2. U.S. DEP’T. OF COMMERCE, FRANCHISING A TOP EXPORT FOR MEXICO 1 (June 2012) [hereinafter FRANCHISING MEXICO REPORT], available at http://www.global trade.net/f/business/pdf/Mexico/Distribution-Networks-Franchising-Franchising .html. 3. Id. at 2. 4. MEXICAN INSTITUTE OF INDUSTRIAL PROPERTY, ANNUAL REPORT 2012, 13–14 (2012) [hereinafter IMPI ANNUAL REPORT 2012], available at http://www.impi.gob .mx/QuienesSomos/Documentos%20Varios/IA2012.pdf#search=2012%20Annual %20Report. 5. Press Release, Burger King Worldwide, Inc., Burger King Worldwide, Inc. and Alsea, S.A.B. de C.V. Sign New Joint Venture to Significantly Expand Brand Pres- ence in Mexico (Dec. 12, 2012), available at http://investor.bk.com/conteudo_en .asp?idioma=1&tipo=43682&conta=44&id=164418.

55 56 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 will obtain operating control of all Burger King restaurants throughout Mexico.6 As one of the largest franchisees in Mexico, Alsea also operates 584 Domino’s, 367 Starbucks, and an increasing number of P.F. Chang’s restaurants.7 Yet despite this recent activity, foreign-based franchises have a small share of the franchise market in Mexico. Currently, 80 percent of all franchises in Mexico are Mexican-based franchises;8 U.S.-based franchises have only a 10 percent share of the market, leaving significant opportunity for expansion.9 An initial step for any franchisor contemplating entering the Mexican market is to learn how Mexico’s laws could affect a franchisor. Conse- quently, the purpose of this paper is two-fold. First, this paper outlines a legal framework relating to franchise operations in Mexico. Second, this paper identifies specific areas of law that may represent a challenge for franchisors in Mexico and suggests approaches to navigate the potential pitfalls. In particular, this paper discusses Mexico’s enforcement of industrial property rights, Mexico’s membership in the Madrid Protocol, and specific provisions in a franchise agreement to help address challenges posed by local laws.

II. MEXICAN LAWS GOVERNING FRANCHISES Franchises in Mexico are governed primarily by the Industrial Property Law (IPL)10 and the Regulations under the Industrial Property Law (Regulations).11 The objective of the IPL is to protect industrial property (the IPL uses the term industrial property instead of intellectual property) through registration requirements and enforcement.12 For example, the IPL protects trademarks and patents against third parties through its registration system.13 In addition, the IPL protects prospective franchisees by requiring a franchisor to make specific disclosures before executing a franchise agreement.14 Furthermore, the IPL protects a franchisor’s industrial property by requiring a franchisee to keep confidential any pro-

6. See id. 7. See ALSEA, S.A.B. DE C.V., INFORME ANUAL 2012 [ANNUAL REPORT 2012], 2–3, available at http://www.alsea.net/uploads/pdf/en/annual_report_msm_2012.pdf. 8. See FRANCHISING MEXICO REPORT, supra note 2, at 1. 9. See id. 10. See Ley de a la Propiedad Industrial [Industrial Property Law], as amended Jan. 25, 2006, Diario Oficial de la Federacion ´ [DO], 27 de junio de 1991 [hereinafter IPL], available at http://www.wipo.int/wipolex/en/text.jsp?file_id=265701 (the IPL was first enacted June 28, 1991). 11. See Reglamento de la Ley de la Propiedad Industrial [Regulations under the In- dustrial Property Law], as amended Jun. 10, 2011, arts. 1–3, Diario Oficial de la Federacion ´ [DO], 18 de noviembre de 1994 [hereinafter Regulations under the IPL], available at http://www.wipo.int/wipolex/en/text.jsp?file_id=128786. 12. See IPL, supra note 10, arts. 2 (the objectives of IPL), 6 (the enforcement of IPL). IPL was enacted on June 27, 1991, to create a more robust and integrated framework to protect industrial property. The law also repealed and replaced both 1982 Transfer of Technology Law and 1990 Transfer of Technology Regulations. 13. See id. arts. 38–61 (patent registration), 87–95, 113–35 (trademark registration). 14. See id. art. 142. 2014] OPPORTUNITY FOR US-BASED FRANCHISES 57 prietary information that the franchisee obtained during the course of its relationship with the franchisor—even after the termination of the franchise agreement.15 The governmental agency charged with applying the IPL is the Mexi- can Institute of Industrial Property (IMPI).16 IMPI oversees the registration and enforcement of patents, trademarks, and other industrial property rights.17 IMPI is similar to the United States Patent and Trade- mark Office (USPTO) in terms of a registry for patents.18 But unlike individual patent holders in the United States who enforce their own patent rights, IMPI is the primary investigator and enforcer of patent infringement in Mexico.19 In addition to the IPL and the Regulations, five other Mexican laws are also pertinent to franchises. The Commerce Code20 and the Federal Civil Code21 contain the general rules for contracts, including the principle of freedom to contract. This means that parties to a franchise agreement may agree to their own terms, except where the IPL expressly regulates the contents of a franchise agreement.22 Second, the Federal Economic Competition Law (Antitrust Law) represents Mexico’s Antitrust Law and prohibits monopolistic practices such as the distribution of goods and services that impede competition.23 Third, the Federal Consumer Protection Law is relevant because it regulates the sale of goods and services to consumers by prohibiting various practices in advertising, credit, and warranties.24 Fourth, the Federal Labor Law (Labor Law) applies to every enterprise operating in Mexico.25 These laws impose various requirements, such as the mandate that 90 percent of an enterprise’s employees

15. See id. art. 142 bis. 2. 16. See Regulations under the IPL, supra note 11, arts. 1–3. 17. See id. arts. 5, 24–49 (registration of patents), 53–68 (registration of trademarks). 18. See id. arts. 5, 24–49. Once a patent is submitted to the IMPI, the Divisional Bu- reau of Patents is responsible for processing patents and granting registration. See IMPI ANNUAL REPORT 2012, supra note 4, at 5. 19. See Regulations under IPL, supra note 11, arts. 69–74. 20. See C´odigo de Comercio [CCo] [Commercial Code], as amended Aug. 27, 2009, Diario Oficial de la Federacion ´ [DO], 7 de octubre de 1889 [hereinafter Commer- cial Code], available at http://www.wipo.int/wipolex/en/text.jsp?file_id=199811. 21. See C´odigo Civil Federal [CC] [Federal Civil Code], as amended Jan. 28, 2010, Diario Oficial de la Federacion ´ [DO], 26 de mayo, 14 de julio, 3 y 31 de agosto de 1928 [hereinafter Civil Code], available at http://www.wipo.int/wipolex/en/text.jsp? file_id=199821. 22. See Commercial Code, supra note 20, arts. 1–5, 78; see also Civil Code, supra note 21, arts. 1, 12, 16, 1832, 1839, 1858. 23. See Ley Federal de Competencia Economica [LFCE] [Antitrust Law], as amended Jun. 28, 2006, arts. 1–3, Diario Oficial de la Federacion [DO], 24 de diciembre de 1992 [hereinafter Antitrust Law], available at http://www.wipo.int/wipolex/en/ text.jsp?file_id=220727#LinkTarget_766. 24. See Ley Federal de Proteccion al Consumidor [LFPC] [Federal Consumer Protec- tion Law], as amended Aug. 19, 2010, art. 1, Diario Oficial de la Federacion [DO] 24 de diciembre de 1992 [hereinafter Consumer Law], available at http:// www.wipo.int/wipolex/en/text.jsp?file_id=200325. 25. See Ley Federal del Trabajo [LFT] [Federal Labor Law], as amended Jan. 17, 2006, art. 1, Diario Oficial de la Federacion [DO] 1 de abril de 1970 [hereinafter Labor Law], available at http://www.wipo.int/wipolex/en/text.jsp?file_id=200305. 58 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 be Mexican, that an employee is entitled to six days paid vacation after one year of employment, and that a person who works on Sunday be paid a premium of 25 percent above the ordinary wage.26 This law also imposes a minimum wage upon employees in the leisure industry, including hotels, restaurants, and bars.27 Fifth, the Federal Law for the Protection of Personal Data in Posses- sion of Private Persons (Personal Data Law) is pertinent to franchises because the law applies to any person who processes personal data of identifiable persons in Mexico.28 Enacted in 2010, the objective of the Personal Data Law is to better protect the privacy of personal data by requiring that persons in possession of the data obtain the individual’s consent and provide him with a privacy notice.29 Franchises in the hotel industry and those with loyalty programs will likely be impacted. Conse- quently, where a franchisee collects and stores customer data, it is important that the franchisor provide clear procedures to provide the customer with a privacy notice and obtain the customer’s consent before retaining the customer’s personal data.30

III. LEGAL REQUIREMENTS UNDER MEXICO’S FRANCHISE LAW Under Mexico’s law, an entity is a franchise when that entity satisfies the legal definition of a franchise. Once this definition is met, Mexico requires a franchisor to provide disclosure documents to prospective franchisees and execute franchise agreements containing the legally-required information. In addition to these minimum requirements, franchisors should register their trademarks and trade secrets with the IMPI so that their industrial property rights are effective against third parties.

A. DEFINITION OF A FRANCHISE In Mexico an entity is considered a franchise when it satisfies the definition of a franchise under IPL. According to article 142 of the IPL, a “franchise exists where, together with the licensing of the use of a trademark, granted in writing, technical know-how is transferred or technical assistance provided, so that the person to whom the license is granted can produce or sell goods or services consistently according to the operating,

26. See id. arts. 7, 16, 71, 76. 27. Id. arts. 344–47. 28. See Ley Federal de Proteccion de Datos Personales en Posesion de los Particulares [Federal Law for the Protection of Personal Data in Possession of Private Persons], art. 2, Diario Oficial de la Federacion [DO], 5 de julio de 2010 [hereinafter Per- sonal Data Law], available at http://www.dof.gob.mx/nota_detalle.php?codigo= 5150631&fecha=05/07/2010 (the regulations under the Personal Data Law became effective December 22, 2011). 29. See id. arts. 1, 3. 30. For more detail on Personal Data Law, see, e.g., JORGE MONDRAGON, RECENT DEVELOPMENTS IN MEXICAN LAW THAT MAY AFFECT FRANCHISING (2011), available at http://www.franchise.org/uploadedFiles/Franchise_Industry/Resources/ Mexico%20Paper.pdf. 2014] OPPORTUNITY FOR US-BASED FRANCHISES 59 commercial and administrative methods established by the owner of the trademark.”31 This definition is broader than the rule provided by the United States Federal Trade Commission (FTC), which requires the franchisee to make a payment or commit to making a payment to the franchisor.32 Moreover, the IPL definition captures any franchise operating in Mexico, including a master franchise, a sub-franchise, or an individual franchise. And IPL does not contain exemptions for particular types of entities such as partnerships, joint ventures, or wholesalers.33 Nor does the IPL provide exemptions for particular types of businesses such as automotive dealerships or gasoline retailers.34 In short, the sole issue is whether the particular business falls within the IPL’s definition of a franchise.

B. DISCLOSURE DOCUMENT The IPL requires that a franchisor provide a prospective franchisee with certain disclosures a minimum of 30 days before execution of a franchise agreement.35 A franchisor does not need the IMPI’s approval of the disclosure document before providing it to a prospective franchisee; nor does the franchisor have to register a copy of the disclosure document with IMPI.36 But Article 65 of the Regulations stipulates that a disclosure document must contain the following ten items: Franchisor’s contact details; description of the franchise; identification of the main franchisor and years in business; description of the intellectual property rights involved in the franchise; amount and purpose of payments made by the franchisee to the franchisor; list of technical assistance that the franchisor will provide the franchisee; geographic territory of the franchise; right of the franchisee to sub-franchise to a third party; duties of the franchisee with respect to confidential information; and the rights and obligations of the franchisee at the conclusion of the franchise agreement.37 Relative to disclosures required by the FTC, disclosures under the Reg- ulations are minimal. For instance, the FTC mandates that a franchisor and its officers disclose whether any of them have filed for bankruptcy within the last 10 years.38 The FTC also requires a franchisor to describe his prior business experience and provide details of any previous

31. IPL, supra note 10, art. 142. 32. See Disclosure Requirements and Prohibitions Concerning Franchising, 16 C.F.R. § 436.1(h) (2007). 33. See generally IPL, supra note 10. 34. See Jorge Mondragon, Mexico, in GETTING THE DEAL THROUGH: FRANCHISE 140 (Philip F. Zeidman, ed., 2013). 35. See IPL, supra note 10, art. 142. The 30-day requirement was enacted on January 25, 2006, thus does not apply to franchise agreements executed before that date. See generally id. 36. See Mondragon Mexico, supra note 34, at 141 ¶ 22. 37. See Regulations under IPL, supra note 11, art. 65. 38. See Disclosure Requirements and Prohibitions Concerning Franchising, 16 C.F.R. § 436.5(d) (2007). 60 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 franchises.39 Moreover, under the FTC a franchisor must disclose any pending litigation against the franchise, its directors, or its officers.40 Yet in Mexico, none of these items are required disclosure under either the IPL or the Regulations. In Mexico, the disclosed information must be accurate at the time the document is delivered to the prospective franchisee.41 Once this obligation is satisfied, a franchisor is not required to update the disclosure document. Where a disclosure document contains misrepresentations, the IPL gives franchisees the right to sue the franchisor to nullify the pertinent franchise agreement.42 In addition, during the first year of the executed franchise agreement, a franchisee may seek compensation up to the amount of actual damages suffered as a result of the franchisor’s non- compliance with its disclosure obligations.43

C. FRANCHISE AGREEMENT A franchise agreement is a contract between a franchisor and franchisee that outlines the rights and duties each party has in the operations of the respective franchise. Under Mexican law, the franchise agreement is governed by the Federal Civil Code, the Commerce Code, and general principles of contract law, including the principle of freedom to contract.44 Thus, the particular terms expressed in the franchise agreement will largely govern the franchise relationship.45 A franchise agreement must be in writing and contain various provisions regarding the finances, operations, transfer, and termination of the particular franchise.46 Specifically, the IPL requires the following three finance provisions: Level of infrastructure investment required by the franchisee; financing and reimbursement terms; and the method to determine profit margins and the franchisee’s commission.47 Regarding operations, the finance agreement must contain the following four provisions: Geographic zone for the franchise; merchandise supply, inventory, and marketing procedures; technical assistance and training; and methods for supervision, evaluation, and quality-assurance.48 And where parties have agreed that the franchisee may transfer its interest to a third party, the IPL requires that any terms and conditions for an assignment be included in the franchise agreement.49 Finally, the IPL also stipulates that a franchise agreement contain the following termination provisions: causes

39. See id. § 436.5(a)(7). 40. See id. § 436.5(c). 41. See IPL, supra note 10, art. 142. 42. See id. 43. See id. 44. See Commercial Code, supra note 20, arts. 1–5, 78; see also Civil Code, supra note 21, arts. 1, 12, 16, 1832, 1839, 1858. 45. See Civil Code, supra note 21, arts. 1832, 1839, 1851, 1858, 1859. 46. See IPL, supra note 10, art. 142 bis. 47. See id. 48. See id. 49. See id. 2014] OPPORTUNITY FOR US-BASED FRANCHISES 61 for termination; renewal terms; and the franchisee’s obligation to sell assets or transfer shares to the franchisor upon termination of the franchise agreement.50

D. TRADEMARK REGISTRATION Mexico provides trademark protection through a registration system managed by the IMPI.51 In addition, Mexico is a member of the Madrid Protocol for the International Registration of Marks (Madrid Protocol), which allows trademark owners to register a trademark in multiple countries.52

1. Mexico’s Traditional System A franchise entering Mexico may continue to use its existing trademarks in Mexico, however, under Mexico’s traditional system, the trademark must be registered with the IMPI in order to be effective against third parties.53 A trademark does not need to be in use at the time it is registered because the IPL provides for an “intent-to-use” application.54 Specifically, the applicant for a registered trademark has three years from the date of application to use that trademark.55 Trademark registration in Mexico is governed by Articles 113 and 114 of the IPL, and Article 5 of the Regulations. The IPL requires applicants for trademark registration to supply details such as the distinctive sign constituting the trademark, the date of first use of the trademark, and the products or services to which the trademark applies.56 IMPI reports that applications with proper documentation and fees will be registered within six months.57 Where a trademark owner previously registered a trademark in another country, the IMPI will assign to its registration in Mexico the application date of that trademark in the country where it was previously registered—as long as the application in Mexico is within the six-month window.58 This grace period is reinforced by the Paris Convention for the Protection of Industrial Property, to which Mexico is a signatory.59 Once a trademark is registered in Mexico, it may be recognized by the

50. See id. 51. See Regulations under the IPL, supra note 11, art. 1. 52. See Press Release, World Intellectual Property Organization, Mexico Joins the In- ternational Trademark System (Nov. 19, 2012), available at http://www.wipo.int/ pressroom/en/articles/2012/article_0024.html. 53. See IPL, supra note 10, arts. 87, 136, 143, 150. 54. See id. art. 113. 55. See id. art. 130. 56. See id. art. 113. 57. See FAQ’s: Trademarks, INSTITUTO MEXICANO DE LA PROPIEDAD INDUSTRIAL [IMPI] (on file with author). 58. See IPL, supra note 10, arts. 117–18; see also Regulations under IPL, supra note 11, art. 60. 59. See Paris Convention for the Protection of Intellectual Property, art. 4(C), as amended Sept. 28, 1979, available at http://www.wipo.int/treaties/en/text.jsp?file_id =288514#P83_6610. 62 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 letters “M.R.” or the symbol ®.60 But if a trademark is not used for the products or services for which it was registered during three consecutive years, it is vulnerable to cancellation.61 Under the IPL, a franchisee’s use of the trademark through a license recorded with the IMPI is sufficient to show trademark use.62 Further, a registered trademark is protected only for ten years, and must be renewed after ten years.63 The IPL provides the IMPI with several tools to protect a registered trademark from possible infringement. For example, the IMPI may reject an application for a confusingly similar trademark when the applicant attempts to apply it to similar products or services.64 In addition, if the IMPI registers a trademark to an unauthorized person, the purported owner of the trademark may challenge that registration by notifying IMPI within three years from the publication of the unauthorized trademark.65 Moreover, where IMPI granted a trademark registration upon false data contained in the application, the registration becomes invalid.66 After a trademark violation has occurred, the IMPI may take administrative action and could impose two remedies.67 First, the IMPI may order the person who violated a registered trademark to cease selling the pertinent goods or services and surrender those items.68 Second, the IMPI may impose an administrative fine based upon a statutory formula.69 Furthermore, where the infringement of industrial property rights causes damages representing at least 40 percent of the public sale price of each good or service sold, the injured party may seek damages through a judicial proceeding.70

2. Madrid Protocol Mexico is a member of the Madrid Protocol as of February 19, 2013.71 The Madrid Protocol is an agreement among members to participate in a system that registers trademarks under an international scheme.72 The general principle is to allow an owner of a registered trademark to protect that trademark in multiple countries by filing one application and paying one fee.73 But a member of the Madrid Protocol may refuse to

60. See IPL, supra note 10, art. 131. 61. Id. art. 130. 62. See Regulations under IPL, supra note 11, art. 62. 63. See IPL, supra note 10, art. 95. 64. Id. art. 90. 65. Id. art. 92. 66. Id. art. 151. 67. Id. arts. 213–14. 68. Id. arts. 199 bis., 219. 69. Id. arts. 214, 218. 70. Id. art. 221 bis. 71. See Press Release, Mexico Joins the International Trademark System, supra note 52. 72. See Protocol Relating to the Madrid Agreement Concerning the International Re- gistration of Marks, June 27, 1989, 116 Stat. 1758, art. 2(1) [hereinafter Madrid Protocol], available at http://www.wipo.int/madrid/en/legal_texts/trtdocs_wo016 .html. 73. Id. arts. 2(1), 8(1)–(2). 2014] OPPORTUNITY FOR US-BASED FRANCHISES 63 grant protection for a particular trademark.74 If a member does not refuse to validate a particular trademark, the protection of that trademark is “the same as if the mark had been registered by [that country’s relevant trademark office].”75 The International Bureau of the World Intellectual Property Organization (International Bureau) maintains an international registry of trademarks and provides the administration of the international trademark applications.76 Mexico has not yet updated the IPL or the Regulations in a manner consistent with trademark registration requirements under the Madrid Protocol. But the IMPI has published new guidelines showing potential users how to register a trademark.77 The IMPI’s guidelines distinguish between trademarks originating in Mexico and those originating outside of Mexico. For trademarks originating in Mexico, a person must first apply with the IMPI using the traditional process. Once the IMPI registers that trademark, the IMPI forwards the applicant’s international application to the International Bu- reau.78 For trademarks registered outside of Mexico in a country that is a member of the Madrid Protocol, the applicant follows the procedures outlined under the Madrid Protocol. For example, a U.S. franchisor with a registered trademark who wants protection in Mexico could submit an international application to the International Bureau. The applicant simply designates Mexico as a country where the franchisor wants the trademark registered. The International Bureau then forwards the application to Mexico. The IMPI then reviews the international application and grant registration, unless the trademark violates the IPL or another law of Mexico.79 Consequently, the trademark must still comply with Mex- ico’s laws. But trademark registration in Mexico for a person with a trademark registered in another country should now be more efficient, particularly if the applicant is seeking trademark protection in numerous countries that belong to the Madrid Protocol.

E. TRADE SECRET REGISTRATION According to article 82 of the IPL, a trade secret includes any industrial or commercial information that a person keeps secret where that information is “associated with securing or retaining a competitive or eco-

74. Id. art. 5(1). 75. Id. art. 4(1)(a). 76. Id. arts. 2(1), 11. 77. See User Guide for Distinctive Signs, INSTITUTO MEXICANO DE LA PROPIEDAD IN- DUSTRIAL [IMPI] (on file with author) (IMPI’s guide provides a basic overview of how to register a trademark with IMPI, either in hard copy or on-line). 78. See IMPI as Office of Origin, INSTITUTO MEXICANO DE LA PROPIEDAD INDUS- TRIAL [IMPI], http://protocolodemadrid.impi.gob.mx/Procedimiento1.html (last visited Mar. 4, 2014). 79. See id.; see also Madrid Protocol, supra note 72, art. 5 (a member of the Madrid Protocol may refuse to trademark protection in that country when the member provides adequate grounds for refusal and the member notifies the International Bureau within 18 months). 64 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 nomic advantage over third parties in the conduct of economic activities.”80 Examples of trade secrets under the IPL include production methods, marketing processes, or means of rendering services.81 The IPL offers some protection to trade secrets when it is registered with IMPI. The IPL prohibits unauthorized disclosure of trade secrets.82 This duty of non-disclosure extends to a third party who is authorized to use that trade secret.83 A person harmed by an unauthorized disclosure of a trade secret may seek actual damages from either the person who disclosed the confidential information or the person who received that information.84 To register a trade secret with the IMPI, a franchisor need not provide all of the detail typically contained within a franchise agreement. Instead, a summary description of the trade secret typically suffices.85 But this summary agreement must be submitted to the IMPI in Spanish.86

IV. POTENTIAL PITFALLS AND IMPLICATIONS FOR FRANCHISORS The basic legal requirements for a franchisor under Mexico’s industrial property law may appear minimal. But, weak enforcement of industrial property rights, Mexico’s recent membership in the Madrid Protocol, and requirements imposed by local laws complicate the scenario for franchisors.

A. CHALLENGES TO ENFORCING INDUSTRIAL PROPERTY RIGHTS In 2006, Mexico made significant changes to bolster its laws protecting industrial property. Notably, Mexico amended the IPL to add a clearer definition of a franchise, delineated information that must be disclosed to a prospective franchisee, and mandated the inclusion of certain provisions within a franchise agreement.87 More recently, Mexico has taken additional steps to strengthen its industrial property laws. For example, Mexico’s membership in the Madrid Protocol should facilitate a stream- lined process for trademark registration.88 Also, the IMPI has established new procedures aimed at reducing the time to investigate and decide complaints regarding industrial property rights infringement. These procedures helped the IMPI resolve 14.7 percent more complaints in 2012 than the agency resolved in 2011.89

80. IPL, supra note 10, art. 82. 81. Id. 82. Id. arts. 84–85. 83. Id. art. 84. 84. Id. art. 86. 85. See Mondragon, Mexico, supra note 34, at 139 ¶ 7. 86. See Regulations under the IPL, supra note 11, art. 5. 87. See IPL, supra note 10. 88. See Press Release, Mexico Joins the International Trademark System, supra note 52. 89. See IMPI ANNUAL REPORT 2012, supra note 4, at 19. 2014] OPPORTUNITY FOR US-BASED FRANCHISES 65

Despite significant changes in its legal framework, Mexico has a ques- tionable record of protecting industrial property rights. At the beginning of 2012, the IMPI had a backlog of 2,339 pending complaints regarding infringement of industrial property rights.90 And the total value of merchandise that the IMPI seized in 2012 as a result of copyright infringement and industrial property infringement was minimal—only 19.45 million pesos.91 Converted to U.S. dollars, that amounts to a paltry sum of $1.4 million.92 Moreover, several months ago the Office of the U.S. Trade Represen- tative issued its “Special 301 Report” and kept Mexico on its watch list.93 The Special 301 Report is the product of an annual review of intellectual property rights and enforcement practices by U.S. trading partners.94 Ac- cording to this report, Mexico has “high levels of intellectual property rights infringement (IPR).”95 To improve enforcement, the report recommended that Mexico “devote additional resources, bring more IPR prosecutions, and impose deterrent penalties against infringers.”96 Eric Schwartz, counsel for the International Intellectual Property Alliance, made similar observations. According to Mr. Schwartz, Mexico continues to have “high levels of piracy of copyrighted works.”97 Mr. Schwartz concluded that Mexico “needs . . . improvements in its administrative enforcement mechanisms, and in its prosecutions by the courts where adjudication of copyright infringement faces significant delays, and . . . sufficient resources to undertake all of these enforcement efforts.”98 Given Mexico’s weak record of enforcing industrial property rights, a franchisor should consider taking three steps to better protect its property. First, it should conduct sufficient due diligence on the prospective franchisee to ascertain the likelihood that the party would respect the franchisor’s intellectual property. For example, the franchisor should determine whether the prospective franchisee has operated other franchises, the duration of those franchises, and whether any suits have been filed against that prospective franchisee. Second, the franchisor should look for prospective franchisees that have significant investments

90. See id. 91. See id. at 23. 92. Conversion rate of 13.0492 Mexican pesos per U.S. dollar; Exchange rate as of Oct. 14, 2013. Exchange Rate to Pay Obligations Entered into in U.S. Dollars Pay- able in the Mexican Republic, BANCO DE MEXICO, http://www.banxico.org.mx/tip camb/tipCamIHAction.do (last visited Mar. 4, 2014). 93. OFFICE OF THE U.S. TRADE REP., EXEC. OFFICE OF THE PRESIDENT, 2013 SPECIAL 301 REPORT 6 (May 2013) available at http://www.ustr.gov/sites/default/files/ 05012013%202013%20Special%20301%20Report.pdf. 94. Id. at 4. 95. Id. at 51. 96. Id. 97. Participation of Mexico in the Trans-Pacific Partnership Trade Negotiations: Hear- ing on USTR-2012-0014 Before the Trade Policy Staff Comm. of the Office of the U.S. Trade Rep. 112th Cong. 2 (2012) (testimony of Eric J. Schwartz, Counsel, International Intellectual Property Alliance), available at http://www.iipa.com/pdf/ 2012_Sep04_Mexico_TPPHearing_AppearanceandTestimony.PDF. 98. Id. at 3. 66 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 with other franchisors. Such investments in existing businesses may deter the prospective franchisee from violating the franchisor’s intellectual property rights lest the prospective franchisee jeopardize its relationship with one of its other franchisors. Third, a franchisor should consider requiring that any person who has access to the franchisor’s trade secrets sign a confidentiality agreement.99 In Mexico, confidentiality agreements are enforceable where a breach of the agreement violates IPL and that agreement contains liquidated damages.100 The IPL protects trade secrets, and a person’s non-authorized use of a trade secret violates the IPL.101 Also, the Civil Code expressly provides that a contract may contain a penalty, or liquidated damages, for breach of a contract obligation.102 Thus, a franchisor should have a good chance of enforcing a liquidated damages clause in the event that a party breaches an agreement to keep the franchisor’s trade secrets confidential.103

B. MADRID PROTOCOL The Madrid Protocol represents a significant improvement for U.S.- based franchisors that seek to obtain protection in Mexico for their existing trademarks.104 The system is designed, and hopefully will deliver, a single international trademark application that will eliminate the need to file separate applications in separate countries.105 Currently ninety-one countries are members to the Madrid Protocol.106 Despite these positive advancements, a couple pitfalls are nonetheless present. First, the applicant for international registration must classify the trademark’s relevant product or service.107 The Madrid Protocol pre- fers that the applicant use one of the forty-five classifications provided by the Nice Classification, but the applicant is not required to do so.108 Be- cause the Madrid Protocol does not mandate a single classification system, it would not be surprising to see disagreements between an applicant

99. See IPL, supra note 10, art. 84. 100. See Mondragon, Mexico, supra note 34, at 143 ¶ 34. 101. See IPL, supra note 10, arts. 84–86. 102. See Civil Code, supra note 21, arts. 1840, 1843–44, 1851. 103. For a sample liquidated damages clause see, e.g., Robert Lauer & Joyce Mazero, Impact of Other Local Laws, in FUNDAMENTALS OF INTERNATIONAL FRANCHIS- ING 143 (Will K. Woods ed., 2nd ed. 2013). 104. See Press Release, Mexico Joins the International Trademark System, supra note 52. 105. See Madrid Protocol, supra note 72, art. 2(1). 106. See WIPO-Administered Treaties: Contracting Parties to the Madrid Protocol, WORLD INTELLECTUAL PROPERTY ORGANIZATION, http://www.wipo.int/treaties/ en/ShowResults.jsp?treaty_id=8 (last visited Mar. 4, 2014). 107. See Madrid Protocol, supra note 72, art. 3(2). 108. Id.; see also WORLD INTELLECTUAL PROP. ORG., INTERNATIONAL CLASSIFICATION OF GOODS AND SERVICES FOR THE PURPOSES OF REGISTRATION OF MARKS xix (10th ed. 2011) [hereinafter NICE CLASSIFICATION], available at http:// www.wipo.int/classifications/nivilo/pdf/eng/nice/10 engp1.pdf (currently the Nice Classification contains forty-five classes, thirty-four for goods and eleven for services). 2014] OPPORTUNITY FOR US-BASED FRANCHISES 67 and a member country regarding an applicant’s particular classification. For example, Frances Jagla, a former member of the International Trade- mark Association’s Board of Directors, anticipates a rise in the number of Mexico’s rejected trademark registrations based on disagreements about goods and services classifications.109 A second problem is the dispute resolution procedure under the Ma- drid Protocol. In the event that a member of the Madrid Protocol refuses to approve the applicant’s international registration, the applicant must resolve the issue with that particular country.110 The International Bu- reau does not become involved in the dispute resolution process.111 Thus, an applicant must respond to a particular country’s refusal, appeal the decision, and negotiate any resolution directly with the trademark office in the relevant country. This could be a time-consuming and tedious process if even a handful of countries out of the ninety-one member countries reject an applicant’s particular trademark registration. In short, despite the significant efficiencies that the Madrid Protocol offers for trademark registration, assistance from a local attorney who has experience with the pertinent trademark office could be invaluable.

C. FRANCHISE AGREEMENT PROVISIONS Nuances of Mexico’s Labor Law, Antitrust Law, and Federal Civil Code all contain potential pitfalls to a franchisor’s interests. But by including certain provisions in the franchise agreement, a franchisor could potentially navigate through some of these challenges. For example, the Labor Law imposes upon employers various regulations regarding employee composition, wages, hours worked, and holi- days.112 Because these laws apply to any enterprise in Mexico involved in the distribution of goods or services, a franchisor based outside of Mexico could be subject to these laws.113 But the Labor Law applies to individuals.114 Therefore, these laws might not apply to a foreign-based franchisor where that franchisor takes two steps. First, require that the prospective franchisee execute the franchise agreement as an entity, rather than as an individual franchisee.115 Second, stipulate in the franchise agreement that both parties are executing the agreement as independent contractors and state that the prospective franchisee is not the franchisor’s employee.116

109. See Giulio Martellini et al., INTA Participates in Celebration of Mexico’s Entrance to Madrid System, 68 INTABULLETIN 9, May 1, 2013 at 1. 110. See Madrid Protocol, supra note 72, art. 5(3). 111. See WORLD INTELLECTUAL PROP. ORG., OBJECTIVES, MAIN FEATURES, ADVAN- TAGES OF THE MADRID SYSTEM, ¶ 29 (2010). 112. See Labor Law, supra note 25, arts. 7, 31, 60, 69, 71, 74, 76. 113. Id. arts. 1, 16, 132. 114. Id. arts. 6, 8, 20. 115. See Mondragon, Mexico, supra note 34, at 139 ¶ 6. 116. See id. 68 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

Under Mexico’s Antitrust Law, a monopolistic practice can include a franchisor’s attempt to sell its product or services in Mexico at a pre- determined price.117 When a franchisor imposes a retail price in Mexico, the law asks whether that franchisor has substantial market power in its relevant market.118 In determining the relevant market, the Antitrust Law considers several factors, including the consumer’s ease of obtaining potential substitutes, distribution costs, and the consumer’s ability to access other markets.119 In order to avoid such a fact-intensive inquiry, a franchisor could insert a provision in the franchise agreement clarifying that any price lists provided to the franchisee are merely suggested prices. The franchise agreement could also expressly state that the franchisee is not obligated to charge a particular retail price.120 Finally, the Federal Civil Code allows both parties to agree to their own terms in the franchise agreement.121 In the event of a dispute, the Civil Code provides that a contract will be given the literal meaning of its terms when “the terms of a contract are clear and leave no doubt about the intention of the parties.”122 For a franchisor, this means that careful drafting of the franchise agreement is critical. The terms should be carefully defined, and the intent of the parties should be clearly identified. This is particularly important because Mexico is a civil law and not a common law jurisdiction.123 Unlike the United States, where case law inter- prets legislation, in Mexico it is the law as presented in its codes that provide the rules for interpreting contracts.124

V. CONCLUSION Mexico’s franchise market is growing approximately three times faster than the underlying economy. This growth is facilitated in part by Mex- ico’s industrial property law that requires minimal documentation. In addition, Mexico’s recent membership in the Madrid Protocol should ease trademark registration in Mexico. But a franchisor that is considering expanding into Mexico should recognize that Mexico’s record of enforcing industrial property rights is weak. In addition, several local laws can impose additional obligations upon a franchisor. Consequently, a franchisor should take affirmative steps to navigate around these potential pitfalls. These steps include investigating a prospective franchisee’s

117. Id.; see also Antitrust Law, supra note 23, art. 10(II). For more information on the Federal Economic Competition Law, see generally Marco Hero & John Pratt, Competition Laws and Data Privacy, in FUNDAMENTALS OF INTERNATIONAL FRANCHISING 302–06 (Will K. Woods ed., 2nd ed. 2013). 118. See Antitrust Law, supra note 23, art. 11. 119. See id. arts. 12–14. 120. See Mondragon, Mexico, supra note 34, at 143 ¶ 39. 121. See Civil Code, supra note 21, arts. 1832, 1839, 1858. 122. See id. art. 1851. 123. See generally, Rodolpho Sandoval & Chung-Pok Leung, A Comparative Analysis of Intellectual Property Law in the United States and Mexico, and the Free Trade Agreement, 17 MD. J. INT’L L. & TRADE 145, 152–53 (1993). 124. See id. 2014] OPPORTUNITY FOR US-BASED FRANCHISES 69 previous franchises, executing confidentiality agreements with a liquidated damages clause, and inserting into a franchise agreement the particular provisions discussed in the article above. Finally, given that Mexico has not yet amended the IPL and its Regulations to be consistent with the Madrid Protocol, one should expect to see future changes to these industrial property laws. 70 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 FRANCHISING IN ARGENTINA: CHALLENGES FOR THE FOREIGN FRANCHISOR

Gustavo M. Papeschi*

I. INTRODUCTION: FOCUS AND SCOPE OF THIS ARTICLE

HIS article discusses many of the challenges that a foreign franchisor may encounter while trying to export its business to Ar- Tgentina under a franchising structure. It focuses on those topics in which the Argentine legal system presently differs most from U.S. law. Nonetheless, these references to U.S. law should only be regarded as academic, given that this article’s conclusions and general perspectives about the current Argentine legal system should be useful to any foreign investor. Even though many of the topics affecting a franchising investment are similarly regulated by both the Argentine and U.S. laws,1 significant differences exist. Whether they are rooted in the very legal foundation of the Argentine legal system or they are the product of incidental circumstances, those differences may substantially affect a foreign franchisor. In that sense, this article seeks to cover topics such as the particularities of the contractual system affecting the franchisor business, labor liabilities of the franchisor or sub-franchisor, currency issues, value added tax, and tax withholdings. In addition, it also discusses a proposed new Civil and Commercial Code (the “New Code”) currently being discussed by the National Congress.2 This New Code includes several provisions affecting the franchising business.

* Gustavo M. Papeschi is an Argentine lawyer whose practice focuses in cross border transactions as well as litigation in banking related issues. He obtained his law degree from Universidad de Belgrano (with highest honors, 2006), and his LL.M. in Comparative and International Law from SMU Dedman School of Law (2013). He is a senior associate with Estudio Beccar Varela in Buenos Aires, and has worked during 2013 as a foreign associate with Haynes and Boone, LLP. 1. Although this may sound like an overstatement, given the many differences between the legal systems, note that both legislations share the basic constitutional principles, values, and aspirations. See generally U.S. CONST.; CONSTITUCION´ NA- CIONAL [CONST. NAC.] (Arg.). 2. It is unclear whether the new Civil Code will be passed. Therefore, this article will only refer to it when addressing the particular issues that will be affected if enacted. Marval O’Farrell & Mairal, Argentina: Bill to Reform the Civil and Com- mercial Codes, MONDAQ (Dec. 12, 2012), http://mondaq.com/x/210766/ Constitutional+Administrative+Law/Bill+To+Reform+The+Civil+And+ Commercial+Codes.

71 72 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

As a consequence, this article should not be regarded as a comprehensive guide to doing business in Argentina (not even for the franchising business specifically) because many legal issues are discussed indirectly and briefly (if discussed at all).

II. LEGAL BASIS OF FRANCHISING IN ARGENTINA: CONTRACTS

A. AMBIGUITY OF THE TERM IN ITS SPANISH TRANSLATION Although the term franquicia is the proper Spanish translation for “franchise,” the term may have several other meanings in everyday speech.3 As a consequence, most businessmen, lawyers, and scholars use the English term franchising to refer to this contract. However, as no express legal regulation currently exists for the franchising business, there is no major legal consequence in using one term or the other.4 The New Code, on the other hand, defines franchising as the contract by means of which a party (franchisor) grants another party (franchisee) the right to use a proven system, addressed to commercialize certain goods or services under the franchisor’s commercial name, logo or mark, which will provide the technical knowledge, as well as the continuous technical or commercial assistance for a direct or indirect consideration paid by the franchisee.5

B. CONTRACTUAL LEGISLATION: ARGENTINE CIVIL CODE AND COMMERCIAL CODE Contractual law in Argentina is governed by both the Civil Code and the Commercial Code (hereinafter referred as “Civil Code” and “Com- mercial Code”).6 Although these bodies of law have been amended several times throughout their existence, the original underlying texts date back to the late 19th century.7 The Civil Code provides general rules

3. (i) The most common alternate meaning of franquicia relates to an insurance policy: is the equivalent of the U.S. insurance’s deductible, meaning that the insurer would only be liable for any damage in excess of that certain amount; (ii) another common meaning for the term is related to customs duties: franquicia is the maximum amount of value that a person may import to the country without paying any custom duties; (iii) in consonance with the translations referred to above, the term is also generally used to describe any type of exemption; (iv) finally, it refers to a franchising business: however, it is rarely used in that sense, to the extent that, if someone is talking about a franquicia, he or she should immediately add a reference to known franchising businesses to clarify the meaning of the term. Fran- quicia, DICCIONARIO DE LA REAL ACADEMIA ESPANOLA˜ , http://lema.rae.es/drae/ ?val=Franquicia (last visited Feb. 20, 2014). 4. See generally COD´ . CIV.; COD´ . COM. 5. CODIGO´ CIVIL Y COMERCIO [COD´ . CIV. Y COM.] [UNIFIED CIVIL AND COMMER- CIAL CODE DRAFT] art. 1512 (2012) (Arg.). 6. See generally CODIGO´ DE COMERCIO [COD´ . COM.] [COMMERCIAL CODE] (Arg.); CODIGO´ CIVIL [COD´ . CIV.] [CIVIL CODE] (Arg.). The New Civil Code unifies the Civil and Commercial Code into one body of law. 7. Law No. 340, Sep. 25, 1869, [1863/69] R.N. 513 (Arg.); Law No. 2637, Oct. 5, 1889, [II] R.N. 795 (Arg.). 2014] FRANCHISING IN ARGENTINA 73 applying to all contracts, while the Commercial Code provides specific rules for those contracts entered by merchants.8 Practicing lawyers usually consider the Civil Code the main body of law and only refer to the Commercial Code in very specific occasions (i.e., rules of interpretation of contracts).9 These two bodies of law (as amended from time to time) set forth the basic provisions regarding the general theory of contracts (capacity rules,10 formalities,11 evidence,12 voidance and validity,13 etcetera) and also provide special regulations for specific contracts (such as sale of goods,14 assignment of rights,15 agency,16 etcetera). In addition to both the Commercial and Civil Codes, many other federal laws also impact contractual relationships, either by providing certain general rules for particular types of contracts (i.e., the Consumer Defense Act,17 which sets forth several rules for contracts executed between merchants and consumers), or by providing special regulation for specific contracts (i.e., the Urban Rent Agreements Act,18 which provides special rules for the lease of real property located within urban areas).

C. LACK OF LEGAL REGULATION: FREEDOM OF CONTRACT Neither the Civil Code, nor the Commercial Code, nor any special law provide special rules for the franchising contract.19 Consequently, Ar- gentine law does not expressly define the term franchising or any other term that reflects the nature of this contract. Nonetheless, the absence of special regulation is not an obstacle for the execution and enforceability of these types of contracts.20 Contractual parties have complete freedom to agree upon any desired terms, and there are very few mandatory provisions regarding the content of the agreement.21 In fact, other than the general prohibition of illegal content, most mandatory restrictions refer to contracts involving minors and family issues, and thus are unlikely to affect any business contract.22 Even if there are no obstacles preventing the legality and enforceability of a franchising agreement in Argentina, some issues should be taken into account, as they might affect the contractual outcome.

8. See generally COD´ . COM.; COD´ . CIV. 9. COD´ . COM. arts. 217–18. 10. COD´ . CIV. arts. 1160–66. 11. Id. arts. 1180–89. 12. Id. arts. 1190–94. 13. Id. arts. 1037–65. 14. Id. arts. 1323–1433. 15. Id. arts. 1434–84. 16. Id. arts. 1869–1985. 17. Law No. 24240, Oct. 15, 1993, 27744 B.O. 34 (Arg.). 18. Law No. 23091, Oct. 16, 1984, 25531 B.O. 1 (Arg.). 19. See generally COD´ . CIV.; COD´ . COM. 20. COD´ . CIV. arts. 1143, 1197. 21. See generally COD´ . CIV.; COD´ . COM. 22. COD´ . CIV. arts. 953, 1275. 74 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

The franchising agreement is considered an “untypical”23 contract because no special regulation exists for it. As a consequence, in the event of a conflict and in the absence of specific contractual provisions, there are no clear default rules for this contract (other than general rules applicable to all contracts).24 Two issues may arise: (i) It is difficult for lawyers to precisely predict which set of regulations would eventually apply in a future ruling. A court may decide that default rules provided for other contracts apply (i.e., default rules set forth for the sales of goods contract or the assignment of rights contract).25 However, because the franchise agreement is not one of those contracts, those “artificially” applied rules might not reflect the real intention of the parties. (ii) As explained further below, Argentine law provides that the exercise of a right or the fulfillment of a duty may not be done in an abusive manner (called “abuse of right”).26 In short, this principle has been used by the courts to solve legal conflicts using concepts of fairness or equity, instead of hard legal principles. Lack of contractual provisions may trigger this principle most easily and, therefore, cause unexpected results. These risks should be taken into special account when drafting the franchising agreement or any incidental agreement. In order to avoid or minimize these risks, the agreements should be drafted thoroughly and, to the extent possible, provide a contractual solution for all foreseeable conflicts.

D. THE FRANCHISING AGREEMENT IN THE NEW CODE Contrary to the current legal scenario, the New Code specifically recognizes the franchising agreement and regulates it in thirteen articles27 (in addition to containing several cross-references to other provisions of this new body of law). The new regulation includes many provisions reflecting trends from foreign legislation. In addition to including a few default rules, it also sets

23. Maure, Mart´ın Jose, ´ Reflexiones sobre la Responsabilidad del Franquiciante frente a Terceros Dependientes del Franquiciado, DT2011 Aug. 1969. Under Argentine Contractual law there are two types of contracts: typical and untypical contracts. Typical contracts are those that have a special default regulation under the Civil or Commercial Codes, or under any special law. On the other hand, untypical contracts are those that are not specially regulated. COD´ . CIV. art 1143. Although both types of contracts are fully enforceable, typical contracts are complemented by legal default rules if any conflict arises between the parties. That is not the case for untypical contracts, where no specific regulation exists for untypical contracts. Although case law and scholar opinions may provide some defaults rules, they are not considered mandatory authority. 24. Id. 25. COD´ . CIV. arts. 1323–1433; 1434–84. 26. Id. art. 1071. 27. COD´ . CIV. Y COM. arts. 1512–24 (2012 Draft). 2014] FRANCHISING IN ARGENTINA 75 forth some mandatory provisions, such as prohibiting the franchisor from owning any corporate interest in the franchisee entity,28 requiring a minimal contract term (except for special circumstances),29 requiring a prior disclosure procedure with regards to the evolution of other franchise units in the country or abroad,30 and term and termination provisions,31 among others. It also expressly declares that a franchising relationship shall not be considered, by itself, as an antitrust action.32 Finally, it clearly provides that, from a labor standpoint, the parties are independent and the franchisor is not liable for the franchisee’s labor related commitments.33

E. ABUSO DEL DERECHO DOCTRINE 1. Introduction The abuso del derecho doctrine (which can roughly be translated as abuse of right) is a very important general principle in civil law systems and it is commonly applied in Argentine courts. Any foreign attorney advising on investments in Argentina (or in any other civil law country) should be familiar with its essential elements. It may be best described as a general principle intended to prevent the exercise of a legally granted right in a manner that does not reflect a certain degree of fairness in accordance with the ratio legis of a particular legal provision.34 In other words, it may be considered a kind of equity principle to help reduce the harshness of written law or legal formalities. Although there are some comparable legal provisions under U.S. law (i.e. the avoidability doctrine35 and the unconscionable contract),36 this doctrine goes far beyond those. To the contrary, this doctrine is one of the very foundations of the legal system and serves as a guide to all legal relationships.37 Although most Argentine lawyers would praise this principle and consider it part of the very foundation of the Argentine law, they would equally consider it a double-edged sword. Given that there are no definitive guidelines for its application, it is difficult to precisely foresee how it may be applied by a judge and to what extent it could affect any contrac-

28. Id. art. 1512. 29. Id. 30. Id. art. 1514(a). 31. Id. arts. 1512, 1516, 1522. 32. See id. 33. Id. art. 1520(b). 34. See COD´ . CIV. art. 1071. 35. RESTATEMENT (SECOND) OF CONTRACTS § 350 (1981). 36. U.C.C. § 2-302; RESTATEMENT (SECOND) OF CONTRACTS § 208 (1981). It is worth mentioning that the Argentine Civil Code also contains a specific section that regulates unconscionable terms (COD´ . CIV. art. 954). However, it is mostly considered as a consequence of the abuso del derecho doctrine. 37. Adrian ´ Oscar Morea, La Doctrina del Abuso Procesal en la Derecho Argentino, Nov. 22, 2012, INFOJUS, http://www.infojus.gov.ar/doctrina/dacf120195-morea- doctrina_abuso_procesal_en.htm?4 (last visited Feb. 11, 2014). 76 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 tual right or obligation.38

2. Legislative Basis The general principle and basis of this doctrine are set forth in the Civil Code, which provides that: [t]he regular exercise of one’s right or the fulfillment of one’s legal duty shall not turn illegal any act. The Law does not safeguard the abusive exercise of rights. It shall be considered such [the exercise] that contradicts the ends of the drafter when it recognized [the right], or those that exceed the limits imposed by good faith, moral and goods practices.39 In addition, the Civil Code also contains a related principle that provides that contracts “should be executed, construed and enforced under a good faith standard,”40 which further supports this doctrine. Needless to say, the limits of this doctrine are far from clear and foreseeable. The judge is not always aware of the intent of the drafter; on the other hand, no one is able to clearly say what good faith, moral, or good practices really are.

3. Practical Consequences and Guidelines Whether this doctrine should apply or not to a particular case is a question of fact.41 Usually, a judge may invoke it when he feels that the outcome of applying the strict legal or contractual provision might be unfair. Although judges are usually cautious when applying this doctrine, it is important to recognize that what is written in an agreement may not necessarily be enforceable because of the factual circumstances surrounding the contract. Even if this is also true for contracts governed by U.S. law (e.g. unconscionable terms), under Argentine law the possibility increases substantially. It is not easy to provide clear guidelines to prevent the application of this doctrine. However, some circumstances may help to minimize the chances that it will be applied or the effects of its application. (i) Bargaining power. As in the case of procedural unconscionability under U.S. law,42 the chances for facing the effects of this doctrine are minimized when it is proven that the parties have specifically

38. As the original drafter of the Civil Code stated when he refused to legislate this doctrine, “[i]f the government acts as a judge of the abuse . . . it will not be long until it acts as a judge of the use, and any true idea of property and freedom would be lost”. COD´ . CIV. art. 2513 (author note). 39. COD´ . CIV. art. 1071. 40. COD´ . CIV. art. 1198. 41. Daniel Roque Vitolo, Un reiterado y saludable freno de la Corte a los acuerdos preventivos abusivos y en fraude a la ley, LA LEY 2009-F, 328. 42. Wilcox v. Valero Ref. Co., 256 F.Supp.2d 687, 691 (S.D. Tex. 2003) (relying on unequal bargaining power as a factor in ruling that the enforcement of an arbitration agreement implemented after an employee’s lawsuit was filed was procedur- ally unconscionable); FARNSWORTH ON CONTRACTS §4.28 (3rd ed. 2004) (“Procedural unconscionability is broadly conceived to encompass not only the 2014] FRANCHISING IN ARGENTINA 77

negotiated the terms of the contracts and both parties have a similar bargaining position.43 Consequently, terms agreed upon by corporate parties are better protected than terms agreed upon by a corporate party and an individual. However, the corporate character of the parties is far from definitive, as the individual power to bargain is the real factor. Accordingly, some judges may find that foreign corporations, especially financial institutions, are in a better bargaining position than local counterparts.44 Furthermore, judges are bound to rule as abusive some terms in consumer contracts or employment contracts where the application of the doctrine has a legal basis.45 (ii) Thoroughness of contractual terms. As stated above, even if both parties have similar bargaining power, the doctrine may still find its way as a subsidiary or default rule. Therefore, legal counsel should draft the agreement with as much detail as possible. (iii) Legislative and case law support. Even if the doctrine’s purpose is to avoid the harshness of legal or contractual provisions, the existence of a law or regulation that supports a specific term (even if completely unrelated to a franchise agreement) would provide some protection. For example, the Central Bank of Argentina has established that the interest rate for outstanding credit card debt should not exceed 50 percent of the original interest rate for said debt.46 Therefore, if the default interest rate of any royalty payment is below that limit, it will surely be upheld by a court. To the contrary, exceeding that limit will mean that a court would surely find that term abusive (even if no specific relation exists between the term and the formal regulation).

F. TERMINATION OF THE FRANCHISING AGREEMENT 1. Introduction Other than the general rules that uphold any private arrangement among the parties, no specific regulations exist for agency, distribution, or franchising agreements. Nonetheless, courts have been rather active in this area, particularly referring to agency and distribution agreements, and mostly basing their rulings on the abuso del derecho doctrine.47 Al-

employment of sharp bargaining practices and the use of fine print and convoluted language, but a lack of understanding and an inequality of bargaining power”). 43. See Wilcox, 256 F. Supp. 2d at 691. 44. Of course, this tendency may only be described as a feeling among corporate lawyers in Argentina and, obviously, is not reflected in any case or scholar’s opinion. 45. Law No. 24240 art. 36, Oct. 15, 1993, B.O. 27744, 34 (as amended) (Arg.); Law No. 20744 art. 7, Sept. 29, 1974, B.O. 23003, 2 (as amended) (Arg.). 46. Central Bank of Argentina, Comunicacion ´ “A” No. 3052: Tasas de Interes ´ en las Operaciones de Credito, ´ Circular OPRAC 1-475, § 2.2.1 (Dec. 23, 1999). 47. Camara ´ de Apelaciones en lo Civil y Comercial de Lomas de Zamora, sala I [CApel.CCLZ] [Lomas de Zamora Court of Civil and Commercial Appeals, Sec- tion I], 06/05/2007, “Mansilla, Oscar c. Shell C.A.P.S.A.,” La Ley Buenos Aires [L.L.B.A.] (2007-Oct.-1045) (Arg.). 78 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 though this doctrine is present in any termination case, it becomes particularly important with regard to termination without good cause.

2. Termination for Good Cause Contractual parties are free to agree upon any termination clause. Even if there is no special provision on termination, the parties may nevertheless terminate the contract if good cause exists.48 In most cases, the good cause will most likely be a party’s material breach of the contract,49 though there are other valid reasons provided by law (impossibility, im- practicability, et cetera).50 In addition, the parties may expressly include several events of default (bankruptcy, material change of circumstances, failure to achieve certain economic goals, etcetera).51 Although these provisions are generally accepted by courts, some issues should be pointed out: (i) If no special contractual provision has been included (or even if there was), a minor breach would not permit the other party to terminate the contract: that breach should amount to a material breach.52 Although no particular legal provisions exist to qualify a breach as a material breach, the most important factor is the essential benefit sought by the injured party (as provided in the agreement).53 (ii) As any other term in the contract, the abuso del derecho doctrine may also apply for termination clauses. (iii) The injured party (terminating party) has the burden of proving materiality of the breach.54

3. Termination Without Good Cause Even if the parties can agree to their own termination clauses with almost unlimited freedom (as well as any event of default), the issue arises when a party seeks to exercise a termination clause that allows him to terminate the contract without good cause (usually, only requiring a prior notice). Under both the Civil and Commercial Codes, this type of termination (when expressly provided by the contract) should not create any liability

48. COD´ . COM. art. 216. 49. Id.; COD´ . CIV. art. 1204 (both provisions are essentially the same); Camara ´ Na- cional de Apelaciones en lo Comercial de la Capital Federal, sala E [CNCom.] [National Court of Commercial Appeals of the Federal Capital, Section E], 31/03/ 2008, “Perez, ´ Faustino Jorge c. Correo Arg, S.A.,” La Ley [L.L.O.] (2008-AR/ JUR-2682). 50. COD´ . CIV. arts. 888, 1198. 51. COD´ . CIV. art. 1195, 1204. 52. Camara ´ Nacional de Apelaciones en lo Comercial, sala A [CNCom] [National Court of Commercial Appeals of the Federal Capital, Section A], 31/03/1995, “C.M.A. Consultor´ıa, Metodos, ´ Assessoria e Mercantil Ltda. c. Finerco S. A.,” La Ley [L.L.O.] (AR/JUR/2399/1995). 53. Id. 54. Id. 2014] FRANCHISING IN ARGENTINA 79 for the franchisor.55 Although such a provision is most common in indefinite-term contracts, where it may be even construed as existing without specific provision, it may also be included in fixed-term contracts. Nonetheless, case law developed a doctrine called economic dependency. This doctrine arises in those cases where the ongoing concern of a firm primarily depends on a contract with the other party (usually the stronger party). Pursuant to this doctrine (which is a consequence of the abuso del derecho doctrine), the right to terminate a contract can only be exercised in a regular and non-abusive manner and within the limits of good faith,56 which has to be evidenced on a case-by-case basis.57 It particularly applies to indefinite-term and long-term contracts that required an important investment on behalf of the injured party in order to allow them to amortize such investment.58 Dependency on the other party and necessity of a large investment are clearly features to be found in the majority (if not all) franchising agreements. Several factors might make this doctrine applicable: (i) The total length of consecutive contracts (including any renewal between the parties); (ii) Whether the franchisee has an exclusivity obligation for the franchise; (iii) Whether the contract may be construed as unconscionable (both from a procedural and a material point of view); (iv) The parties’ actual bargaining power in the contract. If, in the case of an early termination without proper cause, the doctrine is deemed applicable, prior notice must be submitted reasonably in advance to the other party.59 An average of one month per year of contractual relationship has been considered sufficient.60 If no proper prior notice was given, the injured party may claim: (i) Any investment made upon reliance on the contract that had not been amortized by the performance of the contract, (ii) Labor severance payments,

55. COD´ . COM. art. 216; COD´ . CIV. art. 1204. Note that if no provision is included, parties to a fixed-term agreement are not able to terminate the agreement without good cause or after the contractual term has expired. 56. COD´ . CIV. art. 1071; CCLZ, 06/05/2007, “Mansilla, Oscar,” LLBA (2007-Oct.- 1045). 57. Corte Suprema de Justicia de la Nacion ´ [CSJN] [National Supreme Court of Jus- tice], 08/04/1988, “Automotores Saavedra, S.A. c. Fiat Arg. S.A.,” Fallos (1988-311- 1352). 58. Camara ´ Nacional de Apelaciones en lo Comercial, sala E [National Court of Com- mercial Appeals, section E], 17/08/2006, “Etchelecu, Francisco J. c. Carl Zeiss Ar- gentina S.A. y otros” (Arg.). 59. Id. 60. Note that although case law is generally not mandatory in Argentina, judges usually take this rule of thumb into consideration to ground their decisions. CSJN, 08/ 04/1988, “Automotores Saavedra,” Fallos (1988-311-1337). 80 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

(iii) Penalties for early termination of any contract executed by the franchisee to perform the franchising contract (e.g. leases).61 It is worth noting that the injured party has the burden of proving these damages.62 Even if no proper prior notice was given, liability will only extend to the proven damages.63

4. Fixed-Term Agreements Renewal Generally, when the agreement comes to the expiration of its term, it is terminated and no further liability exists for either party because neither party relied on the contract renewal. Therefore, they should have fore- seen that any investment they may have made might be useless after termination (at least, with relation to the contract at hand) and, therefore, assumed the business risk that the contract may not be renewed.64 Nonetheless, two circumstances should be noted: (i) The party in the weaker position may claim that, even if the contract had a fixed term, consecutive fixed-term agreements or continuing an expired contract without a formal renewal have created an indefinite-term agreement. In that case, the franchisor may not be able to prevail under the argument that it was a fixed-term agreement. Such construction would be easier to reach if an automatic renewal provision was included in the contract. (ii) The party in the weaker position may also claim that, even if no renewal was executed, the franchisor had expressly or impliedly (through its conduct) assured the franchisee that a renewal would be entered into and that, relying on that fact, it made several investments that turned out to be useless. Because of these circumstances, it is advisable to give the franchisee notice of the termination, even if the contract is fixed-term and the terminating party is not required to do so.

5. Termination Under the New Code Contrary to the current legislation, the New Code has thoroughly regulated contractual term and termination issues. First, there is a minimum term of two years for fixed-term franchising agreements.65 Only under special circumstances may the parties agree

61. Camara ´ Nacional de Apelaciones en lo Comercial, sala B [CNCom] [National Court of Commercial Appeals of the Federal Capital, section B], 26/12/2005, “Lo- caliza Franchising Int’l S.R.L. c. Perez, ´ Marcelo F.”, La Ley [L.L.] (2006-D-25). 62. Id. 63. Camara ´ Nacional de Apelaciones en lo Comercial, sala D [CNCom] [National Court of Commercial Appeals of the Federal Capital, section D], 13/07/2000, “Dis- tricondor ´ S. A. c. Editorial Coyuntura S. A.,” La Ley [L.L.] (2000-F-524). 64. Camara ´ Nacional de Apelaciones del Trabajo, sala II [CNTrab] [National Court of Labor Appeals, section II], 26/05/1988, “Garrido, Jose ´ M. c. Intersec, S. A.,” La Ley [L.L.] (1988-E-387). 65. COD´ . CIV. Y COM. arts. 1514, 1516 (2012 Draft). 2014] FRANCHISING IN ARGENTINA 81 upon a shorter term.66 Indefinite-term agreements can only be terminated after three years.67 Any fixed-term agreement (except for those with a term shorter than three years, provided that there were special circumstances justifying the shorter term) is considered automatically renewed for one (1) year at the expiration of its original term, unless either party has terminated it with thirty days prior notice.68 As of that renewal, it will be deemed converted into an indefinite-term agreement.69 Finally, if at any moment (for indefinite-term agreements) or upon the term expiration (for fixed-term ones), any party wishes to terminate the agreement without cause, they are required to provide prior notice.70 The prior notice period shall be equal to one month per year of contractual relationship, with a maximum period of six months.71 Failure to provide notice will grant the terminated party the right to claim any lost profits to be obtained during that period.72 Finally, the contract cannot be terminated without good cause (by just one party) during the originally agreed upon term (even if termination without good cause was agreed upon in the agreement).73

III. TAXES

A. LACK OF REGULATION Similarly to the situation under contract law, there are no special tax rules for franchising agreements.74 Therefore, in order to calculate taxes over any franchising agreement and related agreements, general tax principles apply. Needless to say, that lack of regulation may produce some uncertainty for both the franchisor and franchisee.

B. BRIEF SUMMARY OF TAXES IN ARGENTINA As a federal country, taxes in Argentina are levied at three different levels: (i) national or federal, (ii) provincial, and (iii) municipal.75 (i) At the federal level, there are three major taxes: (a) income tax,76

66. Id. 67. Id. 68. Id. 69. Id. art. 1516. 70. COD´ . CIV. Y COM. art. 1522(d) (2012 Draft). 71. Id. 72. Id. 73. Id. at 1522(b). 74. This statement is based on federal level tax law. There may be some legislation at a provincial and municipal level containing special tax regulation for the franchising agreements; nonetheless, its impact on foreign investments should be negligible. 75. Tax Structure in Argentina, GLOBAL ALLIANCE OF SMES, http://www.globalsmes .org/news/index.php?funcdetail&detailid=562&catalog=29&lan=en&search_key words= (last visited Feb. 17, 2014). 76. Law No. 20628, Dec. 31, 1973, 22821 B.O. 6 (as amended) (Arg.). 82 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

(b) value added tax (VAT),77 and (c) tax on credits and debits in bank accounts (CDT).78 - The Income Tax is based on the worldwide income obtained by individuals, legal entities domiciled in Argentina (with permanent establishment in Argentina), and Argentine branches of foreign entities.79 - The VAT is levied on the sale of goods, provision of services, and importation of goods.80 Basically, it is levied upon the value added at each stage of the production and distribution chain (including purchase for final consumption). Under certain circumstances, services rendered outside Argentina that are effectively used or exploited in Argentina are deemed rendered in Ar- gentina and are therefore subject to VAT (i.e., technical assistance).81 The tax is levied on the difference between the tax- debit (the tax payable on the value added in that stage) and the tax-credit (the tax that was paid when acquiring the asset from the provider and before adding value to it).82 The general rate for this tax is 21 percent.83 - The CDT is generally levied on every credit or debit made in any checking account.84 The rate is 0.6 percent over the amount of the debit or credit and is deductible from the Income Tax.85 (ii) At the provincial level, there are two taxes worth mentioning as they are specially regulated by the provincial legislatures: (a) the Turnover Tax (tax on gross income), which is levied on the amount of gross income resulting from business activities conducted within the provincial territory, and (ii) the Stamp Tax, which is levied on written documents with economic content either executed in or having effects in the provincial territory.86 (iii) At the municipal level, there are several taxes, mostly related to advertising, security, and hygiene, and other duties related to property (i.e., land) located in the territory.87 Needless to say, this is only a summary of the main taxes that exist in Argentina, as many others exist as well. This article focuses only on the Income Tax, because of its particular importance to franchising agreements.

77. Law No. 20631, Dec. 31, 1973, 22821 B.O. 14 (as amended) (Arg.). 78. Law No. 25413, Mar. 26, 2001, 29616 B.O. 1 (as amended) (Arg.). 79. Law No. 20628 of Dec. 31, 1973. 80. Law No. 20631 of Dec. 31, 1973. 81. Id. 82. Id. 83. Id. 84. Law No. 25413 of Mar. 26, 2001. 85. Id. 86. BAKER & MCKENZIE, THE CONCISE TAX GUIDE: OVERVIEW ON TAXES IN LATIN AMERICA 1 (2012) available at http://www.bakermckenzie.com/files/Uploads/ Documents/Spain/TheConciseTaxGuideLatinAmerica.pdf. 87. See, e.g., id. at 17. 2014] FRANCHISING IN ARGENTINA 83

C. INCOME TAX 1. General Characteristics As stated above, only individuals, corporations, and branches of foreign entities are subject to income tax, on the condition that they have a permanent establishment in Argentina.88 As expected, regulations do not provide a clear definition of what exactly constitutes a permanent establishment. Non-resident individuals and legal entities without a permanent establishment are only taxed on income from Argentine sources, such as (i) assets located, placed, or used in Argentina, and (ii) activities in Argen- tina that produce an economic benefit.89 On the other hand, any taxes that a resident has paid abroad may be used (with some restrictions) as credit for Argentine taxes, but only to the extent that the foreign tax does not exceed the Argentine tax.90

2. Rates: Withholding Tax The general rate for corporate entities (such as Sociedades Anonimas and Sociedades de Responsabilidad Limitada),91 subsidiaries of a foreign entity with a domicile or permanent establishment in Argentina, and Ar- gentine branches of foreign entities is 35 percent.92 Recently, the distribution of dividends or other corporate profits has become levied on income tax at a reduced rate.93 On the other hand, any payment made by a resident to a foreign individual or entity for services deemed to be from an Argentine source is subject to a withholding tax under different rates.94 For the purposes of a franchising investment (and, of course, subject to the particular circumstances), the following rates should be taken into account (bear in mind, however, that no specific regulation for franchising agreements exists): - Services that cannot be construed as a transfer of technology have a 31.5 percent withholding tax over the amount to be paid.95 - Any trademark, know-how, or other performance that may be construed as a transfer of technology, carries a 28 percent withholding tax over the amount to be paid.96

88. Law No. 20628 of Dec. 31, 1973. 89. Id. 90. Id. 91. An equivalent for the Argentine Sociedad Anonima ´ may be found in the U.S. corporation. An equivalent for the Argentine Sociedad de Responsabilidad Lim- itada may be found in the U.S. LLC, but unlike the LLC, the Sociedad de Respon- sabilidad Limitada’s regulation comprises more mandatory provisions than the common regulation for the LLC. BAKER & MCKENZIE, LATIN AMERICAN TAX TRANSACTIONS GUIDE 10 (2012), available at http://www.bakermckenzie.com/files/ Uploads/Documents/Spain/LatinAmericanTaxTransactionsGuide%202012.pdf 92. BAKER & MCKENZIE, supra note 86, at 1. 93. Law No. 26893, Sep. 23, 2010, 32728 B.O. 2. 94. BAKER & MCKENZIE, supra note 86, at 2. 95. Id. at 3. 96. See infra, subsection 3; BAKER & MCKENZIE, supra note 86, at 2. 84 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

- Any transfer of technology that is not acquirable in Argentina carries a 21 percent withholding tax over the amount paid.97 - Any goods provided by a foreign individual or entity do not have withholding tax (however, they do have VAT and other customs duties which rates vary according to the particular circumstances). Argentina is a party to several tax treaties that impose maximum rates on the withholding of certain taxable income. But no double taxation treaty with the United States is in force. On the other hand, any contractual grossing-up provision included in the agreement is ineffective against the tax authority (although binding among the parties).

3. Transfers of Technology Act It is worth highlighting that trademark licensing and technology transfer agreements executed by either an Argentine resident as licensee or a non-resident as licensor are subject to the provisions of the Transfers of Technology Act.98 Under the regulatory decree of this Act, technology is defined as any patent, industrial model or design, and/or any other technical knowledge necessary for the manufacturing of products or the rendering of services.99 Even though prior administrative approval of these kinds of agreements is no longer required, all agreements should be registered for sta- tistical purposes with the Instituto Nacional de Propiedad Industrial (National Institute of Industrial Property) to obtain preferential rates (if it is determined that the service may be construed as technology and if it is acquirable in Argentina). Note that failure to register the agreement has no effect on its enforceability or validity.100

4. Transfer Pricing Provisions An unrelated set of provisions involves what is called transfer pricing practices, which are considered to exist when (a) an Argentine company enters into an agreement with either (i) a related foreign company, or (ii) an unrelated foreign company located in a low-tax jurisdiction, and (b) the prices agreed upon in those agreements do not reflect normal market practices (called arm’s length).101 Any agreement executed with a foreign related company or non-related company located in a tax haven is presumed not to be at arm’s

97. BAKER & MCKENZIE, supra note 86, at 2. 98. Law No. 22426, Mar. 23, 1981, 24633 B.O. 2 (as amended) (Arg.). 99. Id. 100. BAKER & MCKENZIE, DOING BUSINESS IN ARGENTINA 2–3 (2012), available at http://www.bakermckenzie.com/files/Publication/1d92b86d-3535-4780-89d2-24378 efa0735/Presentation/PublicationAttachment/e447e0cb-5fcc-43a7-93f6-24c454ab7 cb8/bk_dbi_argentina_12.pdf. 101. Law No. 25063, Dec. 30, 1998, B.O. 29053 (as amended) (Arg.). 2014] FRANCHISING IN ARGENTINA 85 length, unless proper evidence to the contrary is presented.102 This presentation is made by submitting detailed information of the agreement and market conditions, as well as supporting documentation.103

IV. LABOR ISSUES

A. INTRODUCTION Argentine labor regulations are one of the major issues any foreign investor will face. It is governed by countless special laws (such as the Labor Contract Act (LCA), a central piece of legislation)104 and regulations emerging from all three levels of the political division (federal, provincial, and municipal). Although the relationship created between the employer and the employee is technically a contract, no significant regulation on the matter is provided by the Civil or Commercial Codes. Any foreign investor should acknowledge the importance of the issue and procure special professional advice on the matter. Given that labor regulations are an enormous topic, this article will only provide a general overview of the matter, pointing out some of the legal principles and rules that govern the employment relationship, and briefly touching upon how a franchising investment would be affected by these particular rules.

B. UNEQUAL BARGAINING POWER The very foundation of Argentine labor law is premised on a simple idea: the lack of equal bargaining power between the employer and the individual employees.105 Taking this inequity into consideration, labor law is a legal instrument that tries to compensate for such inequality. In that sense, there are several general principles that shape the Argen- tine labor regulation: a) The protective principle is the very foundation of labor law. It strongly limits the effects of any agreement106 or resignation107 made by the employee when such accord is contrary to his or her legally recognized interests by the thorough labor regulations.108 Therefore, such agreement would not be enforceable against him (even if expressly agreed upon by him). b) The reality principle sets forth that whenever there is a relationship where one person acts as a working force for another in exchange

102. Id. 103. Id. 104. Law No. 20744, Sept. 29, 1974, 23003 B.O. 2 (as amended) (Arg.). 105. Id.; Arturo Bronstein, National Labour Law Profile: Republic of Argentina, INTER- NATIONAL LABOUR ORGANIZATION, http://www.ilo.org/ifpdial/information-re sources/national-labour-law-profiles/WCMS_158890/lang—en/index.htm (last visited Feb. 17, 2014). 106. Law No. 20744 of Sept. 29, 1974 art. 7. 107. Id. art. 12. 108. See generally id. 86 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

for a salary under the employer dependency, there will be an employment relationship (subject to labor law), regardless of the legal form, title or name the parties give to said relationship,109 even if the “employee” has given his or her full consent to said form.110 Therefore, signing a non-labor contract, acting as an intern, or any other of the countless ways in which employers have attempted to disguise an employment relationship in order to bypass labor regulations is of absolutely no value whatsoever. To the contrary, the relationship would still be regarded an employment relationship in every sense, and the employer may be subject to important fines.111 c) The in dubio pro operario principle provides that if doubt arises regarding the interpretation of an employee’s legal rights, the matter should be interpreted in his favor.112

C. EMPLOYMENT DURATION AND TERMINATION There are two types of employment contracts: (i) fixed-term contracts, and (ii) indefinite-term contracts. It is presumed that all employment contracts are for an indefinite term, unless the employer can prove that the parties have agreed in writing to a fixed-term contract113 (which cannot exceed five years)114 and that a special reason for it exists.115 Failure to prove such circumstance or evidence of any kind of fraud in doing so (by direct application of the reality principle) would make the contract to be regarded as an indefinite-term contract.116 The indefinite-term contract may be terminated by either the employee or the employer at any time.117 If terminated by the employer, his or her liability will depend on whether or not there was good cause for said termination (i.e., a gross violation of the employee’s duties).118 If the employer cannot prove the existence of a good cause for the termination, he is required to give the employee prior notice (the length of which would depend on the duration of the employment), as well as to pay the employee a severance package based on the employee’s highest average monthly salary (one monthly salary per every year of employment).119 Very few cases exist where an employee cannot be terminated by the sole decision of the employer (i.e., union representatives, public employees, discrimination cases, etc.). However, it is uncommon for courts to recognize those exceptional situations.

109. Id. arts. 14, 22. 110. See generally id. 111. Law No. 24.013 of Dec. 17, 1991, 27286 B.O. 10 (as amended) (Arg.) 112. Id. art. 9. 113. Id. art. 92. 114. Id. art. 93. 115. Id. art. 90. 116. Id. arts. 90, 245. 117. Id. 118. Courts have restricted the existence of good cause to a very narrow extent. There- fore, it is very difficult for an employer to prove said existence. 119. Id. art. 245. 2014] FRANCHISING IN ARGENTINA 87

D. LABOR LAW AND FRANCHISING There are no special labor law regulations for the franchising agreement. Therefore, standard labor law applies to the matter. The most important issue that affects the franchisor is whether or not it should be liable for labor claims made by the franchisee’s employees. The LCA provides a legal solution for liabilities emerging from a subcon- tractor’s employees.120 Given that no regulation exists for franchisors and franchisees, courts have often relied upon this provision to find a legal solution. Under this provision, a contractor is liable for its subcontractors’ employees’ claims if they perform labor that may be deemed to be related to the commercial activity of the contractor.121 Nonetheless, because this provision was not created for the franchising agreement, when applying the rule to this type of contract there have been two lines of judicial interpretation: (i) A broad interpretation contemplates that because the commerciali- zation by a franchisee (through its employees) ultimately benefits the franchisor and its activity, the latter should be held liable for any claim arising from the franchisee’s employees.122 According to this interpretation, there would be no logic in the franchisor’s activity if the franchisee would not commercialize its products.123 Furthermore, the existence of franchisor’s control over the activities of the franchisee also provides a basis for this interpretation.124 (ii) A narrow interpretation has considered that the provisions of the LCA regarding sub-contractors should not be applicable for franchising relations because the franchisor and franchisee are two independent contractors.125 Nonetheless, courts have ruled that whenever there is fraud (i.e., the independence of the parties is

120. Id. art. 30. 121. Id. 122. Camara ´ Nacional de Apelaciones del Trabajo, sala V [CTrab.] [National Court of Labor Appeals, section V], 18/10/2007, “Santa Clara, Mario c. L.L. y L. S.A. y Otros,” L.L.O. AR/JUR/7457/2007 (Arg.). 123. Camara ´ Nacional de Apelaciones del Trabajo, sala VII [CTrab.] [National Court of Labor Appeals, section VII], 21/09/2005, “Pereyra, Liliana Mar´ıa del Milagro c. Arista, Marcelo Daniel y otro,” L.L.O. AR/JUR/9307/2005 (Arg.); Camara ´ Na- cional de Apelaciones del Trabajo, sala VII [CTrab.] [National Court of Labor Appeals, section VII], 17/05/2007, “Serantes, Milagros J. I. c. Quinones, ˜ Julio H. y otro,” D.T. 2007 (agosto), 915 (Arg.). 124. Camara ´ Nacional de Apelaciones del Trabajo, sala II [CTrab.] [National Court of Labor Appeals, section II], 23/04/2008, “Leguizamon, ´ Pablo Javier c. Palerva S.A. y otro,” D.T. 2008 (setiembre), 778 (Arg.). 125. Camara ´ Nacional de Apelaciones del Trabajo, sala III [CTrab.] [National Court of Labor Appeals, section III], 19/02/2007, “Punta, Diego Leonardo c. Pronto Wash S.A. y otros,” L.L.O. AR/JUR/469/2007 (Arg.); Camara ´ Nacional de Apelaciones del Trabajo, sala III [CTrab.] [National Court of Labor Appeals, section III], 26/11/ 2008, “Chazarreta, Hector ´ Edgardo c. Emparte S.R.L. y otros s/ despido,” D.T. 2009 (julio) (Arg.); Camara ´ Nacional de Apelaciones del Trabajo, sala III [CTrab.] [National Court of Labor Appeals, section III], 09/03/2009, “Jamar, Mar´ıa Eugenia c. Cheek S.A. y otro s/ despido,” L.L.O. AR/JUR/8018/2009 (Arg.). 88 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

only apparent), the franchisor should be liable.126 Because the solution for this issue is not clear, the franchisor should always account for the serious possibility of being held liable for any labor claims against the franchisee. In this sense, franchisors commonly include two key provisions in the franchising agreement: (i) Indemnity provisions. Although there are no legal obstacles in agreeing upon an indemnity provision, these commitments are only as good as the franchisee’s solvency. (ii) Franchisor’s inspection and control abilities. In most franchising agreements, the franchisor has the ability to inspect the franchisee’s activity and records to prevent any future claim (because most claims come from the inaccuracy of the employee’s registration). Although this might be the only way to prevent claims, it has been ruled that including this ability also creates a duty for the franchisor.127 The New Code expressly sets forth that the franchisor-franchisee relation does not create a labor relationship among the franchisor and the franchisee’s employees (except fraud).128

E. DIRECTORS AND CORPORATE OFFICERS’ LIABILITY

Another issue that foreign franchisors should take into serious consideration is the ease with which Argentine labor courts pierce the corporate veil to find both shareholders129 and directors130 liable. Although the legal requirements and factors capable of piercing the corporate veil are no different than those under U.S. law (e.g., undercapitalization, alter ego, et cetera), the most important factor is the use of the corporate form in a fraudulent manner. Nevertheless, courts have surprisingly ruled that fail- ing to duly register an employee is equal to creating a corporation just for fraudulent acts.131

126. Camara ´ Nacional de Apelaciones del Trabajo, sala VIII [CTrab.] [National Court of Labor Appeals, section III], 17/06/2008, “Far´ıas, Alicia Cristina c. Dieta Club S.A. y otros,” L.L.O. AR/JUR/4787/2008 (Arg.); Camara ´ Nacional de Apelaciones del Trabajo, sala III [CTrab.] [National Court of Labor Appeals, section III], 28/02/ 2007, “Fernandez, ´ Mirta L. c. Aquino, Marciana y otro” (Arg.). 127. Camara ´ Nacional de Apelaciones del Trabajo, sala VI [CTrab.] [National Court of Labor Appeals, section VI], 03/04/2008, “Cegna Fichera, Walter Gaston ´ c. Supermercados Norte S.A. y otros,” L.L.O. AR/JUR/2439/2008 (Arg.). 128. COD´ . CIV. Y COM. art. 1520 (b) (2012 Draft). 129. Law No. 19550 art. 54, Apr. 25, 1972, 22409 B.O. 11 (as amended) (Arg.). 130. Id. art. 59. 131. Camara ´ Nacional de Apelaciones del Trabajo, sala III [CTrab.] [National Court of Labor Appeals, section III], 31/08/2012, “Rodriguez Varas, Cristian Mart´ın c. Go For It S.R.L. y otros s/ despido,” L.L.O. AR/JUR/45205/2012 (Arg.). 2014] FRANCHISING IN ARGENTINA 89

V. CURRENCY ISSUES

A. INTRODUCTION: HISTORICAL AND CURRENT SCENARIO Currency restrictions in Argentina are probably the most important issue for foreign investors nowadays (in addition to the problems that they regularly cause for domestic businessmen). Even though currency restrictions had been common throughout Argentine history, they are often the product of incidental circumstances because they are contrary to the sense of freedom that guides the Argentine legal system. Furthermore, currency restrictions are usually a result of underlying economic crisis. But, as recent (and not so recent) history has proven, currency restrictions never helped solving economic crises. To the contrary, they have always had the opposite effect by deepening the economic crisis and trig- gering major political crises.132 Current currency restrictions began soon after the major crisis of 2001–2002, when the government seized all private bank deposits to prevent a collapse of the banking system. The causes of this crisis may be found in the backlash created by the convertibility system enacted by the Convertibility Act in 1991133 as a response to the hyperinflation scenario that existed in the late 1980s. The Convertibility Act created a fixed exchange rate between the USD and the Argentine Peso (a currency created by said law).134 After the financial support to that system (the profits of which were generated by the privatization of state-owned national companies) ran out, no further support to exports was developed. They were diminished because of the lack of competiveness of Argentine commodities in foreign markets since their prices were attached to the USD. The system was dropped and the government was forced to deval- uate in early 2002. After the devaluation, certain currency provisions were enacted, creating the Mercado Unico´ y Libre de Cambios (Unique and Free Exchange Market), in which only authorized financial institutions are able to perform exchange operations.135 At this point, no significant restrictions

132. The most recent example of this occurred at the end of 2001, when a few days after the government decreed that all of the domestic bank deposits in US$ were to be converted into Argentine Pesos, massive public protests forced the then current president (Fernando de la Rua) ´ to resign. Hubo 18 v´ıctimas m´as en otra jornada de estallido social, CLARIN´ (Dec. 21, 2001) available at http://edant.clarin.com/ diario/2001/12/21/p-329975.htm (last visited Feb. 18, 2014). Furthermore, the last currency restrictions implemented by the current government in October, 2011 negatively impacted the current president (Cristina Fernandez de Kirchner) causing her approval ratings to drop significantly and currently causing massive public protest against her government. Michael Warren, Cristina Fernandez De Kirch- ner’s Popularity Plunges As Inflation Soars In Argentina, Polls Show, HUFFINGTON POST (May 7, 2013, 7:56 PM), http://www.huffingtonpost.com/2013/05/08/cristina- fernandez-de-kirchner-popularity_n_3231726.html?view=print&comm_ref=false. 133. Law No. 23928, Mar. 28, 1991, 27104 B.O. 1 (Arg.). 134. Law No. 23928 of Mar. 28, 1991. 135. AFIP General Resolution No. 3417/2012, Dec. 20, 2012, 32547 B.O. (as amended) (Arg.). 90 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 were made, but a simple information control process was introduced.136 Exchange operations were freely made and the exchange rate was floata- ble and solely determined by supply and demand. It was in 2009 when the government established increasingly stringent measures to slow the rate of inflation. As a preliminary note, it is important to highlight that even if all of these measures were implemented by formal executive legislation (enacted by the Argentine treasury), their final implementation and the granting of any related authorization there- upon was dependent on government officers’ final approval. However, the rules and criteria for specifically granting the authorizations were never clarified and, until now, nobody but a few government officers really understands them.

1. Non-Automatic Import Licenses In 2009, the non-automatic import licenses were created.137 Clearly violating the GATT agreement, these licenses provided that the importation of several products would only be possible after the government authorized the particular import.138 Furthermore, no clear rules of procedure were created and only importers close to the government or those who made private and informal commitments with the Industry Department were allowed to import. Most of them were eventually derogated.

2. Obligation to Liquidate Foreign Currency in the Unique and Free Exchange Market Argentine exporters of goods and services are required to bring the foreign currency paid in consideration for the exported commodities and liquidate them in the Argentine Unique and Free Exchange Market at the official rate (the importance of the official rate will be evident after reading the following sections of this article). Consequently, Argentine exporters cannot retain abroad any amount paid to them (even if they are to be used for paying for imports), and they must always repatriate them. Over the months, the terms and conditions of this repatriation became increasingly stringent.

3. Foreign Currency Transaction Consultation (FCTC) Soon after the current president was re-elected in 2011, the government implemented a system called Consulta de Operaciones Cambiarias (Foreign Currency Transaction Consultation).139

136. Id. 137. See Press Release, United States Challenges Argentina’s Widespread Use of Im- port Restrictions, Office of the U.S. Trade Representative (Aug. 21, 2012), available at http://www.ustr.gov/node/7719 (last visited Feb. 18, 2014). 138. Id. 139. AFIP General Resolution No. 3210/2011, Oct. 31, 2011, B.O. 32266, 38 (as amended) (Arg.). 2014] FRANCHISING IN ARGENTINA 91

In its original form, the system provided that if any particular entity intended to acquire foreign currency, they would have to log on to the Administracion ´ Federal de Ingresos Publicos ´ (Argentine Federal Tax Au- thority, AFIP) website and ask for real-time authorization using their tax identification number.140 After a few glitches with the online system were solved, the system proved to be effective (although inconvenient) and people with good tax standing were able to acquire USD. It could be estimated that a person would be authorized to acquire up to 60 percent of his or her salary or monthly income, although nobody really knows how this was calculated. However, given that it was required to go through this procedure in order to wire money internationally,141 it was practically impossible to send large amounts of money abroad.142 As “well” as things may have been going, in May of 2012 the online system stopped authorizing operations, even when the taxpayer had good tax standing. After a few months like that and though the possibility of buying foreign currency through the system was formally possible (though no operation was ever approved), in July of 2012143 the government finally enacted a resolution that prohibited individuals or entities from acquiring USD for what was called atesoramiento (roughly translated as “savings”). Therefore, ordinary people were no longer able to buy USD through the official market to protect their savings from inflation by converting them into hard currency (now only able to do so through the illegal market, discussed infra section 5.2).144

4. DJAI (Anticipated Imports Affidavit) The resolution took effect on January 1, 2012145 and provided that to acquire foreign currency for imports’ payments, the importer would have to file several documents with the AFIP and wait for approval.146 This requirement was independent from the need to obtain the non-auto-

140. Id. The political justification was that only people with good standing with the tax authority should be able to acquire USD and only to the extent that their tax filings would allow. 141. Id. Even if the individual already had UDS they would have to convert them into Argentine pesos and, once again, buy USD. 142. Trade Regulations, Customs, and Standards, EXPORT.GOV, http://export.gov/argen tina/doingbusinessinargentina/argentinacountrycommercialguide/traderegulations andstandards/index.asp (last visited Feb. 18, 2014). 143. Central Bank of Argentina, “A” Communication No. 5318 (Arg.). 144. Only a few exceptions were made for people who could prove that they would be travelling abroad but, obviously, the rules for this acquisition were (and remain) unclear. However, credit card payments made abroad were still possible as it was of paying the credit card bill in Argentine pesos at the official exchange rate. Nonetheless, as of October 1, 2012 a 15 percent withholding tax was added to that payment and, after a few months, it was increased to 20 percent (currently, is 35 percent). Although AFIP eventually restored the individuals’ ability to acquire foreign currency for savings, it can only be done for up to 20 percent of the individual’s monthly income and it is subject to a 20 percent withholding tax has to be added. 145. AFIP General Resolution No. 3252/2012, Jan. 10, 2012, 32314 B.O. 7 (as amended) (Arg.). 146. Id. 92 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 matic147 importing license referred to above. Even though many of the non-automatic importing licenses were eventually derogated, the DJAI procedure is still in force.

5. DJAS (Anticipated Services Affidavit) Enacted shortly after the DJAI, this system provides a similar procedure for any payment to be made abroad in consideration for foreign services, including consideration for trademark license agreements and royalties.148 In this case, the recipient of the services would have to file several documents with the National Central Bank in order to acquire the necessary foreign currency.149 For payments over $100,000 USD in one year or over $10,000 USD in a single payment, the National Central Bank’s authorization is needed. For lower payments, only the filing is needed (which itself is rather troublesome, even if no authorization is needed).150

6. Dividend Payments for Foreign Shareholders By the end of 2012, the currency restrictions for wiring dividends abroad (both for branches of foreign entities as well as subsidiaries) were formalized (even if it was rather difficult to send dividends abroad prior to this, no formal legislation was enacted).151 Once again, there is a filing procedure with the National Central Bank and in every case, an authorization from it is needed.152 Before this regulation, the National Central Bank required the filing of several documents and in order to get final approval, an email had to be sent (to a Gmail address, which further demonstrates the informality of the system). Currently, even if the procedure is duly completed, no authorization of this kind is practically granted.

B. THE CREATION OF THE INFORMAL (AND ILLEGAL) EXCHANGE MARKET The enactment of these restrictions (mostly the FTCT) led to the creation of an informal market (called the “blue market”) where both people and entities would resort to acquiring foreign currency without complying with the hard and practically impossible requirements.153 This market is completely illegal.154 Nonetheless, the exchange rate for this market is

147. Id. Contrary to an “automatic license,” the non-automatic license depends on a particular government approval. 148. AFIP General Resolution No. 3276/2012, Feb. 22, 2012, 32343 B.O. 8 (as amended) (Arg.). 149. Id. 150. Id. 151. AFIP General Resolution No. 3417/2012, Dec. 20, 2012, 32547 B.O. (as amended) (Arg.). 152. Id. 153. Patrick J. McGinnis, Meanwhile, In Argentina The Black Market Dollar Exchange Has 17,000 Facebook Likes, BUSINESS INSIDER, http://www.businessinsider.com/ argentina-black-market-dollar-exchange-2013-6 (last visited Feb. 18, 2014). 154. Id. 2014] FRANCHISING IN ARGENTINA 93 commonly publicized in newspapers and even an app for the iOS was developed to provide updated rates.155 Currently, the difference between the official market and the blue market is about 70 percent and it continues to increase with every new currency restriction implemented by the government.156 Nonetheless, individuals still buy USD in this market since they prefer to save in USD rather than in Argentine pesos.157 On the other hand, it is worth mentioning that, even though this is an illegal market, most prices and inflation are attached to this rate rather than the official rate.

C. CONSEQUENCES FOR THE FOREIGN INVESTOR/FRANCHISOR The consequences for the foreign investor/franchisor are evident. Any prospective franchisor thinking about investing should be aware that it would very difficult to take any profits from the Argentine business venture. If those profits are to be sent abroad by way of royalty payments, they would have to comply with the DJAS procedure and, if over $100,000 USD, they would have to wait (for a long time) for the National Central Bank authorization. If those profits are to be sent abroad by way of dividends, they would have to wait for an authorization that will never come. In addition, if they are to import goods they may have to comply with the DJAI and, if applicable, with the non-automatic license import. Re- garding this issue, a case involving Starbucks Coffee Company was fa- mous. After running out of their original stock for the classic Starbucks cups, Starbucks had to use domestically-manufactured cups (of a clearly inferior quality) because they were unable to import to correct ones.158 Even if after considering these restrictions, a foreign franchisor would still be willing to invest in Argentina, he would have to send the foreign investment though the official market and receive the equivalent amount of AR$ according to the official rate. However, his investment would not be as cost efficient as it could be (because most of the prices in Argentina are attached to the blue rate) because this rate does not reflect the actual value of the money.

VI. CONCLUSION: WHAT THE FUTURE LOOKS LIKE FOR FOREIGN INVESTMENTS IN ARGENTINA Investing in Argentina is, at least for now, unclear. Even if the differences between the Argentine legal system and the U.S. legal system are

155. DefconSolutions, Dolar Blue Argentina, ITUNES PREVIEW, https://itunes.apple.com /us/app/dolar-blue-argentina/id642099328?mt=8 (last visited Feb. 18, 2014). 156. See, e.g., McGinnis, supra note 164. 157. Because of inflation rates exceeding 25 percent per year. Argentina’s Dollar Tour- ists: A Vacation From Inflation, THE ECONOMIST (May 16, 2013), available at http:/ /www.economist.com/blogs/americasview/2013/05/argentinas-dollar-tourists. 158. Starbucks pidio ´ “disculpas” por las primeras disculpas, LA NACION´ (July 17, 2012), available at http://www.lanacion.com.ar/1491119-starbucks-pidio-disculpas-por-las- primeras-disculpas. 94 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 no reason to frighten a foreign franchisor (because they are far more wel- coming than many other legislations), the current currency restrictions, though incidental and hopefully temporary, make foreign investment difficult nowadays. By enacting these restrictions, the current government has closed the door for foreign investments in general and foreign franchisors in particular. Minor franchisors who have already invested in Argentina are currently leaving the country. Major franchisors with huge investments in Argentina are trying to keep them just to avoid the enormous losses that leaving the country would entail, hoping that the situation will eventually change. Surprisingly, they are taking the opportunity to expand their businesses while waiting for a regulatory change because they are not distributing their profits. Nonetheless, political and economic analysts foresee that any candidate supported by the current government159 will probably fail to be elected as president in the next presidential election. Although the ruling government did not lose the control of the National Congress after the 2013 legislative elections, they have certainly lost a great deal of political power. Thus, it is yet to be seen what the government’s approach will be during the upcoming two years until the 2015 presidential elections.

159. The current government started in 2003, when Nestor Kirchner was elected as president. It currently continues with his wife, Cristina Fernandez, as president. Given that the Argentine Constitution prevents a person from being elected for more than two consecutive terms, she cannot be elected as president in 2015. Ar- gentina Midterm Elections Expected To Deliver Blow To Cristina Fernandez, THE GUARDIAN (Oct. 27, 2013), available at http://www.theguardian.com/world/2013/ oct/27/argentina-midterm-elections-cristina-fernandez. UPDATE: FRANCHISING IN BRAZIL

Kitty McGahey*

I. INTRODUCTION

RAZIL has a well-established franchise market and a strong economy—the strongest in South America.1 Its economy is characterized by, among other things, a well-developed services sector B 2 and a low unemployment rate. The franchise market, considered one of the world’s largest and most sophisticated,3 has in recent years consistently grown faster than the overall Brazilian economy.4 The downside is that foreign franchisors face serious competition from established domestic products; local franchisors hold approximately 90 percent of the market.5 But, the upside is a mature consumer base accustomed to and prepared for franchise products.6 Foreign franchisors, especially from the United States, are gaining traction in Brazil.7 This update outlines the requirements under Brazilian law for establishing a franchise agreement. It also highlights a couple other considerations when establishing a franchise in Brazil: the benefits of arbitration

* Katherine “Kitty” McGahey maintains a general litigation practice. She received her law degree from Southern Methodist University Dedman School of Law in 2013, where she was a member of the SMU Law Review Association working on both the SMU Law Review and Journal of Air Law & Commerce. While in law school, she also served as a volunteer intern for the Honorable Catharina Haynes of the U.S. Court of Appeals, 5th Circuit. She earned her undergraduate degree in Physics from Purdue University. 1. Brazil is a federal republic governed by civil law; the official language is Portu- guese. CENT. INTELLIGENCE AGENCY, Brazil, THE WORLD FACTBOOK, https:// www.cia.gov/library/publications/the-world-factbook/geos/br.html (last updated Feb. 26, 2014). 2. Id. 3. PAULO RODRIGUES, U.S. COMMERCIAL SERV., BRAZIL: FRANCHISING (2011); see also BRAZILIAN FRANCHISE ASSOCIATION, ECONOMIC IMPACT IN BRAZIL REACHES NEW HEIGHTS IN 2010 (2011) available at http://www.franchise.org/ uploadedFiles/Economic%20Impact%20in%20Brazil%20Reaches%20New%20 Heights%20in%202010.pdf. 4. Kristin Houston, U.S. Commercial Service to Franchisors: Seize the Trends and Grow Globally, FRANCHISING WORLD, Mar. 2011, at 15, available at http:// www.franchise.org/Franchise-Industry-News-Detail.aspx?id=53749; see also MFV Franchise Expo., The Brazilian Political-Economic Scenario and the Reflexes in the Growth of the Franchise Market, NASDAQ (Mar. 28, 2013), http://www.nasdaq.com/ article/the-brazilian-politicaleconomic-scenario-and-the-reflexes-in-the-growth-of- the-franchise-market-cm231758. 5. RODRIGUES, supra note 3. 6. In addition, the number of young Brazilians (ages eighteen to twenty-four) “who became entrepreneurs . . . rose 74 percent between 2002 and 2010.” Franchises in Brazil, EZ BRAZIL (Nov. 6, 2012), http://ezbrazil.com/franchises-in-brazil/. 7. Houston, supra note 4.

95 96 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 for Brazilian franchise agreements and the presence of a strong national franchise association.

II. REQUIREMENTS

A. DISCLOSURE LAW Brazil has an established body of franchise law (“Franchise Law”), unlike most South American countries.8 Common Law No. 8955 of Decem- ber 14, 1994 is a pure disclosure law, with no specific registration requirements,9 and applies to any franchise system installed or operated in Brazil.10 Under the law, a franchisor is required to deliver to a prospective franchisee a written disclosure at least ten days prior to the execution of a franchise agreement or payment of any fee.11 The franchise agreement is also regulated under the intellectual property law which does have specific registration requirements, as discussed below.12 A franchise is defined as a system, which is not characterized as employment,13 in which “franchisors grant franchisees . . . the right to use a trademark or patent . . . in exchange for . . . direct or indirect remuneration.”14 The system includes “exclusive or semi-exclusive distribution rights for products or services” and may also include the right to use business deployment and administration technology, or operating systems developed by the franchisor.15 The term franchisor includes a sub- franchisor, such as a master franchisee.16 Because a master franchisee’s primary role is to build and support a network of franchises within the country, or a region of the country, the master franchisee is, in effect, a

8. See Mary-Ellen Wayne, Review, The Five Stones: Bill 15, The Franchises Act, 35 MAN. L.J. 135, 159 (2012) (listing franchise laws in the South American countries of Brazil and Venezuela). 9. Lei No. 8.955 de 15 de Dezembro de 1994 [Law No. 8.955 of December 15, 1994], DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 16.12.1994 (Braz.), available at http:// www.planalto.gov.br/ccivil_03/Leis/L8955.htm. 10. Id. art. 8. 11. Id. art. 3–4. 12. Lei No. 9.279 de 14 de Maio de 1996 [Law No. 9.279 of May 14, 1996], DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 14.5.1996 (Braz.), available at http:// www.planalto.gov.br/ccivil_03/Leis/L9279.htm. 13. An employee is one in a position of subordination who continuously renders service to the employer for a wage. The characteristics of an employment relationship are: individual (work is performed solely by employee), continuous (i.e. not occasional), compensation (for services rendered), and subordinate. Subordina- tion is the critical characteristic, however, and is determined by how the relationship of the parties develops in the regular course of business. The individual is subordinate to an employer when the employer instructs the individual in how to do the work, directs and supervises the work, including how and when the work is to be performed, and has the ability to penalize the individual for non-compliance. RENE´ GELMAN & RODRIGO D’AVILA MARIANO, Brazil, in GETTING THE DEAL THOUGH - FRANCHISE 2013 25, 27 (Philip F. Zeidman, et al. eds., 2013), available at http://www.franchise.org/uploadedFiles/F2013%20Brazil.pdf. 14. Id. 15. Id.; see also Law No. 8955 of December 15, 1994, art. 2. 16. Id. art. 9. 2014] UPDATE: FRANCHISING IN BRAZIL 97 franchisor in its region.17 The sub-franchisor is, therefore, subject to the same disclosure requirements as the franchisor. The franchisor must prepare a written franchise offering circular, or franchise disclosure document (FDD), that is in clear and accessible language.18 The FDD must contain the following fifteen items:19 1. The complete name of the franchisor and all related companies, as well as respective trade names; addresses for each named company; the business form; and a brief history; 2. Financial statements and balance sheets for the past two years;20 3. Precise description of all pending litigation, worldwide, related to the franchise system which may affect the continuation of the franchise business. This includes suits involving the franchisor, related companies such as controlling companies or sub-franchisors, and owners of licensed trademarks, patents, and copyrights;21 4. Detailed description of the franchise with a general description of the business activities to be performed by the franchisee; 5. Detailed description of the “ideal franchisee,” including education and experience, as well as mandatory and preferred characteristics; 6. Requirements for the franchisee’s direct involvement in the operation and administration of the business; 7. Total estimated initial investment for acquisition, installation, and startup of franchise operations; amount of initial fees (membership, affiliation, franchise fee, security deposit, guaranty, etc.); estimated value of the premises, equipment, and initial stock; and payment terms; 8. Clear information on any periodic fees or other amounts payable by the franchisee to the franchisor or a third party, with a description of the rights, products, or services for which the fees are paid. The information must include any relevant calculations or formu- lae, and specifically indicate: o Royalties—periodic compensation for use of the system, the trademark, or services provided by the franchisor; o Equipment rental or lease of premises;

17. See Catherine A. Riesterer, Structuring the Contractual Relationship, in FUNDA- MENTALS OF INTERNATIONAL FRANCHISING 37, 48 (Richard M Asbill & Steven M. Goldman, eds., 2001). 18. Law No. 8.955 of December 15, 1994, art 3. 19. See Law No. 8.955 of December 15, 1994, art 3. 20. There is no requirement in the law for the financial statements to be audited. See id.at art 3(II); LUIZ HENRIQUE DO AMARAL, CANDIDAˆ RIBEIRO CAFFE´ & CAMILA COSTA DE CASTRO SILVA, BRAZILIAN FRANCHISE ASSOCIATION, GUIDELINES FOR THE RECORDAL OF FRANCHISE AGREEMENTS IN BRAZIL 3 (2011) [hereinafter GUIDELINES]. 21. Examples include breach of contract claims by former franchisees, claims that the franchise relationship is a fraud or a labor relationship, claims of intellectual property infringement, or bankruptcy proceedings against the franchisor. GUIDELINES, supra note 20, at 3. 98 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

o Advertising fee, or any similar payment; o Minimum insurance, and any other amounts owed that are linked to it; 9. Complete list of all franchisees, sub-franchisees, and sub- franchisors, including any that left the system within the last twelve months, with name, address, and phone number; 10. Whether the franchisee is guaranteed exclusivity or right of first refusal in any particular territory or activity and, if so, under what conditions; whether the franchisee will have the right to sell products or provide services outside its territory or outside of Brazil; 11. Detailed information regarding franchisee’s requirement to purchase goods, services, or materials deemed necessary for establishment, operation, or management of the franchise from suppliers designated and approved by the franchisor, including a complete list of those suppliers; 12. Description of products and services offered by the franchisor to the franchisee with respect to: o Supervision of the chain; o Orientation or guidance in how to operate the business, and other services to the franchisee; o Franchisee training, including content, duration, and cost; o Training of franchisee’s employees; o Franchise manuals; o Assistance with analysis and selection of location for franchise; o Layout and architectural plans for the facility; 13. Status of National Institute of Industrial Property (INPI) registration for any trademarks or patents franchisee will be authorized to use; 14. Existence of post-agreement non-disclosure requirements for trade secrets or business knowledge the franchisee will have access to during the operation of the franchise, as well as post-agreement non-compete requirements; 15. Model standard franchise agreement and a standard preliminary franchise agreement,22 if applicable, with full text, including ex- hibits and expiration dates. The franchisor must deliver the FDD to the prospective franchisee at least ten days prior to signing either a preliminary or final franchise agreement, or receiving any fee payment.23 There is no requirement in

22. It is not unusual to execute a preliminary franchise agreement even before the franchisee’s legal entity is formed. After the entity is formed, the preliminary agreement is replaced with the final franchise agreement, executed with the newly formed entity. GELMAN & MARIANO, supra note 13, at 29. 23. Id. art. 4 (discussing that after initial disclosure, there is no requirement to provide ongoing disclosures). 2014] UPDATE: FRANCHISING IN BRAZIL 99 the Franchise Law that the document be in Portuguese.24 If the franchisor does not allow the franchisee the ten-day evaluation period, any contract that is signed is voidable by the franchisee and all sums25 paid by the franchisee must be returned.26 The franchisee may also be in entitled to damages.27 In addition, if any information in the FDD is false, criminal sanctions may also apply.28 The Franchise Law is purely a disclosure law, i.e., it does not contain any relationship provisions.29 There is no requirement for on-going disclosure, only to deal in good faith.30 All other aspects of the franchisor- franchisee relationship are governed by principles of both contract law and civil law.31 For example, there are no specific clauses governing the termination of the franchise agreement; instead, “in general, the Civil Code allows either party to terminate [the] contract upon breach by the other party.”32 And, under Brazilian law, no one is obligated to remain in a contract relationship with someone else.33 Under the principles of contract law, the parties are free to negotiate the renewal and termination terms as they see fit.34

B. REGISTRATION Although the Franchise Law is a pure disclosure law, there are three registration and recording requirements to complete the franchise agreement.35 First, the intellectual property—trademark or patent—that is licensed in the franchise agreement must be properly registered with the

24. Because the law does require the FDD be in clear and comprehensible language, it is a best practice to either deliver the document in Portuguese or have the prospective franchisee execute and acknowledgement that the signatories are fluent in the language in which the FDD is written. See Luiz Henrique O. Do Amaral, Moshe B. Sendacz & Eduardo Turkienicz, Brazil, in INTERNATIONAL FRANCHISE SALES LAW S 18 (Andrew P. Loewinger & Michael K. Lindsey, eds., 2006). 25. Sums are adjusted for inflation based on the interest rate of official savings accounts during the period. See id.; see also GELMAN & MARIANO, supra note 13, at 29. 26. Law No. 8.955 of December 15, 1994, art. 4. 27. Id. Damages can include compensatory, consequential (lost profits), and “moral damages” (an equivalent to pain and suffering). While punitive damages are not specifically allowed, courts have discretion to adjust moral damages to account for “bad behavior.” GELMAN & MARIANO, supra note 13, at 30. 28. Id. art 7. 29. See generally Law No. 8.955 of December 15, 1994. 30. Id. 31. Id.; see also Amaral et al., supra note 24, at 18 (“The terms of the contract and the relationship between the Franchisor and Franchisee may be freely stipulated by the parties . . . .”). 32. GELMAN & MARIANO, supra note 13, at 30. 33. See id. (“Brazilian law does not impose specific limitations on a franchisor’s ability to terminate a franchise relationship; nor does it list specific event in which it may occur.”). 34. See id. at 31. 35. There are other registrations that may be required under Brazilian law. For example, the transfer of real estate must be registered with the Real Estate Registry for the jurisdiction. Id. at 27. This update addresses only the registrations necessary to properly put a franchise agreement in place. As always, consultation with local counsel is advised. 100 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

INPI.36 Second, the franchise agreement itself must be recorded with the INPI.37 Finally, the franchise agreement must be registered with the Cen- tral Bank of Brazil.38

1. Registration and Protection of Trademark39 Any trademarks that will be part of the franchise agreement must be registered with the INPI, Brazil’s patent and trademark office, in order to be valid and the rights enforceable.40 An application consists of a filing request, prints of the mark, and proof that the applicable fees have been paid.41 The original application does not have to be in Portuguese, but a translation must be submitted within 60 days of filing.42 A foreign applicant must appoint a qualified Brazilian agent and the agent must be retained during the entire registration process.43 The power of attorney for the agent also must be filed, in Portuguese, within 60 days.44 The agent will represent the applicant both administratively and judicially.45 Registrations are valid for ten years and renewable for subsequent ten- year periods during the last year of the current registration.46 There is an automatic six month grace period, however, upon expiration of the registration period, subject to a fee surcharge.47 Brazilian law does not require use in order to file, nor does it require continued use to maintain the registration.48 But, a registration may be subject to cancellation for non-use if the mark is not used within five years, or if it is not used for any five consecutive years during the registration period.49 A request for cancellation may be brought by any person having a legitimate interest, which can include the INPI.50 The owner will maintain the registration, however, if it can provide legitimate reasons for the lack of use.51 Brazil is a contracting party to the Paris Convention which provides priority and protection for international marks.52 Under the Paris Con-

36. Id. at 30. 37. Id. 38. Id. 39. Because a franchise system usually involves trademarks as opposed to patents, a discussion of Brazilian patent law is beyond the scope of this article. 40. See generally Lei No. 9.279 de 14 de Maio de 1996 [Law No. 9.279 of May 14, 1996], DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 14.5.1996 (Braz.). 41. Id. art. 155. 42. Id. 43. Id. art. 217. 44. Id. art. 216. 45. Id. art. 217. 46. Id. art. 133(1). 47. Id. art. 133(2). 48. Id. art. 133. 49. Id. at art. 143. 50. Id.; see also BRA-6 ETHAN HORWITZ, WORLD TRADEMARK LAW & PRACTICE § 6.05 (Mathew Bender, Rev. Ed. 2012) (discussing non-use cancellation). 51. Lei No. 9.279 de 14 de Maio de 1996 [Law No. 9.279 of May 14, 1996], DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 14.5.1996 art. 143 (Braz.). 52. See Paris Convention for the Protection of Industrial Property arts 1, 4, Mar. 20, 1883, 21 U.S.T. 1583, 828 U.N.T.S. 305, available at http://www.wipo.int/treaties/en/ text.jsp?file_id=287556 [hereinafter Paris Convention]. Brazil became a con- 2014] UPDATE: FRANCHISING IN BRAZIL 101 vention, the owner of a foreign mark, registered in a member country, can apply for protection of its mark in any other member country.53 For example, if the Brazilian application is made within six months of the original foreign application for registration, the Brazilian application will be treated as if it was filed on the same day as the foreign application.54 Especially important for foreign franchisors, the Paris Convention also provides protection for well-known marks.55 When a mark is well-known in a member country, regardless of whether it is registered or even used in that country, no conflicting mark can be registered in that country. The owner of a well-known mark can challenge a registration and, under the Paris Convention, the conflicting registration must be denied or cancelled. This applies when the conflicting mark is used, registered, or filed for identical or similar goods.56 Intellectual property protection is also available through the World Trade Organization (WTO). Brazil became a member of the WTO on January 1, 1995.57 Membership in the WTO carries with it compliance with the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS).58 TRIPS is the product of the Uruguay Round of WTO negotiations and was signed in April of 1994.59 There are three main parts to TRIPS: standards, enforcement, and dispute resolution.60 The parties took—as a starting point—the main conventions of the World In- tellectual Property Organization (WIPO): the Paris Convention and the Berne Convention. All of the substantive obligations of those conventions are incorporated by reference into TRIPS, which then goes on to add additional obligations to complete the standards section. The set of enforcement provisions defines general principles for domestic enforcement procedures for all members. It specifies with a degree of detail the civil, administrative, and criminal procedures and remedies that must be available to intellectual property owners. And finally, TRIPS-related dis-

tracting party to the Paris Convention on July 7, 1884. The United States became a contracting party on May 30, 1887. See Contracting Parties, WORLD INTELLEC- TUAL PROP. ORG., http://www.wipo.int/export/sites/www/treaties/en/documents/ pdf/paris.pdf. 53. Paris Convention, supra note 52, art. 4. 54. Id.; see also WIPO INTELLECTUAL PROPERTY HANDBOOK 243 (2d ed. 2004), available at http://www.wipo.int/export/sites/www/freepublications/en/intproperty/489/ wipo_pub_489.pdf [hereinafter HANDBOOK]. 55. Paris Convention, supra note 52, art. 6bis. 56. HANDBOOK, supra note 54, at 252; see also Law No. 9279 of May 14, 1996, art. 126. 57. Members and Observers, WORLD TRADE ORG. [WTO] (Mar. 2, 2013), http:// www.wto.org/english/thewto_e/whatis_e/tif_e/org6_e.htm. The United States of America became a WTO member on the same date. Id. 58. Trade-Related Aspects of Intellectual Property Rights, WTO, http://www.wto.org/ english/docs_e/legal_e/27-trips_01_e.htm (last visited Mar. 6, 2014) (“The TRIPS Agreement is Annex 1C of the Marrakesh Agreement Establishing the World Trade Organization signed in Marrakesh, Morocco on 15 April 1994.”). 59. WTO Legal Texts, WTO, http://www.wto.org/english/docs_e/legal_e/legal_e.htm (last visited Mar. 6, 2014). 60. See Agreement on Trade-Related Aspects of Intellectual Property Rights, Apr. 15, 1994, Marrakesh Agreement Establishing the World Trade Organization, Annex 1C, Legal Instruments—Results of the Uruguay Round, 33 I.L.M. 1125 (1994). 102 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 putes between WTO members are subject to the settlement procedures of the WTO.61

2. INPI Recordation of the Franchise Agreement

Recording the franchise agreement with the INPI is not required, but is highly recommended.62 Recordation enables the agreement to be enforceable against third parties, allows for tax deductions, and permits payments to be remitted to the foreign franchisor.63 In addition, it serves as prima facie evidence of Brazilian antitrust compliance.64 Either the foreign franchisor or the local franchisee must file the following documents:65 • Franchise Agreement: The original and two certified copies along with a Portuguese translation. The agreement must be executed by all parties indicating the place and date of execution. Two witnesses are required for filing; parties’ and witnesses’ initials must be on each page. If the franchise agreement is executed outside of Brazil, it must be signed before a notary public and legalized at a Brazilian Consulate. The full name and title of all representatives is required and, if any representative is an attorney, a duly notarized and legalized power of attorney must also be included. • INPI Forms as specified on its website66 accompanied by a cover letter.67 • Statement of Delivery: A document executed by the franchisee at least ten days before the execution of the Franchise Agreement or the payment of any fees indicating that the franchisee received the required FDD in accordance with the Franchise Law.68

61. Overview: The TRIPS Agreement, WTO, http://www.wto.org/english/tratop_e/trips _e/intel2_e.htm (last visited Mar. 6, 2014). 62. See Guia Básico–Contratos de Tecnologia [Basic Guide–Technology Contracts], INPI (Oct 3, 2013, 3:22 PM), http://www.inpi.gov.br/portal/artigo/guia_basico_ contratos_de_tecnologia [hereinafter Basic Guide]. 63. Id. Limitations on remittances are controlled by Regulation No. 436/58, and “vary between 1 percent and 5 percent . . . depending on the field.” GUIDELINES, supra note 20, at 5. 64. Candida ˆ Ribeiro Caffe, ´ Franchising in Brazil, FRANCHISING WORLD, Mar. 2008, at 28, available at http://www.franchise.org/franchise-news-detail.aspx?id=38426. The INPI has the authority to identify potential antitrust violations in intellectual property contracts. Id. 65. GUIDELINES, supra note 20, at 7; Caffe, ´ supra note 64, at 30–31; Documentos Necessários [Necessary Documents], INPI, http://www.inpi.gov.br/images/docs/ documentos_necessarios__cgtec.pdf (last visited Mar. 6, 2013) (discussing Franchise Law documentation requirements). 66. See Downloads de Formulários para Pedidos Protocolados em Papel no INPI [Downloads of Forms for Paper Claims Filed with the INPI], INPI, http://www. inpi.gov.br/portal/artigo/downloads_de_formularios_para_pedidos_protocolados_ em_papel_no_inpi (last updated Feb. 11, 2014) (listing forms required to comply with the Franchise Law). 67. See Necessary Documents, supra note 65 (discussing cover letter requirements). 68. GUIDELINES, supra note 20, at 7. 2014] UPDATE: FRANCHISING IN BRAZIL 103

• Power of Attorney for registered agent. This document does not have to be legalized by the Brazilian Consulate for agreements executed outside of Brazil. The FDD, itself, is not required for recordation, only a Statement of Delivery. This is important because the recordation documents are part of the public record, but the FDD remains private. The Statement should include a declaration by the franchisee that the FDD was received in accordance with the Franchise Law.69 By law, the INPI has thirty days to issue a decision regarding the recordation.70 Sources report, however, that the process can take longer.71 The examination focuses on the validity and identification of the trademarks, the applicable rate for tax deductibility, and remittances.72 Once the documents are accepted by the INPI, it will issue a Certificate of Recordal that will be valid as of the date of filing.73 Remittances are allowed as of this date, but not before.74

3. Central Bank of Brazil

Brazil has a strong central bank that requires approval prior to remittances of foreign currency abroad.75 The recorded franchise agreement must be filed with the Central Bank of Brazil before the foreign franchisor can receive payments from the Brazilian franchisee.76 Unlike the INPI recordal process, this registration is simple and is usually completed in about two days.77 All remittances abroad require registration with the Bureau of Currency and Credit (SUMOC) and proof of income tax payment.78 Note, however, that the United States and Brazil do not have a treaty in place against double taxation.79

69. GUIDELINES, supra note 20, at 3. 70. Lei No. 9.279 de 14 de Maio de 1996 [Law No. 9.279 of May 14, 1996], DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 14.5.1996 art. 211 (Braz.). 71. Caffe, ´ supra note 64, at 30; GUIDELINES, supra note 20, at 6. 72. See Caffe, ´ supra note 64; GUIDELINES, supra note 20, at 5. 73. GUIDELINES, supra note 20, at 6. 74. Id. There is an exception for Agreements presented within sixty days of execution. In this case, the Certificate is valid from the execution date. Id. 75. Joyce Mazero, Impact of Other Local Laws, in FUNDAMENTALS OF INTERNA- TIONAL FRANCHISING 216, 224 (Richard M. Asbill & Steven M. Goldman, eds., 2001). 76. Lei No. 4.31 de Setembro de 1962 [Law No. 4.131 of Sepember 3, 1962], DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 3.9.1962 art. 11 (Braz.), available at http://www .planalto.gov.br/ccivil_03/Leis/L4131.htm; Mazero, supra note 75, at 223. 77. GUIDELINES, supra note 20, at 6. 78. Law No. 4.131 of September 3, 1962, art. 9 § 1. 79. United States Income Tax Treaties – A to Z, IRS (last updated Oct. 21, 2013), http:/ /www.irs.gov/Businesses/International-Businesses/United-States-Income-Tax- Treaties—-A-to-Z. Note: a complete discussion of Brazilian tax law is beyond the scope of this update. 104 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

III. CONSIDERATIONS

A. ARBITRATION While the franchise agreement is registered with the INPI and the Cen- tral Bank of Brazil, there is no entity that has specific jurisdiction over the agreement. If a dispute arises, it will be handled as any other breach of contract issue: in the courts or through arbitration.80 In international disputes, arbitration is usually the mechanism of choice.81 And, in Brazil, it is a good option. Brazil accessioned to the New York Convention effective September 5, 2002.82 Under the New York Convention, parties have the assurance that an arbitration award will be recognized and enforced by the courts of member nations. Arbitration will be recognized as the only forum for dispute resolution if the franchise agreement so specifies.83 Brazil, along with the United States and most South American countries, is also a signatory of the Inter-American Convention on Interna- tional Commercial Arbitration, or Panama Convention.84 Unlike the New York Convention, the Panama Convention expressly states which rules will govern if the Agreement does not specify the arbitration rules.85 Under U.S. law, if both the New York and Panama Conventions apply, the Panama Convention will govern when a majority of the parties are citizens of OAS member states.86

B. BRAZILIAN FRANCHISE ASSOCIATION (ABF)87 One of the significant benefits of franchising in a well-established market such as Brazil, is the existence of a strong franchise association. The ABF is a non-governmental, nonprofit organization, established in 1987. Its membership is comprised of franchisors, franchisees, and employees. It conducts national and international activities such as symposia, semi- nars, meetings, and training. It has even created an MBA course in Franchising in Latin America. It is a member of the International

80. GELMAN & MARIANO, supra note 13, at 29. 81. Roger Schmidt & Joyce Mazero, Legal Enforcement of International Franchise Re- lationships: What Makes Sense for the Business, FRANCHISING WORLD, Mar. 2008, at 24 available at http://www.franchise.org/franchise-news-detail.aspx?id=38406. 82. New York Convention Countries, N. Y. ARB. CONVENTION, 2009, http://www.new yorkconvention.org/contracting-states/list-of-contracting-states. The United States of America accessioned effective Dec. 29, 1970. Id. 83. Eric B. Wulff, Dispute Resolution: Choice of Law and Forum, in FUNDAMENTALS OF INTERNATIONAL FRANCHISING 305, 312 (Richard M. Asbill & Steven M. Goldman, eds., 2001). 84. Inter-American Convention on International Commercial Arbitration, ORG. OF AM. STATES, http://www.oas.org/juridico/english/sigs/b-35.html (last visited Mar. 6, 2014). 85. Inter-American Convention on International Commercial Arbitration art. 3, Jan. 30, 1975, 1438 U.N.T.S. 245, available at http://www.oas.org/juridico/english/ treaties/b-35.html (last visited Mar. 6, 2014). 86. 9 U.S.C. § 305 (2006). 87. ASSOCIAC ¸ AO˜ BRASILEIRA DE FRANCHISING, http://www.portaldofranchising.com .br/ (last visited Mar. 6, 2014). 2014] UPDATE: FRANCHISING IN BRAZIL 105

Franchise Association and founding member of the World Franchise Council. It offers many publications on franchising and guides to franchising in Brazil. Most importantly, the ABF has a Code of Ethics in place that applies to all members.

IV. CONCLUSION Brazil is an excellent choice for foreign franchisors, and from a technical standpoint, is a relatively easy market to enter. The country has a Franchise Law, and it has been in effect for almost twenty years. There is proper protection in place for intellectual property rights. And registration requirements are minimal. Brazil is a signatory to most major international conventions that would be of interest in protecting the rights of a foreign franchisor. Because of its strong, well-established franchise market, the economic opportunities are significant. This update outlines the basic requirements for establishing a franchise relationship in Brazil. But, as is the case with any foreign franchise operation, the use and advice of local counsel is an absolute requirement. 106 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 FRANCHISE LAW I N CHILE: CURRENT ISSUES AND FUTURE OUTLOOK

Guillermo Carey,* Tim R. Samples,** Paulina Silva***

INTRODUCTION Franchising in Latin America gained momentum in the late 1980s with an influx of franchising investment, primarily from the United States.1 Foreign investment in franchising first swept through the largest economies in the region, Brazil and Mexico, before turning to Argentina and Chile.2 In the decades that followed, the franchising industry diversified and consolidated across the region. More recently, with the emergence of middle-class consumers across the region, Latin America has attracted a new wave of franchising investment.3 The character and record of franchise law are well established in academic literature.4 An immensely popular practice with its origins in contract law, franchising has been wildly successful throughout developed economies.5 In the United States alone, franchising is responsible for $700 billion worth of goods and services, approximately 8 million jobs, and adding $400 billion to GDP.6 Some twenty-nine countries have en-

* Partner at Carey y C´ıa. and co-head of the firm’s Intellectual Property and Infor- mation Technology Group. ** Assistant Professor of Legal Studies, Terry College of Business, University of Georgia. *** Associate at Carey y C´ıa. and member of the firm’s Intellectual Property and In- formation Technology Group. 1. William R. Long, Doing Business: Latin America’s New Retailers, L. A. TIMES (November 30, 1993), http://articles.latimes.com/1993-11-30/news/wr-62354_1_ master-franchise (last visited Nov. 9, 2013). 2. Id. 3. Taylor Barnes, Franchising Boom in Latin America, LATIN BUS. CHRON. (May 29, 2012), http://www.latinbusinesschronicle.com/app/article.aspx?id=5688; REUTERS, Darden Announces Additional Franchise Deals In Latin America (July 12, 2013), http://www.reuters.com/article/2013/07/12/fl-darden-latin-amer-idUSnPNFL46284 +1e0+PRN20130712. 4. For historical accounts of franchising, see COLEMAN R. ROSENFIELD, THE LAW O F FRANCHISING 1–8 (1970); Robert W. Emerson, Franchising and the Collective Rights of Franchisees, 43 VAND. L. REV. 1503, 1506–07 (1990). For a thorough discussion of how franchising is defined, see Robert W. Emerson, Franchise Con- tract Clauses and the Franchisor’s Duty of Care Toward Its Franchisees, 72 N.C. L. REV. 905, 908 (1994). For a treatment of franchise encroachment, see Robert W. Emerson, Franchise Encroachment, AM. BUS. L.J., 191 (2010). 5. See Robert W. Emerson & Uri Benoliel, Can Franchisee Associations Serve as a Substitute for Franchisee Protection Laws?, 118 PENN ST. L. REV. 99, 100–101 (2013). 6. Id. at 101. See also IHS GLOBAL INSIGHT, FRANCHISE BUSINESS ECONOMIC OUT- LOOK: MAY 2012, available at http://emarket.franchise.org/BusinessOutlookReport 2012.pdf.

107 108 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 acted specific franchise legislation.7 Other countries, including Israel and Japan, prefer to leave the operation of franchises to their extant contract and property law.8 The business of franchising seems to thrive in either situation. With an established middle-class and a stable investment framework, Chile offers a mature market for franchising. Franchising revenues in Chile are estimated at $1.48 billion dollars per year.9 Though Chile does not have franchise-specific legislation, a variety of general commercial laws apply to franchise activities, including the Civil Code,10 Commercial Code,11 Intellectual Property Law,12 Industrial Property Law,13 and in some cases the Labor Code14 and the Consumer Protection Act.15 This article provides an overview of franchise law in Chile, identifying key legal issues and particular themes under the Chilean legal environment.

I. THE CHILEAN MARKET FOR FRANCHISING

A. THE ECONOMY OF CHILE Chile has arguably the most advanced and stable economy in Latin America.16 As of 2012, Chile’s gross domestic product was $269.9 billion with a population of 17.46 million.17 Roughly a third of Chile’s population—almost 6 million people—is concentrated in the metropolitan area of Santiago, the nation’s capital.18 With per capita income of nearly $15,000,19 the highest in Latin America, Chile was recently classified as a

7. MARK ABELL, MARCO HERO & R. SCOTT TOOP, INTERNATIONAL FRANCHISE AS- SOCIATION, IFA 45TH ANNUAL LEGAL SYMPOSIUM: ADVANCED BEST PRACTICE FOR INTERNATIONAL REGULATORY COMPLIANCE (2012), available at http://www .franchise.org/uploadedFiles/Advanced%20Intl%20Regulatory%20Compliance .pdf. 8. Emerson & Benoliel, supra note 5, at 102. 9. NICOLE PINAUD VERDE-RAMO, MERCADO DE LAS FRANQUICIAS EN CHILE [FRANCHISE MARKETS IN CHILE] 28 (2012), available at http://www.cnc.cl/ downloadfile.aspx?CodSistema=20020129172812&CodContenido=201210161810 42&CodArchivo=20121127130805. 10. See generally COD´ . CIV. (Civil Code of Chile). 11. See generally COD´ . COM. (Commercial Code of Chile). 12. See generally Law No. 17.336, Octubre 2, 1970, DIARIO OFICIAL [D.O.] (Chile). 13. See generally Law No. 19.996, Marzo 11, 2005, DIARIO OFICIAL [D.O.] (Chile). 14. See generally COD´ . TRAB. (Labor Code of Chile). 15. See generally Law No. 19.496, Marzo 7, 1997, DIARIO OFICIAL [D.O.] (Chile). 16. See Why Chile, MINISTRY OF FIN., http://www.hacienda.cl/english/investor- relations-office/why-chile.html (last visited March. 26, 2014) (“In international comparisons of competitiveness and economic freedom, Chile is at the forefront of Latin America, and despite its emerging status, ranks alongside the most developed economies in the world.”). 17. Data: Chile, THE WORLD BANK, http://data.worldbank.org/country/chile (last visited Mar. 26, 2014). 18. Chile Population 2014, WORLD POPULATION REVIEW, http://worldpopulation review.com/countries/chile-population/ (last visited Mar. 26, 2014). 19. United Nations Development Programme, Human Development Report 144 (2013), available at http://hdr.undp.org/sites/default/files/reports/14/hdr2013_en _complete.pdf. 2014] FRANCHISE LAW IN CHILE 109

“high income” country by the World Bank.20 Chile’s economy grew 5.6 percent in 2012 but cooled somewhat in 2013.21 The economy is on track to grow between 4.0 and 4.5 percent in 2013 and between 4.0 and 5.0 percent in 2014.22 Though a relatively small economy, Chile offers a mature market with an appetite for international brands. Chile has a well-established and diversified financial system compared with other countries in Latin America.23 Business regulation in Chile is stable and transparent. Chile consistently performs well in the World Bank’s international Doing Busi- ness report, ranking 34 out of 189 in the most recent rankings.24 Exclud- ing Chile, the average rank for Latin America is 76 out of 189.25

B. THE FRANCHISING INDUSTRY IN CHILE Franchising developed rapidly in Chile in the late 1980s after the arrival of United States fast-food icons like McDonald’s, Pizza Hut, and Ken- tucky Fried Chicken.26 Domestic franchises expanded during this period as well.27 Restaurants like Doggi’s and Lomiton ´ established a market share for the first time while existing franchises such as Fuenzalida Propiedades (real estate services) and Farmacias Cruz Verde (retail phar- macy) consolidated their positions.28 More recently, Chile was the first country in Latin America to open Gap retail locations.29 Interest in the Chilean market for franchising remains strong today.30 Chile’s franchise industry accounts for an estimated $1.48 billion per year in revenues.31 Franchise revenues have tripled in just eight years.32 The franchise industry provides an estimated 31,000 jobs in Chile, repre-

20. New Country Classifications, THE WORLD BANK (July 2, 2013), http:// data.worldbank.org/news/new-country-classifications. 21. Update 1-Chile Economy to Grow 4.5 pct in 2013-Finance Minister, REUTERS (Oct. 1, 2013, 10:49 AM), http://www.reuters.com/article/2013/10/01/chile-economy-id USL1N0HR0YV20131001. 22. Update 1-Chile Central Bank Cuts 2013 GDP View, 2014 Forecast Similar, RUETERS (Sept. 4, 2013, 12:35 PM), http://www.reuters.com/article/2013/09/04/ chile-bank-forecasts-idUSL2N0H011520130904. 23. See generally BANCO CENTRAL DE CHILE, FINANCIAL STABILITY REPORT: FIRST HALF 2013, available at http://www.bcentral.cl/eng/publications/policies/pdf/fsr 1_2013.pdf. 24. See WORLD BANK, DOING BUSINESS 2014: CHILE 5, available at http://www.doing business.org/~/media/giawb/doing%20business/documents/profiles/country/CHL. pdf. The World Bank’s Doing Business In report provides an aggregate ranking of countries based on regulations that apply to starting up and maintaining domestic enterprise, including small-to medium-size businesses. 25. Id. at 7. 26. VERDE-RAMO, supra note 9, at 5. 27. Id. 28. Id. 29. Press Release, Gap, Inc., Gap Inc. Expands in Latin America with First Stores in Chile (Oct. 12, 2011), available at http://gapinc.com/content/gapinc/html/media/ pressrelease/2011/med_pr_Gap_Inc_Expands_in_Latin_America101211.html. 30. Beth Solomon, Chile Keeps Warming to U.S. Franchising, IFA FRANBLOG (Sep. 6, 2012), http://www.ifafranblog.com/chile-keeps-warming-to-u-s-franchising-2/. 31. VERDE-RAMO, supra note 9, at 2. 32. Id. 110 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 senting 24 percent growth in the last five years.33 Startup costs for franchisees tend to be quite reasonable in Chile. In 60 percent of cases, the initial investment required to start a franchise business is less than $100,000.34 In more than 80 percent of cases, it takes less than $200,000.35 The payback period—the amount of time it takes to recover the initial investment in terms of profits or savings—averages just below two years for franchise investments in Chile.36 Initially, the fast-food restaurant industry dominated franchise activity in Chile.37 Currently, services and restaurants are the most active sectors with 60 percent of franchised trademarks.38 Fast-food remains a key franchising industry but clothing, retail, and education have become increasingly important sectors in recent years.39 Approximately 130 franchises are operating through 3,666 locations across Chile.40 Figure 1 below illustrates the number of franchise trademarks by sector.41

Education (10%) Restaurants (30%) Other Retail (16%)

Clothing (13%) Services (31%)

II. FOREIGN INVESTMENT IN CHILE

A. THE CONSTITUTION AND FOREIGN INVESTMENT Protection of foreign investment in Chile is rooted in constitutional provisions. Article 19 of the Chilean Constitution of 1980 guarantees numerous rights to “all persons”42—thus including foreign persons— whereas the previous Constitution of 1925 provided guarantees only to

33. Id. 34. Id. 35. Id. 36. Id. at 26–27. 37. Id. at 5; VERONICA PINTO, U.S. COMMERCIAL SERVICE, CHILE: FRANCHISE INDUS- TRY BACKGROUND (2010), available at http://www.franchise.org/uploadedFiles/ Franchise_Industry/International_Development/Country_Profiles/Chile_ Franchising_2010.pdf. 38. VERDE-RAMO, supra note 9, at 2. 39. Id. at 19. 40. Id. at 16. 41. Id. at 19. 42. CONSTITUCION´ POLITICA´ DE LA REPUBLICA´ DE CHILE [C.P.] art. 19. 2014] FRANCHISE LAW IN CHILE 111

“inhabitants of the Republic.”43 Under Chilean law, the concept of “person” extends to natural persons and legal entities.44 To that end, section 2 of article 19 of the 1980 Constitution further provides that there shall be “no privileged persons or groups” or “arbitrary distinctions.”45 Further- more, article 57 of the Civil Code provides that “the law does not recognize differences between Chilean and foreigners in regards to the acquisition and exercise of the civil rights regulated by this code.”46 These provisions establish a broad foundation for equality among Chile- ans and foreigners.47

B. STATUTES AND FOREIGN INVESTMENT Statutes provide additional protection and regulation of foreign investment.48 Enacted in 1974, Decree Law No. 600 is known as the Foreign Investment (FDI) Statute and guarantees equal footing for foreign investors and local businesses.49 The FDI Statute provides an optional mechanism for the entry of capital into Chile with flexible options for the deployment and remittance of foreign investment capital. As of 2011, nearly $82 billion in capital entered Chile through the FDI Statute mechanism, representing 56.5 percent of foreign capital invested in Chile since 1974.50 The Foreign Investment Committee (FIC) is the regulatory agency charged with processing foreign capital received under the FDI Statute.51 Investments entering Chile under the FDI Statute require FIC approval.52 Aside from certain industries deemed to be of national interest, whole ownership of investments by foreigners is permitted. Repatriation of capital and profits is also quite permissive, with few exceptions.53

43. CONSTITUCION´ POLITICA´ DE LA REPUBLICA´ DE CHILE DE 1925, art. 10, available at http://biblio.juridicas.unam.mx/libros/4/1641/10.pdf (replaced by the current Con- stitution in 1980). 44. CONSTITUCION´ POLITICA´ DE LA REPUBLICA´ DE CHILE [C.P.] art. 19, § 15. 45. Id. art. 19, § 2. 46. COD´ . CIV. art. 57. 47. For a thorough review of constitutional protections of foreign investment in Chile, see Rodrigo Polanco Lazo, Legal Framework of Foreign Investment in Chile, 18 L. & BUS. REV. AMERICAS., 203, 203–209 (2012). 48. For complementary Chilean legislation on foreign investments, see Law No. 19.840, Noviembre 13, 2002, DIARIO OFICIAL [D.O.] (on Investment Platform); Law No. 18.840, Octubre 4, 1989, DIARIO OFICIAL [D.O.] (the Constitutional Or- ganic Act of the Central Bank of Chile); Law No. 18.657, Septiembre 16, 1987, DIARIO OFICIAL [D.O.] (on Investment Funds of Foreign Capital). 49. See Law No. 600, Septiembre 3, 1993, DIARIO OFICIAL [D.O.] (Chile) (FDI Statute). 50. See What is DL 600?, FOREIGN INV. COMM., http://www.ciechile.gob.cl/en/dl-600/ que-es-el-dl600/. 51. Lazo, supra note 47, at 210. 52. Id. 53. See Law No. 600, Septiembre 3, 1993, DIARIO OFICIAL [D.O.] (Chile) (FDI Stat- ute); Law No. 18.840, Octubre 4, 1989, DIARIO OFICIAL [D.O.] art. 47 (the Consti- tutional Organic Act of the Central Bank of Chile). For summaries of these two laws, see Legal Framework, MINISTRY OF FIN., http://www.hacienda.cl/english/ investor-relations-office/incentives-for-foreign-investment/legal-framework.html (last visited Mar. 27, 2014). 112 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

C. INTERNATIONAL TREATIES AND MULTILATERALISM With one of the most open economies in the Americas, Chile has shown a strong commitment to multilateral economic integration. Chile was the first South American country to join the Organization for Eco- nomic Cooperation and Development.54 Chile is also a founding member of the General Agreement on Tariffs and Trade (GATT).55 In recent decades, Chile has pursued a policy of open trade through numerous bilateral, regional, and multilateral trade agreements.56 Chile has signed over fifty bilateral investment treaties to date.57 Additionally, Chile has twenty-five double taxation treaties in force.58 Chile also recognizes and participates in multilateral efforts for investment dispute resolution mechanisms, including the International Centre for Settlement of Invest- ment Disputes (ICSID or Washington Convention), the Inter-American Convention on International Commercial Arbitration, and the Conven- tion on the Recognition and Enforcement of Foreign Arbitral Awards.59 Chile is a member of the Multilateral Investment Guarantee Agency (MIGA) as well.60

III. FRANCHISE LAW IN CHILE Like many countries, Chile does not have franchise-specific legislation. The legal dimensions of franchising activities in Chile are primarily defined by franchise agreements, the contract between the franchisor and the franchisee. Like all commercial contracts, franchise agreements in Chile are governed by the principle of the contractual autonomy of the parties. As article 1545 of the Civil Code sets forth, “[a]greements law-

54. Press Release, OECD, Chile Invited to Become a Member of the OECD (Dec. 15, 2009), available at http://www.oecd.org/general/chileinvitedtobecomeamemberof theoecd.htm. 55. Press Release, WTO, Fiftieth Anniversary of the Multilateral Trading System (1998), available at http://www.wto.org/english/thewto_e/minist_e/min96_e/ chrono.htm. 56. See Why Chile, MINISTRY OF FIN., http://www.hacienda.cl/english/investor-relations-office/why-chile.html (last visited March. 26, 2014) (“Chile, one of the most open economies in the world, has signed more free trade agreements than any other nation.”). 57. United Nations Conference on Trade and Development, Bilateral Investment Treaties Signed by Chile (June 1, 2013), available at http://unctad.org/Sections/ dite_pcbb/docs/bits_chile.pdf. 58. International Tax Conventions, SERVICIO DE IMPUESTOS INTERNOS, http:// www.sii.cl/pagina/jurisprudencia/convenios.htm (last visited Mar. 27, 2014). 59. INTERNATIONAL CENTRE FOR SETTLEMENT OF INVESTMENT DISPUTES, LIST OF CONTRACTING STATES AND OTHER SIGNATORIES OF THE CONVENTION (Nov. 1, 2013), available at https://icsid.worldbank.org/ICSID/FrontServlet?requestType =ICSIDDocRH&actionVal=ShowDocument&language=English; Inter-American Commercial Arbitration Commission, ORG. AM. STATES, http://www.oas.org/ juridico/english/Sigs/b-35.html (last visited Mar. 27, 2014); Convention on the Rec- ognition and Enforcement of Foreign Arbitral Awards, UNITED NATIONS TREATY COLLECTION, http://treaties.un.org/pages/ViewDetails.aspx?src=TREATY&mtdsg _no=XXII-1&chapter=22&lang=en (last visited Mar. 27, 2014). 60. MIGA Member Countries, MULTILATERAL INVESTMENT GUARANTEE AGENCY, http://www.miga.org/whoweare/index.cfm?stid=1789 (last updated Dec. 17, 2013). 2014] FRANCHISE LAW IN CHILE 113 fully entered into are deemed to be law for the parties, and cannot be revoked but by mutual consent, or for legal causes.”61 However, a variety of general commercial laws apply to the franchise agreement and franchise activity, particularly intellectual property, taxes, and royalties.

A. INTELLECTUAL PROPERTY A key factor in the legal environment for franchising is the role of intellectual property rights. More specifically, in order to mitigate infringement risks and to define the limits and outlines of the franchise agreement (such as purpose of the contract, rights and obligations of the parties, territory, duration, exclusivity) the franchisor must grant to the franchisee authorization for use of the intellectual property rights involved in the franchise. The franchisor’s authorization of use takes the legal form of a license. As a general matter, Chilean law distinguishes between intellectual works and industrial works. Intellectual works are protected under Intel- lectual Property Law No. 17.336.62 Industrial works, including trademarks, patents, utility models, industrial designs and drawings, service inventions, integrated circuits, denominations of origin, and trade secrets, are protected under Industrial Property Law No. 19.039.63

1. License to Use Intellectual Works Protected under Intellectual Property Law 17.336 (IP Law) The IP Law protects an author’s rights arising from the creation of works in the literary, artistic, and scientific fields, whatever the medium of expression, and the corresponding rights provided for under law.64 As a general rule, the author of a work is deemed to be the person who appears as such at the time of the work’s disclosure, or who appears as such in the Registry of Intellectual Property in Chile.65 In the case of computer programs, however, Chilean law presumes the existence of work for hire, which means that intellectual property rights are vested in the natural person or the corporation whose employees or contractors have developed the software for the first party, unless otherwise provided by written agreement.66 As a general rule, the protection provided by the IP Law lasts for the life of the author plus seventy years after the author’s death.67 Article 3 provides a non-exclusive list of the different works protected under the IP law.68 This list includes intellectual works such as

61. COD´ . CIV. art. 1545. 62. See generally Law No. 17.336, Octubre 2, 1970, DIARIO OFICIAL [D.O.]. 63. See generally Law No. 19.039, Enero 25, 1991, DIARIO OFICIAL [D.O.]. 64. Law No. 17.336, art. 1. 65. Id. art. 8. For more information on the Registry of Intellectual Property in Chile, see Departamento de Derechos Intelectuales, DIRECCION´ DE BIBLIOTECAS, ARCHIVOS Y MUSEOS, http://www.propiedadintelectual.cl/Vistas_Publicas/public Home/homePublic.aspx?idInstitucion=75 (last visited Mar. 27, 2014). 66. Id. See also infra note 71. 67. Law No. 17.336 art. 10. 68. Id. art. 3. 114 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 books, leaflets, articles, audiovisual productions, drawings, software programs, and data compilations, among others.69

a. Scope and Content of the License to Use The IP Law grants two categories of rights to the author for the protected work: (i) a moral, inalienable right that is not subject to a statute of limitations;70 and (ii) patrimonial or economic rights.71 The latter rights allow the author to make a financial profit on his work and these rights parallel the common law concept of copyright. Patrimonial rights can be freely used, licensed, or transferred by their owners.72 Articles 18 and 19 of the IP Law create a legal monopoly for specific uses of the protected work for the benefit of the author, who has exclusive rights to grant licenses on his work or to assign patrimonial rights to any third party.73 Multiple licenses for the same work may coexist in different territories or in the same territory in the event the rights licensed are not exclusive. Likewise, an author may also grant different licenses for the same work and territory but covering different uses, such as reproduction, representation, adaptation, public communication, distribution, or publication.74 As for the content of the license, article 20 of the IP Law stipulates that licenses, or authorizations of use, must provide for certain specific elements, such as the scope of the granted rights, the duration of the license, the royalties or terms of remuneration, the minimum or maximum number of authorized performances or copies—if limited—or the territories concerned.75

b. Registration of Intellectual Property Rights Intellectual property rights arise at the moment a work is created.76 Registration is not required for the creation of intellectual property rights.77 However, registration is recommended for the purposes of notice and proof. There is a presumption of authorship in favor of the person in whose name the work is registered.78 Registered authors may be natural persons or companies, but companies must provide evidence of the assignment of the intellectual property rights (or the work for hire agreement) from the individual that actually created the work because

69. Id. 70. Article 14 of the IP Law establishes the existence of a moral right for the benefit of the author and his heirs. Id. art. 14. 71. Under the IP Law, patrimonial rights are exclusive, assignable, and temporary. Id. arts. 10, 17. Article 10 of the IP Law grants patrimonial rights to the author for seventy years during the author’s lifetime or for life plus seventy years after the date of his death, depending on whether the author was a natural or artificial person. Id. art. 10. 72. Id. art. 17. 73. Id. arts. 18–19. 74. Id. 75. Id. art. 20. 76. Id. art. 1. 77. See id. 78. Id. art. 8. 2014] FRANCHISE LAW IN CHILE 115 the law assumes that only human beings are capable of creation.79 The Registry of Intellectual Property in Chile is run by the Department of Intellectual Property Rights, which operates under the Direction of Li- braries, Archives and Museums of Chile (DIBAM).80

c. Practical Approaches to Franchise Agreements In franchise agreements, a franchisor commonly provides to a franchisee various franchise manuals. These franchise manuals often detail instructions, systems, and processes related to the franchise including relationships with clients, dealings with third parties, marketing strategies, instructions on promotional materials, equipment, insurance, accounting directives, sales techniques, personnel training, or customer service. In other words, a franchisor frequently provides a franchisee with know- how, techniques, and instructions needed to operate the franchised business. Consequently, the information, material and intellectual works (designs, software programs, manuals, etc.) transferred to the franchisee should be recognized as licensed works. License agreements are not subject to any specific legal formalities or registration requirements.81

2. License to Use Works Protected Under Industrial Property Law No. 19.996 Industrial property rights are critical to franchising in Chile. Because one of the main objectives of the franchisor is to gain brand recognition and market share, a franchisor often authorizes a franchisee to use trademarks, trade names, designs, and models, all of which are protected under the Industrial Property Law.82 The Industrial Property Law also governs industrial property license agreements and patents.83 As a general principle, a license agreement does not require prior governmental approval or registration to be effective. However, industrial property license agreements subject to Chilean law and involving industrial privileges registered in Chile (trademarks, patents, utility models, and industrial designs) must be made in writing, signed by the parties, and executed before a notary public.84 If executed outside of Chile, these agreements must be legalized by the nearest Chilean Consul in order to be valid in Chile.85 In addition, these license agreements, including franchise agreements, must be recorded before the Chilean National In- stitute of Industrial Property (INAPI) in order to be enforceable against

79. Id. arts. 5, 10–12, 72bis, 73. 80. See DIRECCION´ DE BIBLIOTECAS, ARCHIVOS Y MUSEOS, www.dibam.cl (last visited Mar. 27, 2014). 81. Law No. 17.336 art. 20. 82. Law No. 19.996, Marzo 11, 2005, DIARIO OFFICIAL [D.O.] art. 1. 83. Id. 84. Id. art. 14. 85. Id. art. 15. 116 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 third parties.86

B. FRANCHISING TAXATION REGULATIONS In a franchise agreement, the franchisee, as consideration, pays a certain amount of money to the franchisor. This payment may be structured as a fixed amount payable at the signature of the contract, as monthly or annual royalties, or as a combination of both. Whether the payment is a fixed amount or royalties, applicable taxes will vary depending on whether or not the franchisor is a resident company of Chile.

1. Corporate Taxation of Chilean Resident Companies A foreign franchisor may opt to create a Chilean business organization as a corporation, a limited liability company, or a branch. In this case, the local entity is liable for a 20 percent corporate tax according to the In- come Tax Law (ITL).87 Therefore, all amounts paid by the franchisee to the franchisor would be taxed up to 20 percent.

2. Taxation of Royalties Transferred Abroad If the franchisor is not a resident Chilean entity, amounts paid upon execution of the franchising agreement or paid in royalties are subject to a withholding tax when transferred outside of Chile.88 Whether or not franchisors are residents of double taxation treaty jurisdictions will also affect tax liabilities.

a. Franchisor is a Resident of a Double Taxation Treaty Jurisdiction When the country of residence of the franchisor has signed a double taxation treaty with Chile, applicable tax liabilities are determined by the provisions of the treaty in question. Chile currently has double taxation treaties in force with the following twenty-five countries: Australia, Belgium, Brazil, Canada, Colombia, Korea, Croatia, Denmark, Ecuador, Spain, France, Ireland, Malaysia, Mexico, Norway, New Zealand, Para- guay, Peru, Poland, Portugal, Russia, Sweden, Switzerland, Thailand, and the United Kingdom.89 Chilean tax law provides that royalty payments subject to a 10 percent withholding tax are exempted from value added tax (VAT).90 However, this VAT exemption will not apply when payments are ultimately exempt from withholding by taxation treaty or other domestic relief.91

86. INSTITUTO NACIONAL DE PROPIEDAD INDUSTRIAL, DIRECTRICES DE PRO- CEDIMIENTO DE REGISTRO MARCAS COMERCIALES 127 (2010). 87. Law No. 824, Diciembre 31, 1974, DIARIO OFICIAL [D.O.] art 20 (law on income tax). 88. Id. tit. IV. 89. International Tax Conventions, supra note 58. 90. Law No. 825, Diciembre 27, 1974, DIARIO OFICIAL [D.O.] art. 12(E)(7). 91. Chile–Recent VAT Exemption Changes for Services Supplied from Chile, KPMG (Dec. 12, 2013), http://www.kpmg.com/global/en/issuesandinsights/articlespublica- tions/global-indirect-tax-brief/pages/chile-recent-vat-exemption-changes.aspx. 2014] FRANCHISE LAW IN CHILE 117

b. Franchisor Is Not a Resident of a Double Taxation Treaty Jurisdiction If not a resident of a double taxation treaty country, the franchisor will be subject to withholding taxes on payments received from a Chilean franchisee. Under Chilean tax law, the general withholding tax rate is 35 percent.92 However, Article 59 of the ITL provides that the royalty payment should be subject to a 30 percent withholding tax over the gross amount transferred abroad.93 At the same time, under Article 59, professional or technical services are subject to a reduced 15 percent withholding tax rate.94 Transferred amounts are exempted from VAT.95

C. IMPACT OF THE CHILEAN LABOR REGULATION ON FRANCHISE AGREEMENTS Under Chilean labor law, a company may be held liable for subcontractors’ labor obligations.96 In 2008, the Supreme Court of Chile considered a case on this subject.97 In this case, seven terminated employees brought employment claims against the subsidiary franchisee as well as the parent franchisor.98 The Supreme Court determined that a franchisor can be held liable for the labor obligations of a subsidiary franchisee—including salaries, retirement contributions, and social security contributions—but is not liable for obligations related to the termination of an employment contract.99 The Supreme Court based its decision on a broad interpretation of Article 64 of the Labor Code.100 In doing so, the Supreme Court justified its finding by recalling that the franchise arrangements allowed the franchisor to gain profitable and effective distribution networks without significant costs or investments.101

D. CONSUMER PROTECTION ACT The Consumer Protection Act (the CPA) regulates the relationship between consumers and providers.102 The CPA defines consumers as all natural persons or legal entities who, by virtue of any legal act, acquire use or enjoy as final users, goods, or services.103 Providers are defined as persons who produce, manufacture, import, distribute, or commercialize goods or services for consumers on a regular basis for a price or fee.104

92. Law No. 824, Diciembre 31, 1974, DIARIO OFICIAL [D.O.] art 58. 93. Id. art. 59. 94. Id. 95. Law No. 825, Diciembre 27, 1974, DIARIO OFICIAL [D.O.] art. 12(E)(7). 96. COD´ . TRAB., art. 183-B. 97. Corte Suprema de Justicia [C.S.J.] [Supreme Court], 25 Septiembre 2008, “Ortiz c. Comercial Proventa SA y Movistar SA,” Rol de la causa: 4.012-2008, contrato. 98. Id. 99. Id. 100. Id. 101. Id. 102. Law No. 19.496, Febrero 7, 1997, DIARIO OFICIAL [D.O.] (Chile). 103. Id. art. 1. 104. Id. 118 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

The CPA, therefore, may be directly applicable to a franchisor in two scenarios:

1. Micro or Small Businesses Franchisees If the franchisee qualifies as a micro or small business, the CPA considers the franchisee as a “consumer” and the franchisor as a “supplier.”105 A recent modification to the CPA has defined micro, small, and medium- sized businesses on the basis of sales revenues.106 Various provisions in the CPA benefit micro and small-sized businesses (MSBs) vis-a-vis ` suppliers.107 A company may be considered an MSB depending on its annual sales and service revenues after VAT and excise taxes. • Micro business: Annual sales of UF 2,400 or less (approximately $100,000); • Small business: Annual sales between UF 2,401 and 25,000 (approximately $100,000 and $1,050,000).108 In other words, MSBs are considered “consumers” vis-a-vis ` suppliers. Consequently, franchisors should consider issues arising under the CPA in relations with MSB franchisees, including mass contracting, remote contracting, warranties, advertising, and information provided to MSBs.

2. Non-MSB Franchisees If the franchisee is not an MSB, the CPA applies to the franchisor as a manufacturer or producer of the goods or services sold or provided in Chile. Under the CPA and as a matter of public policy, a customer may claim damages directly against the manufacturer or importer (or a franchisor, as the case may be) in case a seller ceases to exist due to bankruptcy, business termination, or other similar cause.109 In cases of defec- tive or non-conforming products, consumers have rights to request from the franchisor, in its position of manufacturer or importer, repair or re- placement in addition to the indemnification for any damages that might have been caused.110 These rights cannot be waived in advance by the consumers.111

105. Law No. 20.416, Febrero 3, 2010, DIARIO OFICIAL [D.O.] (Chile) art. 9; Law No 19.496 art. 1. 106. Law No. 20.416 art. 9. 107. Id. 108. Id. art.2. 109. Law No. 19.496, Febrero 7, 1997, DIARIO OFICIAL [D.O.] (Chile) art. 21. 110. Id. arts. 21–22. 111. Id. art. 4. Case Note

AUSTRALIA’S UPDATED FRANCHISE CODE OF CONDUCT: DOES AN EXPRESS OBLIGATION OF GOOD FAITH BENEFIT THE FRANCHISOR OR FRANCHISEE?

Natalie Sears*

I. INTRODUCTION

USTRALIA regulates its franchising operations more heavily than most other countries through the enforcement of its AFranchising Code of Conduct (“the Code”).1 The Code became a mandatory Industry Code under the Competition and Consumer Act 2010.2 It aims to inform local franchisees by disclosing details regarding their rights and obligations under a franchise agreement, including disclosure, contractual, and dispute resolution rights.3 The Code is enforced by the Australian Competitor and Consumer Commission and seeks to provide guidance to people interested in entering a franchising relationship.4 The most recent revision to the Code occurred in 2010, but since then, the number of business format franchises has grown by over 3,000 units.5 Growth within the franchising industry has led to increased unfair trade practices, an issue exacerbated by the imbalance of power inherent in the franchisor/franchisee relationship. Unfair trade practices were a growing concern for the Australian Commonwealth Government while revising the Franchising Code in 2009.6 On January 4, 2013, the Australian Gov- ernment announced another review of the Franchising Code to be con-

* J.D. Candidate, May 2015 at Southern Methodist University; B.B.A. at Texas Christian University. She would like to thank her family and friends for their continued support. 1. See Trade Practices (Industry Codes—Franchising) Regulations 1998 (Cth) (Austl.), available at http://www.comlaw.gov.au/Details/F2010C00457/. 2. Complying with the Franchising Code of Conduct Franchising, BUSINESS.GOV.AU, http://www.business.gov.au/BusinessTopics/Franchising/Buyinganewfranchise/ Pages/Complying-with-the-Franchising-Code-of-Conduct.aspx (last visited Mar. 17, 2014). 3. Id. 4. Id. 5. LORELLE FRAZER, SCOTT WEAVEN & KELLI BODEY, FRANCHISING AUSTRALIA 2012 12 (2012) available at http://www.australianfranchising.com.au/downloads/ FranchisingAustraliaSurvey-2012.pdf. 6. OPPORTUNITY NOT OPPORTUNISM: IMPROVING CONDUCT IN AUSTRALIAN FRANCHISING 2–3(2009) [hereinafter OPPORTUNITY NOT OPPORTUNISM], available at http://www.innovation.gov.au/SmallBusiness/CodesOfConduct/Documents/ GovernmentresponseFranchising.pdf.

121 122 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 ducted by Mr. Alan Wein. Mr. Wein earned a Law Institute of Victoria (LIV) practicing certificate and is an accredited mediator with the Aus- tralian mediation organizations LIV and LEADR, having also gained experience as a mediator in the Office of the Franchising Mediation Adviser (OFMA).7 In addition, Mr. Wein was appointed as the inaugural chair of the Victorian government’s Small Business Advisory Council in 2000.8 The short three-year gap between Code revisions is evidence of the Aus- tralian Government’s ability and tendency to implement new provisions in the Code more efficiently than other countries, such as the United States.9 After Mr. Wein provided his recommendations, the Australian Govern- ment announced its response on July 24, 2013 and accepted, in full or in principle, most of his proposals.10 Among the most anticipated and disputed provisions included the accepted recommendation for an express obligation of good faith.11 The duty of good faith can permeate a franchise agreement in three different ways: “as an express term of the contract, as a term implied in fact on an ad hoc basis to give business efficacy to the contract, or as a term implied in law as a necessary incident of the contract.”12 A default option is that the duty of good faith can be applied to all common law contract principles, regardless of whether such language is present within the franchising agreement.13 Prior to the Aus- tralian Government’s amendment to the Code, a conflict existed in the nation’s case law as to whether any of the above options fit within their common law jurisdiction.14

II. DUTY OF GOOD FAITH The Australian Government’s acceptance of Recommendation 9, an “express obligation to act in good faith,” extends to most phases of the franchise relationship, including the negotiation and performance of the parties’ agreement, performance of the Code’s requirements, and resolution of disputes between the franchisor and franchisee.15

7. Franchising Code of Conduct, AUSTL. GOV’T DEP’TOF INDUS., http://www.innovation.gov.au/smallbusiness/codesofconduct/Pages/FranchisingCodeofConduct.aspx (last visited Mar. 18, 2014); Alan Wein, LLB, AUSTL. GOV’T DEP’TOF INDUS., http://www.innovation.gov.au/smallbusiness/codesofconduct/Pages/AlanWeinLLB. aspx (last visited Mar. 18, 2014). 8. Id. 9. Rupert M. Barkoff, A Look at Franchise Regulation from Ground Level to 30,000 Feet, 32 FRANCHISE L.J. 153, 155 (2013). 10. Press Release, Austl. Gov’t, Government to Strengthen $130 Billion Franchising Sector (July 24, 2013), available at http://www.franchise.org.au/articles/government-to-strengthen—130-billion-franchising-sector.html. 11. GARY GRAY & BERNIE RIPOLL, FORWARD LOOKING FRANCHISING REGULATION 4 (2013), available at http://www.innovation.gov.au/smallbusiness/codesofconduct/ Documents/GovernmentResponsetoFranchisingCodereview.pdf. 12. Andrew Terry & Cary Di Lernia, Franchising and the Quest for the Holy Grail: Good Faith or Good Intentions?, 33 MELB. U.L. REV. 542, 546 (2009). 13. Id. 14. Id. at 546–47. 15. GRAY & RIPOLL, supra, note 11 at 13. 2014] AUSTRALIA’S UPDATED FRANCHISE CODE 123

Legal scholars and courts have debated whether a duty of good faith should be applied to franchise agreements at all. Some courts believe that an express duty of good faith runs afoul of the economic principle of caveat emptor.16 Other courts have stated that such a duty would rarely entice franchisors and franchisees to actually comply or cooperate with the standards required of good faith behavior.17 For example, in Butt v. McDonald, Chief Justice Griffith wrote that “a general rule [applies] to every contract that each party agrees, by implication, to do all such things as are necessary on his part to enable the other party to have the benefit of the contract.”18 The Australian High Court subsequently affirmed this idea in Secured Income Real Estate (Australia) Ltd v. St Martins Invest- ments Pty Ltd.19 Legal scholars in the United States have addressed this issue by critiquing the common assumption that franchisees consider all relevant information before signing franchise agreements.20 Many scholars find that franchisees’ lack of business experience and knowledge hinder their ability to consider relevant information before opening a franchise unit, and are thus more susceptible to franchisor abuse.21 The Australian Government previously addressed whether to add an express obligation of good faith, but believed such an obligation should only be included in the Code “as long as the scope of this obligation is well defined.”22 The government stated specific concerns related to enacting a good faith requirement that included potential increases in the risks, costs, and financing of franchising operations.23 The Government was also concerned that a broad definition of good faith would inhibit franchisors’ or franchisees’ ability to recognize when a breach of that duty occurred.24 It also worried that franchisees would be at a comparative disadvantage because they have less access to legal advice than franchisors. In addition, the Government believed an express obligation of good faith would result in franchisees having to pay increased fees to compensate for franchisors increased risk in the uncertainty of such a provision in the Code.25 Although civil law jurisdictions consistently apply the good faith standard to contract law, which controls franchising agreements, common law jurisdictions such as Australia are not as consistent in applying such a

16. GILES CONSULTING INT’L, DUTY OF GOOD FAITH BACKGROUND BRIEFING PAPER 15 (2012), available at http://www.innovation.gov.au/smallbusiness/codesofconduct/ Documents/Lottery%20Agents%20Association%20of%20Victoria%20Attach ment.pdf. 17. Marilyn Warren, Good Faith: Where Are We At?, 34 MELB. U.L. REV. 344, 349–50. 18. Id. at 349 n.32 (quoting Butt v. McDonald, 7 QLJ 68, 70–71 (1896) (Griffith, CJ)). 19. Id. at 349. 20. Robert W. Emerson & Uri Benoliel, Are Franchisees Well-Informed? Revisiting the Debate over Franchise Relationship Laws, 76 ALB. L. REV. 193, 194 (2013) 21. Id. 22. OPPORTUNITY NOT OPPORTUNISM, supra note 6, at 4. 23. Id. 24. Id. at 13. 25. Id. 124 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 concept.26 Despite the Australian Government’s decision to decline an earlier implementation of an express duty of good faith, prior case law shows conflicting judicial support of such an implied duty.27 For example, Justice Finkelstein of the Federal Court of Australia wrote that “such a term will ordinarily be implied; not as an ad hoc term . . . but as a legal incident of the relationship.”28 In addition, the New South Wales Court of Appeal has opined that the law should always imply a duty of good faith upon parties of contractual relationships.29 But the High Court of Australia has neither addressed the issue of implementing a duty of good faith nor defined the standard, which further complicates the application of the duty of good faith.30 This uncertainty contributes to parties’ concerns when resolving disputes because even courts are unsure of exactly what the good faith standard entails.31 It will particularly disadvantage franchisees, whom typically have less legal and economic resources at their disposal.32 Other common law jurisdictions have statutorily provided for a duty of good faith in the franchising context. For example, in the United States, the Uniform Commercial Code § 1-304 provides that “every contract or duty within this Act imposes an obligation of good faith in its performance or enforcement.”33 In addition, the Restatement (Second) of Con- tracts states that the duty of good faith and fair dealing is applied to both parties in every contract.34 In declining to explicitly define the definition of “good faith” within the revised Code, the Australian Government chose to apply case law, impliedly inserting the standard within the contractual relationship context.35 Similarly, the United States’ statutes governing this duty also decline to provide a specific definition. The majority view within the United States is to use a standard of honesty and reasonableness when determining whether a breach of the duty of good faith occurred.36

26. Terry & Di Lernia, supra note 12, at 543. 27. Id. at 547–48. 28. Id. at 547 (quoting Garry Rogers Motors (Aust) Pty Ltd v. Subaru (Aust) Pty Ltd [1999] FCA 903 ¶ 34 (Finkelstein, Judge) (internal citations omitted)). 29. Andrew Stewart, Good Faith: A Necessary Element in Australian Employment Law?, 32 COMP. LAB. L. & POL’Y J. 521, 541 (2011). 30. Terry & Di Lernia, supra note 12, at 548. 31. GILES CONSULTING INT’L, supra note 16, at 3. 32. Id. 33. U.C.C. § 1-304 (2012). 34. RESTATEMENT (SECOND) OF CONTRACTS § 205 (1981). 35. GRAY & RIPOLL, supra note 11, at 13. 36. Auto-Chlor Sys. of Minn. v. JohnsonDiversey, 328 F. Supp. 2d 980, 1006 (D. Minn. 2004). 2014] AUSTRALIA’S UPDATED FRANCHISE CODE 125

III. THE DUTY OF GOOD FAITH’S IMPACT ON FRANCHISING RELATIONSHIPS

A. GOOD FAITH REQUIREMENT SEEKS TO REDUCE UNEQUAL BARGAINING POWER INHERENT DURING PRE-CONTRACTUAL RELATIONS The Australian government’s decision to add an express duty of good faith applies to all phases of the franchise relationship, beginning with negotiations between a franchisor and prospective franchisee.37 The unequal bargaining power typically occurring between franchisors and franchisees is of huge concern to the Australian government, so they will apply the duty of good faith to negotiations and dealings before a contract is signed in order to prevent one party from making material misrepresentations or omissions. In the 2013 review of the Code, the Australian government also amended the duty to disclose information imposed upon the franchisor.38 Franchisors must now provide prospective franchisees with a list of risks and other matters they should be aware of before entering a franchising agreement.39 During pre-contractual negotiations, the duty to disclose will be based on the good faith of both parties. But in reality, the franchisor will be the party disclosing the most pertinent information and therefore also the party most likely to breach the duty of good faith upon failure to disclose.40 This scenario has frequently played out in the U.S. court system with the application of the Federal Trade Commission rule requiring disclosure within franchising and business opportunities.41

B. EFFECTING THE ONGOING FRANCHISE RELATIONSHIP The express duty of good faith will also have a significant impact on the ongoing relationship between franchisors and franchisees. After signing the franchising agreement, disputes ranging from contract interpretation to required additional capital expenditure issues are likely to arise. One of the additional recommendations accepted by the Australian government is the requirement for franchisors to give franchisees the basis for additional capital improvements.42 One implication of this requirement is that franchisors must now include provisions requiring such improvements within the franchising agreement. If franchisors fail to expressly include this provision within the agreement, they will have to subsequently prove that such capital improvements are not “unreasonable.”43 In addition, franchisors will now have to protect them-

37. GRAY & RIPOLL, supra note 11, at 13. 38. Id. at 8–9. 39. Id. at 9. 40. Paul Steinberg & Gerald Lescatre, Beguiling Heresy: Regulating the Franchise Re- lationship, 109 PENN. ST. L. REV. 105, 109 (2004). 41. See 16 CFR § 436.1(d) (2007). 42. GRAY & RIPOLL, supra note 11, at 11–12. 43. Id. at 12. 126 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 selves from claims by franchisees arguing that such improvements breach their contractual duty to act in good faith. This will only complicate interpretation disputes down the road because a franchise agreement alone will provide the court with little guidance as to whether the franchisor’s requiring of a franchisee to build a new office space violates the terms of the contract and the duty of good faith.44 An additional issue that commonly arises in jurisdictions with an express duty of good faith is whether a franchisor has the ability to waive the duty of good faith within their franchising agreement and whether the express terms of the agreement will supersede the good faith requirement.45 This situation commonly occurs when a franchisor attempts to waive the duty of good faith to reduce their liabilities for franchisees’ conduct.46 The Australian government’s decision to use the unwritten law’s definition of good faith, rather than to create an express definition within the Code, will only exacerbate this dispute. The practice is also used in the United States, where neither the Uniform Commercial Code nor the Restatement (Second) of Contracts precisely defines good faith. The benchmark used by U.S. courts to determine a breach of good faith is the Restatement’s definition of bad faith, which involves “violat[ing] the community standards of decency, fairness or reasonableness.”47 The Australian courts will continue to apply the unwritten law to define good faith in resolving franchise relationship disputes. But they will have to provide more guidance on what constitutes breach to protect franchisees that have less access to legal services when drafting contracts with franchisors. A court may also use the duty of good faith to interpret contracts with ambiguous or omitted terms. For example, the court could forbid enforcement of contracts that allow one party (usually the franchisor) to use its inherent discretion to act unreasonably or outside the scope of the contract.48 In addition, both the Australian government and United States have stated that the duty of good faith aims to serve exactly those kinds of contracts—where one party has the discretion to determine certain terms of a contract.49 Because the Code has not previously required a duty of good faith in Australian franchising agreements, the issue of waivers attempting to ex- clude the duty of good faith has not been addressed in the Australian court system. In the United States, however, there is still dispute as to whether the covenant of good faith is mandatory and therefore a provi-

44. Carmen D. Caruso, Franchising’s Enlightened Compromise: The Implied Covenant of Good Faith and Fair Dealing, 26 FRANCHISE L.J. 207, 209 (2007). 45. Id. at 211. 46. Id. 47. RESTATEMENT (SECOND) OF CONTRACTS § 205 (1981). 48. Frank J. Cavico, The Covenant of Good Faith and Fair Dealing in the Franchise Business Relationship, 6 BARRY L. REV. 61, 78–79 (2006). 49. Id. at 79. 2014] AUSTRALIA’S UPDATED FRANCHISE CODE 127 sion parties cannot contract around.50 For this reason, many franchising agreements written in the United States include provisions attempting to revoke the duty to act in good faith, “except as may be provided by statute or regulation,” knowing that the duty of good faith is an implied covenant, rather than statutory principle.51 It is likely Australian courts will uphold the principle that the good faith requirement is binding because unlike in the United States, the Australian Code expressly provides for an obligation to act in good faith, rather than simply implying a covenant to do so.

C. DUTY OF GOOD FAITH IS LIKELY TO RESULT IN INCREASED LITIGATION BETWEEN A FRANCHISOR AND FRANCHISEE The most likely repercussion of incorporating a duty of good faith into franchising agreements will be a significant increase in litigation between franchisors and franchisees claiming a breach of this duty. Franchisees will likely supplement their lawsuits against franchisors with this claim and franchisors will follow suit. As a result, the issue of whether express terms of a franchising agreement, where applicable, will supersede the duty of good faith and control the outcomes of such lawsuits will arise.52 The Australian government’s amendment to the Code will make the duty of good faith binding upon every franchise agreement entered into. But the issue may still arise as to whether contractual provisions in conflict with the duty of good faith will prevail or be held unenforceable against the franchisee. The Government’s decision to include an express duty of good faith in the Code reflects their longstanding aim to improve franchise relationships and neutralize the unequal bargaining positions of both parties.53 But the Australian government’s decision to apply unwritten law relating to good faith to franchising agreements will likely cause confusion among franchisors, franchisees, and even the courts.54 In accepting the duty of good faith recommendation, the Australian government also stated concerns that “merely referring to the unwritten law will make it difficult for parties without legal representation to appreciate what may be required of them.”55 This obstacle will prove especially burdensome to franchisees, which ordinarily have fewer resources and access to legal representation than their franchisor counterparts. Franchisees, franchisors, and courts looking for guidance in determining what actions constitute a breach of the duty of good faith can look to

50. Kathryn Lea Harman, The Good Faith Gamble in Franchise Agreements: Does Your Implied Covenant Trump My Express Term?, 28 CUMB. L. REV. 473, 478 (1997). 51. Caruso, supra note 44, at 207. 52. Id. 53. See GRAY & RIPOLL, supra note 11; OPPORTUNITY NOT OPPORTUNISM, supra note 6. 54. GRAY & RIPOLL, supra note 11, at 13. 55. Id. 128 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 case law that used the business unconscionability provision in 51AC of the Trade Practices Act of 1974.56 That section of the Trade Practices Act allows courts to determine if a party has acted unconscionably by factor- ing in whether their actions were made in good faith.57 But the new amendment creating an express duty of good faith should aid courts, which have previously been in conflict over whether such a duty is present in the franchising sector.58 The courts were primarily in dispute as to whether an implied term of good faith is applicable in a commercial contract, especially because such a term conflicts with common law principles of caveat emptor.59 But, because the obligation of good faith will now be statutorily required, the courts will have no other option but to impose such obligation upon both parties to a franchise agreement.

D. DOES THE DUTY OF GOOD FAITH BENEFIT THE FRANCHISEE, AS INTENDED BY THE AUSTRALIAN GOVERNMENT, OR THE FRANCHISOR? The Australian government declared that the express duty of good faith now applies to every franchising agreement with the hope that it will benefit their growing franchise industry.60 A duty of good faith, on its face, appears to benefit franchisees, typically small business owners who are outdone in size and power by large franchisors looking to form agreements most favorable to their concerns. But the Australian government declined to provide a formal explicit definition within the Code and instead decided to use the current case law on the implied duty of good faith as a guide for franchisors and franchisees.61 The Australian government pointed out that because of this decision, parties without legal representation would find it difficult to ascertain the true meaning of the duty of good faith.62 Further complicating the effort to define an obligation of good faith is the fact that many requirements in the Code already go beyond what traditional notions of good faith require. Examples of this dilemma include the requirement for franchisors to disclose information that may have been withheld for their own economic advantage and to give notices of intended conduct. For this reason, some scholars have suggested that it may have been better to prohibit intentional conduct that is intended to injure the other party within their franchise relationship.63 Adding to the ambiguity of this new amendment, previous case law has conflicted on the extent of the duty of good faith’s application.64 For example, one court found that McDonald’s action in denying a current fran-

56. Terry & Di Lernia, supra note 12, at 545. 57. Id. 58. Id. at 546–47. 59. Id. at 549. 60. See GRAY & RIPOLL, supra note 11. 61. Id. at 13. 62. Id. 63. Steinberg & Lescatre, supra note 40, at 198. 64. Terry & Di Lernia, supra note 12, at 561. 2014] AUSTRALIA’S UPDATED FRANCHISE CODE 129 chisee the ability to open a new store was not made in bad faith, but rather an action taken in accord with its own legitimate business interests.65 Some courts, in deciding the standard for finding a breach of good faith, have evaluated the intent of the franchisor’s actions in making decisions, while other courts have used a standard of requiring franchisees to avoid conduct that would damage or destroy a franchisee’s business.66 The ambiguities present in both the updated Code and case law will be a great concern to franchisees bringing suit against their franchisors.

IV. CONCLUSION The duty of good faith is one of the most widely disputed, and accepted, notions of contract law around the world. Australia’s recent amendment providing for an explicit obligation of good faith in the franchising sector further increases regulations in an already highly regulated franchising industry. This amendment is important because it will affect the way foreign and domestic franchisors conduct business in Aus- tralia with their local franchisees. Although such a duty would seek to equalize power among parties throughout all phases of the franchise relationship, U.S. case law covering similar ideals proves otherwise. In order for Australia to continue growing their franchise industry, there must be a more clearly defined duty of good faith. The Australian government accepted Mr. Wein’s recommendation for an express obligation of good faith, but declined to provide a specific definition within the Code. As it stands, Australian case law addresses only the implied common law obligation of good faith, and court decisions vary widely regarding the duty’s application and measure of breach. When the obligation of good faith becomes codified, Australian courts will likely see an increase in litigation surrounding disputes among parties in a franchise relationship. The majority of suits will probably be brought by franchisees, who may use this duty to supplement other claims against their franchisor counterparts. In addition, there will be more riding on these case decisions, as the new Code will provide for civil pecuniary penalties for violating the obligation of good faith.67 The only guidance franchisors and franchisees have in acting in accordance with the duty of good faith will have to come out of court decisions. The average franchisor will have more legal resources at their disposal to resolve these disputes and ensure compliance during the ongoing franchise relationship. Most franchisees, however, are local Australian citizens who don’t have access to such resources. Therefore, it appears that the inequality in bargaining power sought to be decreased through an express obligation of good faith will actually remain until the obligation of good faith is more clearly defined through case law. Moving forward, it is wise for franchisees to define the controlling obligation of good faith and the subsequent duties upon both

65. Id. 66. Id. at 562. 67. OPPORTUNITY NOT OPPORTUNISM, supra, note 6, at 7. 130 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 parties in a franchise agreement. This specificity can only help franchisees narrow their opportunity for error during the ongoing relationship and assist courts in resolving disputes between the parties. Overall, it appears that the obligation of good faith will prove beneficial to the franchisor relationship, but will require considerable common law development with regards to its scope and application. Let the litigation begin. Updates

TWO DOWN, ELEVEN TO GO: CREATING A CANADIAN SEC OR SOMETHING LIKE IT

John J. Kappel*

N September 19, 2013, Canada’s Minister of Finance, Jim Fla- herty, Ontario’s Minister of Finance, Charles Sousa, and British Columbia’s Minister of Finance, Mike de Jong, announced the O 1 creation of the Cooperative Capital Markets Regulator (CCMR). The CCMR is being created to serve as a new Canadian securities regulator,2 partially unifying Canada’s current securities regulation system, which is almost entirely administered at the provincial and territorial level.3 The first section of this article will outline the current method of Canadian securities regulation, the second section will discuss the 2011 attempt by the Canadian Parliament to create a single federal securities regulator and the Canadian Supreme Court’s advisory opinion against the creation of such a regulator, and the third section will explore the recently proposed CCMR and the effects that the creation of the CCMR might have on Canadian securities regulation.

I. THE CURRENT METHOD OF CANADIAN SECURITIES REGULATION: A COMMITMENT TO DECENTRALIZATION

Currently, Canadian securities regulation is done entirely at the regional level; there is no national Canadian Securities regulator.4 Securi- ties are regulated by thirteen independent agencies, one for each of Canada’s ten provinces and three territories.5 In this respect, Canada possesses the unique, although perhaps not positive, distinction of being the only major industrialized country in the world to not have a single

* John Kappel is a third-year student at SMU Dedman School of Law. 1. Gordon Isfeld & Barbara Shecter, Jim Flaherty: Ottawa, B.C. and Ontario Agree to Establish Co-operative Securities Regulator, FINANCIAL POST (Sept. 19, 2013, 10:22 AM), http://business.financialpost.com/2013/09/19/flaherty-announces-historic- cooperative-market-watchdog-with-ontario-b-c/. 2. Id. 3. Who We Are, CANADIAN SECURITIES ASSOCIATION, http://www.securities- administrators.ca/aboutcsa.aspx?id=77 (last visited Mar. 24, 2014). 4. See id. 5. Id.

133 134 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 national securities regulator.6 However, the thirteen regulators have achieved a certain degree of unity through their membership in the Cana- dian Securities Association (CSA).7

A. THE CANADIAN SECURITIES ASSOCIATION The CSA refers to itself as an “umbrella organization” comprising all of the provincial and territorial regulators and created to “improve, coor- dinate and harmonize regulation of the Canadian capital markets.”8 While the CSA “umbrella” does effectively facilitate cooperation and a certain degree of uniformity between the provincial and territorial regulators, the CSA itself is not a true regulatory body.9 Ultimately, the provincial and territorial securities regulators function independently of the CSA and each other to investigate complaints and manage enforcement issues and proceedings within each regulator’s respective jurisdiction.10 The direct consequence of this fragmented group of regulators is an increased degree of red tape and paperwork encoun- tered by anyone who works in the securities industry and who wishes to operate in more than one province or territory.11 In an effort to interconnect the regulatory schemes of the thirteen provincial and territorial regulators and alleviate the burden that can come with having to comply with multiple regulators, the CSA created the Passport System.12 The goal of the Passport System is to give market participants “automatic access to the capital markets in other jurisdictions by obtaining a decision only from [the market participant’s] principal regulator and meeting the requirements of one set of harmonized laws.”13 To this end, each market participant falls within the jurisdiction of one of the thirteen regulators, dubbed the market participant’s “principal regu-

6. Barbie McKenna, Steven Chase, Janet McFarland & Sophie Cousineau, Ottawa Renews Push for National Securities Regulator, THE GLOBE AND MAIL, http:// www.theglobeandmail.com/report-on-business/flaherty-new-securities-regulator/ article14407154/ (last updated Sept. 20, 2013). 7. The thirteen regulators that are members of the CSA are: the Alberta Securities Commission, the British Columbia Securities Commission, The Manitoba Securi- ties Commission, the Financial and Consumer Services Commission (New Bruns- wick), the Office of the Superintendent of Securities Service Newfoundland and Labrador, the Northwest Territories Securities Office, the Nova Scotia Securities Commission, the Nunavut Securities Office, the Ontario Securities Commission, the Office of the Superintendent of Securities (Prince Edward Island), Autorite ´ des marches ´ financiers (Quebec), the Financial and Consumer Affairs Authority of Saskatchewan, and the Office of the Superintendent of Securities (Yukon). CSA Members, CANADIAN SECURITIES ASSOCIATION, http://www.securities-admini strators.ca/aboutcsa.aspx?id=80 (last visited Mar. 34, 2014). 8. Overview, CANADIAN SECURITIES ASSOCIATION, http://www.securities-admini strators.ca/aboutcsa.aspx?id=45 (last visited Mar. 24, 2014). 9. See id. 10. Id. 11. McKenna et al., supra note 6. 12. Pan-Canadian Regulatory Cooperation, CANADIAN SECURITIES ASSOCIATION, http://www.securities-administrators.ca/aboutcsa.aspx?id=96 (last visited Mar. 24, 2014). 13. Id. 2014] TWO DOWN, ELEVEN TO GO 135 lator.”14 Once a market participant complies with any requirements set forth by its principal regulator, it is deemed to have complied with the requirements of the other regulators.15 One rather distinctive flaw with the Passport System is the fact that the Ontario Securities Commission does not participate in it.16 Unlike the twelve other securities regulators, the Ontario Securities Commission in- sists on making its own regulatory decisions.17 Fortunately, the twelve Passport-participating regulators do accept regulatory decisions of the Ontario Securities Commission, making this only a unilateral disconnect.18

II. THE SECURITIES ACT: PARLIAMENT’S THOUGHT EXPERIMENT IN COMPREHENSIVE CENTRALIZATION After decades of considering the creation of a national securities regulator and with a certain degree of dissatisfaction with the limited uniformity that the CSA was able to bring to Canadian securities regulation,19 the Parliament of Canada proposed the Securities Act with the intent of creating “a single Canadian securities regulator supported by a comprehensive statutory and regulatory regime that applies across Canada.”20 The Ca- nadian Parliament elected to unify securities regulation by creating a single national entity to displace the provincial and territorial regulators.21 Parliament indicated that the Securities Act was designed to provide improved protection for investors,22 “foster fair, efficient and competitive capital markets” in Canada,23 and “to contribute . . . to the integrity and stability of [Canada’s existing] financial system.”24 To meet these goals, Parliament intended to enact: registration requirements for securities dealers,25 prospectus filing requirements,26 disclosure requirements,27 specific duties for market participants,28 a framework for the regulation of derivatives,29 private civil remedies,30 and regulatory and criminal of- fenses pertaining to securities.31

14. See id. 15. See id. 16. Id. 17. Id. 18. Id. 19. Reference re Securities Act, [2011] 3 S.C.R. 837, paras. 11–28 (Can.). 20. Proposed Canadian Securities Act, Order in Council P.C. 2010-667, preamble. 21. Reference re Securities Act, [2011] 3 S.C.R. para. 2. 22. Proposed Canadian Securities Act, Order in Council P.C. 2010-667, § 9(a). 23. Id. § 9(b). 24. Id. § 9(c). 25. Id. pt. 5. 26. Id. pt. 6. 27. Id. pt. 8. 28. Id. pt. 10. 29. Id. pt. 7. 30. Id. pt. 12. 31. Id. pt. 11. 136 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

Likely realizing that not all of the provincial and territorial regulators would welcome the creation of a single national regulator, Parliament drafted the Securities Act so that its provisions would only apply to provinces and territories that opted-in to be under the authority of the national regulator.32 Nevertheless, on May 26, 2010,33 the Canadian Governor in Council petitioned the Supreme Court of Canada to issue an advisory opinion ruling on whether the Securities Act fell within the scope of Parliament’s legislative authority.34

A. SUPREME COURT OF CANADA’S ADVISORY OPINION ON THE SECURITIES ACT

On December 22, 2011,35 the Supreme Court of Canada released the requested advisory opinion36 accessing whether Parliament had the legislative authority to pass the proposed Securities Act.37 The Attorney Gen- eral of Canada and intervener Attorney General of Ontario argued that the Securities Act falls within Parliament’s general power to regulate trade and commerce.38 The Attorneys General of Alberta, Quebec, Manitoba, and New Brunswick intervened and argued that the Securities Act intrudes upon provincial legislative authority.39 The Attorneys Gen- eral for British Colombia and Saskatchewan also opposed the Securities Act, but were not against the concept of a national securities regulator in principal, so long as the national regulator was designed to respect the division of authority between the federal government and the provinces.40 In support of the Securities Act, the Canadian government argued that the Canadian securities markets expanded over time from local markets to a national market with nationwide implications.41 The government further argued that this evolution of the securities market gave the federal government concurrent jurisdiction to regulate the securities market alongside the provinces and territories.42 The federal government possesses the broad authority to regulate national trade and commerce and it argued that this power grants Parliament the ability to pass the Securities Act.43 In conducting its analysis the Supreme Court of Canada took note of

32. Id. pmbl. 33. Reference re Securities Act, [2011] 3 S.C.R. at 837. 34. Id. para. 1. 35. Id. at 837. 36. The Supreme Court of Canada has authority to issue advisory opinions. Supreme Court Act, R.S.C 1985, c. S-26, at § 53. 37. Reference re Securities Act, [2011] 3 S.C.R. para. 1. 38. Id. para. 32. 39. Id. para. 34. 40. Id. para. 35. 41. Id. para. 4. 42. Id. 43. Id. para. 5. 2014] TWO DOWN, ELEVEN TO GO 137 the decisions of the Quebec Court of Appeal44 and the Alberta Court of Appeal45 who both declared the Securities Act unconstitutional.46 The Supreme Court also examined the legal basis for the provincial securities regulation47 and the nature of national securities regulation in foreign countries including Germany,48 Australia,49 and most notably, the United States.50 The Court paid particular attention to the U.S. Constitution’s Commerce Clause and Supremacy Clause which allow U.S. states to regulate securities at the local level, the federal government to regulate securities between the states, and for federal laws regulating securities to trump similar state laws when the two are in direct conflict with each other.51 The Supreme Court took particular note of the fact that the regulatory system with federal preemption crafted in the United States does not foreclose the ability of the states to have a role in the regulatory process.52 The Supreme Court also took the time to recount Canada’s principles of federalism in general53 and the particular nature of the Supreme Court’s interpretation of the scope of the federal government’s trade and commerce power.54 After analyzing the proposed Securities Act, the Supreme Court came to the conclusion that certain provisions within the act were a valid exercise of Parliament’s trade and commerce power because the Canadian securities market is too large and economically important to be fully and properly regulated by the provinces and territories alone.55 However, the Supreme Court ultimately found that the proposed Securities Act went well beyond simply augmenting provincial and territorial securities regulation and amounted to a “wholesale takeover of the regulation of securities.”56 Finally, the Supreme Court indicated that it believed the primary focus of the proposed act, or the act’s “pith and substance,” was not regulation of nationwide economic risk, but rather protecting investors and ensuring market fairness.57 Unfortunately for the Canadian government, the Su- preme Court found the latter two objectives to fall squarely within the powers of the provinces and territories, making the Securities Act’s primary objectives an unconstitutional intrusion on provincial powers.58

44. Id. para. 38. 45. Id. para. 37. 46. Id. para. 36. 47. Id. para. 43. 48. Id. para. 49. 49. Id. para. 50. 50. Id. paras. 51–52. 51. Id. para. 51. 52. Id. para. 52. 53. Id. paras. 54–67. 54. Id. paras. 68–90. 55. Id. para. 128. 56. Id. 57. Id. 58. Id. 138 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

As a consolation prize, the Supreme Court indicated that a hypothetical cooperative regulatory scheme where the federal government would address systemic security market risk and national economic concerns while provincial and territorial regulators would regulate investor protection and market fairness.59 In support of this hypothetical cooperative approach, the Supreme Court noted that other countries with national securities regulators reserve certain aspects of regulation for local regulators instead of condensing all regulatory authority in a single national regulator.60

III. THE COOPERATIVE CAPITAL MARKETS REGULATOR: AN ASPIRATION FOR COOPERATION AND A MIDDLE GROUND Less than two years after the Supreme Court decided Reference re Se- curities Act, the Canadian Minster of Finance, along with the Ministers of Finance for Ontario and British Columbia, reached an agreement to create a cooperative securities regulator, the CCMR,61 very similar to the one contemplated by the Supreme Court in the closing remarks of its Securities Act opinion.62 The announcement indicated that the new cooperative securities regulator will provide increased protection for investors, make improvements to Canada’s financial services sector, and “support efficient capital markets and manage systemic risk.”63 The cooperative system has been designed with the goals of preserving the current ability to weigh and consider local perspectives and achieving “needed reforms within a national context.”64 The CCMR will accomplish these goals by creating a “uniform act” for each participating jurisdiction that addresses everything currently addressed by provincial and territorial legislation.65 A single complementary federal act that addresses national data collection and problems like system risk will also be created. The act will conform to the goals that federal securities legislation may properly pursue according to the Su- preme Court’s opinion in Reference re Securities Act.66 Both the provincial acts and the federal acts will be administered by the CCMR under authority delegated to the CCMR by the federal government and the par-

59. Id. para. 131. 60. Id. 61. Ministers of Finance of British Columbia, Ontario and Canada Agree to Establish a Cooperative Capital Markets Regulator, DEP’TOF FIN. CAN. (Sept. 19, 2013), http:// www.fin.gc.ca/n13/13-119-eng.asp [hereinafter Ministers of Finance]. 62. Reference re Securities Act, [2011] 3 S.C.R. paras. 128, 131; Ministers of Finance supra note 61. 63. Ministers of Finance supra note 61. 64. Id. 65. Backgrounder: Agreed Elements of a Cooperative Capital Markets Regulatory Sys- tem, DEP’TOF FIN. CAN. (Sept. 19, 2013), http://www.fin.gc.ca/n13/data/13-119_1- eng.asp. 66. Id. 2014] TWO DOWN, ELEVEN TO GO 139 ticipating provinces and territories.67 The type of cooperative regulator outlined in the Department of Fi- nance’s announcement is very much in line with the type of regulator that the government of British Columbia was advocating for when the Securi- ties Act was being challenged.68 The Minsters of Finance for Canada and Ontario have evidently come to agree with British Columbia in this respect and have invited the other eight provinces and three territories to participate in the new cooperative system.69 It remains to be seen how many, if any, additional provinces and territories will choose to participate in the CCMR. Alberta and Quebec almost immediately announced their intentions to not participate in the new regulatory system.70 With a target implementation date of July 2015,71 there is ample time for more provinces and territories to elect to participate in the CCMR. The fact that the CCMR’s initial draft regulations will not be published until April 30, 2014 creates a great deal of uncertainty with respect to the details of the new regulatory scheme.72 But this has not stopped a considerable number of people from expressing support; response to the announcement of the CCMR has been largely positive.73 Evidently, the prospect of having something closer to a national securities regulator is akin to the light at the end of a long tunnel. Canada’s Minster of Finance seems particularly proud of the announcement which is not surprising considering he has been trying to reform Canada’s system of securities regulation since 2006.74 The CCMR is in its infancy, only two provinces have agreed to participate in it so far. While it will be not as significant a change to Canada’s system of securities regulation that some hoped for, even if every province and territory were to participate, it is a significant step in the right direction that holds significant promise for the future of Canadian securities regulation.

67. Id. 68. Reference re Securities Act, [2011] 3 S.C.R. para. 35; Ministers of Finance supra note 61. 69. Ministers of Finance supra note 61. 70. McKenna, Chase, McFarland & Cousineau, supra note 6. 71. Isfeld & Shecter, supra note 1. 72. Id. The release date “for the draft provincial capital markets legislation, draft complementary federal legislation, and CCMR memorandum of agreement” was extended to April 30, 2014. Statement Regarding Establishment of a Cooperative Capital Markets Regulator, DEP’TOF FIN. CAN. (Jan. 31, 2014), http:// www.fin.gc.ca/n14/14-015-eng.asp. 73. Isfeld & Shecter, supra note 1; McKenna, Chase, McFarland & Cousineau, supra note 6. 74. Isfeld & Shecter, supra note 1. 140 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 BRAZIL’S LANDMARK ANTI-CORRUPTION LAW

Michelle Richard*

ATIN America has constantly battled with corruption, especially corruption in transactions with public officials. But, within the last Ltwo decades, Brazil has taken a firm stance against corruption by passing new laws aimed at combating corruption in business transactions.1 Brazil just passed a monumental anti-corruption law, the Brazilian Clean Companies Act (BCCA), enacted on August 1, 2013, which now makes companies and individuals liable for bribing public officials.2 The law is the first of its kind in Latin America and has been likened to the U.S. Foreign Corrupt Practices Act and the U.K. Bribery Act, although it actually imposes more severe penalties than either its U.S. or U.K. counterparts.3 The law represents a new anti-corruption precedent in Latin America that will expectantly change perceptions concerning corruption in business transactions in Brazil and should severely curtail corruption if effectively enforced.4

I. HISTORY OF CORRUPTION IN BRAZIL Brazil has a fast-growing economic market with many incentives for multinational companies; yet, the perception of corruption within the Brazilian market has posed a significant obstacle for Brazil’s continued growth.5 On a scale measuring the degree of corruption perceived in the public sector, Brazil scored 3.7, with zero being very corrupt and ten be-

* Michelle Richard graduated from Baylor University in 2011 and is currently a third-year law student at SMU Dedman School of Law. She would like to thank her friends and family for their continued love and support. 1. Juan Carlos Varela, Geida D. Sanlate & Daniela Sedes, Brazil’s New Anti-Corrup- tion Law: What Every Multinational Employer Should Know, LITTLER (Aug. 22, 2013), http://www.littler.com/publication-press/publication/brazils-new-anti- corruption-law-what-every-multinational-employer-shou. 2. Id. 3. Jacyln Jaeger, Brazil Passes Landmark Anti-Bribery Law, COMPLIANCE WEEK (July 9, 2013), http://www.complianceweek.com/brazil-passes-landmark-anti- bribery-law/article/302203/. 4. Anthony Boadle & Dan Grebler, Brazil enacts tough anti-bribery law required by OECD, REUTERS (Aug. 2, 2013), http://www.reuters.com/article/2013/08/02/us- brazil-bribery-idUSBRE97111A20130802. 5. KELLIE T. CURRIE, GABRIEL AVES DA COSTA & CARLO DE LIMA VERONA, CROWELL MORING, ANTI-CORRUPTION COMPLIANCE IN BRAZIL: TOP TEN CON- SIDERATIONS (2011), available at http://www.crowell.com/files/2011-anti-corruption -compliance-in-brazil-top-ten-considerations.pdf.

141 142 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 ing very clean.6 Moreover, while Brazil’s anti-corruption laws may be exemplary compared with many developing countries, great concern exists over Brazil’s enforcement of these laws.7 Brazil’s most recent corruption case exemplifies Brazil’s continuing struggle to enforce anti-corruption measures and portray Brazil as dedi- cated to fighting corruption so as to attract investors. Brazil’s largest and most highly publicized corruption trial has recently been reopened; the Mensalao case deals with public funds that were paid to parties for political support, essentially members of coalition parties received monthly payments in consideration for their support of the minority government under the former President Luiz Inacio Lula da Silva.8 Twenty-five people out of thirty-seven people charged received convictions, including some key political figures.9 Most notably, Jose Dirceu, considered a likely Presidential candidate to replace former President Lula, received almost eleven years incarceration on counts of conspiracy and bribery.10 The convictions of powerful political figures brought hope to many Brazilians, but this hope was short lived when the Supreme Court agreed to reopen the cases of twelve of the convicted defendants.11 Now Brazil must wait and see whether the convictions are upheld; if the court over- turns these convictions it will reflect very negatively on Brazil’s new anti- corruption position and considerably hamper their efforts to reduce perceptions of corruption. Another corruption scandal involved Munich-based Siemens’ alleged participation in a cartel that fixed prices during the bidding for the subway line in Sao Paulo and Brasilia.12 In 2008, a member of parliament and a former Siemens employee reported that Siemens had fixed prices with multiple global companies and employed the use of bribes to raise the price of the contracts.13 Siemens actually self-reported their involvement in the alleged cartel to Brazilian officials in exchange for leniency and protection from any criminal proceedings that may ensue if authorities prove the cartel did in fact exist.14 The illegal price-fixing between at least five international conglomerates increased bids anywhere from ten

6. Id. Transparency International, a non-profit organization, conducted research into 178 countries, with Brazil ranking sixty-ninth. 7. Snapshot of the Brazil Country Profile, GLOBAL ADVICE NETWORK (Sept. 2013), http://www.business-anti-corruption.com/country-profiles/the-americas/brazil/ snapshot.aspx. 8. Brazil ‘Mensalao’ Corruption Trial to Be Reopened, BBC (Sept. 18, 2013), www.bbc.co.uk/news/world-latin-america-24154273 [hereinafter Mensalao Re- opened]; Joao Fellet & Alessandra Correa, Will Brazil’s ‘Mensalao’ Corruption Trial Bring Change?, BBC BRASIL (Dec. 7, 2012), www.bbc.co.uk/news/world- latin-america-20639111. 9. Fellet & Correa, supra note 8. 10. Id. 11. Mensalao Reopened, supra note 8. 12. Andreas Knobloch, Cartel Accusations Against Siemens in Brazil, DEUTSCHE WELLE (July 18, 2013), http://www.dw.de/cartel-accusations-against-siemens-in- brazil/a-16960997. 13. Id. 14. Id. 2014] BRAZIL’S ANTI-CORRUPTION LAW 143 to twenty percent, ultimately landing Siemens the construction contract for $268 million in the late 1990s.15 The media has reported the use of bribes in the scheme, but Siemens reports that no such allegations have been supported thus far in internal investigations.16 Regardless, on Octo- ber 10, 2013, Siemens publicly announced in an investigation hearing that if authorities prove the existence of a price-fixing cartel for the subway bidding, Siemens will reimburse Brazilian authorities.17 Investigations are still underway in the subway price-fixing scheme; however, these highly publicized corruption scandals involving the government, politi- cians, and international corporations explain Brazil’s motivation for enacting a strict anti-corruption law.

II. ANTI-CORRUPTION EFFORTS PRIOR TO PASSAGE OF THE BRAZILIAN CLEAN COMPANIES ACT As previously mentioned, Brazil began efforts to combat corruption almost two decades ago.18 Until recently, corruption was prosecuted under Brazilian penal codes; accordingly, some of Brazil’s first steps towards ending corruption began with a host of changes and additions to the penal code, “including legislation against bribery-related money laun- dering, securities fraud, concealment of assets, and economic power abuse.”19 Then, in 2000, Brazil adopted the Organisation for Economic Co-operation and Development’s (OECD) Convention on Combating Bribery of Foreign Public Offices in International Business Transactions (Convention on Combating Bribery) and in 2003, Brazil signed the United Nations Convention against Corruption.20 While not actually a member of the OECD, the OECD requested that Brazil, as a party to the Convention on Combating Bribery, update its corruption legislation to impose direct liability on companies for bribery of foreign officials.21 Ap- parently, from the time Brazil ratified the Convention on Combating Bribery in 2002 until 2012, Brazilian authorities had initiated only one case and pursued two investigations concerning international bribery.22 But, since 2008, some progress has occurred as convictions for Brazilian bribery have increased thirty percent.23 The OECD’s request for updated anti-corruption legislation in combination with the public outcry arising from the Mensalao trial presented the perfect backdrop for Brazil to pass the landmark anti-corruption law and make a drastic step towards fighting corruption in transactions with public officials.

15. Id. 16. Siemens Says Will Reimburse Brazil if Cartel Proven -Papers, REUTERS (Oct. 11, 2013), www.reuters.com/article/2013/10/11/brazil-siemens-idUSL1N0I10GL20131 011. 17. Id. 18. Varela, supra note 1. 19. Id. 20. Id. 21. Boadle & Grebler, supra note 4. 22. Id. 23. Id. 144 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

III. THE BRAZILIAN CLEAN COMPANIES ACT The Brazilian Chamber of Deputies approved the legislation in April, Brazil’s Senate subsequently approved it in July,24 and finally President Dilma Vana Rousseff signed the legislation, officially enacting the BCCA in August.25 It will come into effect on January 28, 2014.26 The BCCA concentrates on combating fraud and corruption within the bidding and acquisition process for public contracts; however, the law imposes very comprehensive liability and covers a wide array of acts of corruption be- sides acts directly related to public contracts.27 The BCCA has received considerable attention as a forward step for Brazil’s fight against corruption, but it remains to be seen how effectively the BCCA can be implemented and enforced.28

IV. THE ACT’S KEY PROVISIONS The BCCA imposes very comprehensive liability, but first and fore- most, it imposes civil liability on individuals and corporations, whereas previously only individuals could be liable for their acts.29 Now an entity may be held civilly and administratively liable for any corrupt act of any of its agents, including any of its directors, officers, or employees.30 Under the BCCA, civil and administrative liability can arise when a Bra- zilian company or its agents bribe foreign officials or when any company or its agents bribe any local Brazilian official.31 Basically, any entity doing business in Brazil that attempts to bribe either a foreign or Brazilian official imposes liability on that entity, even if the act occurs outside of Brazil.32 Furthermore, unlike its U.S. and U.K. counterparts, the BCCA holds all parent and subsidiaries jointly liable for any public contract found to be in violation of the Act.33 The BCCA employs broad prohibitions to tackle corruption. Accord- ingly, it prohibits more than simply bribery, but rather it prohibits conduct that gives an unfair advantage or even actions that would in any way prohibit the natural competitiveness inherent in public bidding.34 For ex-

24. Jaeger, supra note 3. 25. Louise Zornoza, Brazil’s President Signs Anti-Bribery Law, REG. AFF.PROF. SOC’Y (Aug. 16, 2013), http://www.raps.org/focus-online/news/news-article-view/ article/3952/brazils-president-signs-anti-bribery-law.aspx. 26. Valera, supra note 1. 27. Id. 28. MARCELO DOS SANTOS BARRADAS CORREIA, MYLES K. BARTLEY & REGINA F. KILVER, ASS’NOF CORP. COUNSEL, A COMPARISON OF THE NEW BRAZILIAN AN- TICORRUPTION LAW , THE FCPA, AND THE UK BRIBERY ACT (2013), available at http://www.acc.com/legalresources/quickcounsel/cnbalfuba.cfm?makepdf=1. 29. Id. 30. Jaeger, supra note 3. 31. Boadle & Grebler, supra note 4. 32. Jaeger, supra note 3. 33. BARRADAS CORREIA ET AL., supra note 28. Holding companies and their subsidiaries jointly liable is one of the major differences of the BCCA in comparison with other anti-corruption statues. 34. Id. 2014] BRAZIL’S ANTI-CORRUPTION LAW 145 ample, “acts of offering, promising, sponsoring or otherwise supporting” bribery or any conduct that would unfairly advantage any third party or any public official are illegal.35 This covers direct and indirect benefits offered to a public official or even offered to a relative of a public official.36 Attempting to cover up the interests or beneficiaries of illegal acts through the use of third parties also constitutes a violation of the BCCA.37 If an entity finances any act prohibited by the BCCA, then they too become liable for the acts.38 Furthermore, the BCCA is a strict liability statute and therefore no showing of a specific intent is required.39 Lia- bility arises simply upon a showing that any agent or employee of an entity engaged in an act prohibited under the statute.40 Basically, prose- cutors do not need to prove that a high level employee knew of the incident or even that the entity failed to take reasonable precautions, so long as they demonstrate that the illegal act occurred.41

V. PENALTIES AND INCENTIVES On top of providing very comprehensive civil and administrative liability, the BCCA imposes severe penalties for violations.42 If a company receives a conviction for bribery under the BCCA, up to twenty percent of their gross annual revenue from the previous year is susceptible to fines, with a maximum fine of $26,220,000.43 During the drafting of the BCCA, the fines capped off at the value of the contract; however, Presi- dent Dilma Rousseff vetoed this provision to allow for the imposition of greater fines.44 The BCCA allows for sanctions on top of fines including blacklisting companies previously convicted for bribery and preventing them from obtaining government contracts, subsidies, or funding for a maximum of five years.45 Additional penalties allow for disgorgement of benefits, suspension, and in extreme cases, even dissolution of the entity.46 But, while the BCCA does impose strong penalties, it also provides some incentives. For example, companies that have an effective compli-

35. Id. 36. Zornoza, supra note 25. 37. Id. 38. Valera, supra note 1. 39. BARRADAS CORREIA ET AL., supra note 28. 40. Id. 41. Michael Volkov, Brazil and its Commitment to Anti-Corruption Enforcement, COR- RUPTION, CRIME AND COMPLIANCE (Sept. 4, 2013), http://corruptioncrime compliance.com/2013/09/brazil-and-its-commitment-to-anti-corruption-enforce ment/. 42. Zornoza, supra note 25. 43. Boadle & Grebler, supra note 4. 44. BARRADAS CORREIA ET AL., supra note 28. This veto has been commended as a demonstration of Brazil’s true commitment to end corruption through strong penalties. 45. Boadle & Grebler, supra note 4. 46. Jaeger, supra note 3. 146 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 ance program in place47 or entities that self-report any incidents of bribery may have reduced penalties.48 If a company self-reports, the BCCA allows the government to create leniency agreements, which can reduce fines by a maximum of two-thirds, so long as the companies cooperate in all of the subsequent investigative and administrative proceedings.49 General demonstrations that the entity has cooperated in investigations and has attempted to comply with the new provisions allow the government to impose lesser penalties and even to execute non-prosecution agreements, completely barring the government from bringing suit.50

VI. POSSIBLE SHORTCOMINGS Thus far, the BCCA has been perceived as on par with some of the most advanced anti-corruption laws in the world;51 however, certain aspects of the legislation have been doubted, if not criticized. For example, many terms within the BCCA have no definition, which will likely result in confusion for companies trying to comply; hopefully, with time such confusion should dissipate with actual implementation and enforcement.52 Also, any branch of the Brazilian government can bring an action for a violation and the highest authority within that public body then presides over the hearing, creating a high risk for inconsistent practices and potential conflict of interests.53 Unlike the Federal Corrupt Practices Act, the BCCA does not cover corruption in private transactions; it only addresses liability for illegal acts in relation to public official.54 Lastly, although many international organizations and foreign governments have praised Brazil’s new anti-corruption law as a positive step forward, skep- ticism remains about effective enforcement.55

VII. CONCLUSION After struggling with corruption in transactions with public officials that negatively impacted Brazil’s economic opportunities, Brazil has now enacted a monumental anti-corruption law similar to corruption laws in the United States and United Kingdom. The BCCA sets an unprece- dented new standard in anti-corruption legislation in Latin America and brings Brazil into compliance with international standards. If effectively enforced, the BCCA’s comprehensive personal and corporate liability

47. Id. 48. Id. 49. BARRADAS CORREIA ET AL., supra note 28. 50. Volkov, supra note 41. 51. See Valera, supra note 1. 52. BARRADAS CORREIA ET AL., supra note 28. For example, the BCCA does not define what sufficiently demonstrates that a company took “adequate procedures” so as to mitigate possible liability or who qualifies as a “public agent.” 53. Id. (an exception exists for proceedings relating to foreign public officials; the Federal Government General Controller governs such proceedings). 54. Id. 55. Jaeger, supra note 3. 2014] BRAZIL’S ANTI-CORRUPTION LAW 147 and strict penalties should severely curtail future bribery and corruption in transactions with public officials. 148 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 AMERICAN TRADE NEWS HIGHLIGHTS FOR WINTER, 2013 COSTCO CASHEWS: HOW MUCH ROASTING MAKES THEM AMERICAN FOR PURPOSES OF NAFTA PREFERENTIAL TARIFF TREATMENT BY CANADA?

Vanessa Humm*

I. INTRODUCTION

HE Canada Border Services Agency (CBSA) recently ruled that the reduced tariffs under the North American Free Trade Agree- Tment (NAFTA) do not apply to Costco cashews.1 Costco Whole- sale Canada Ltd. (Costco) appealed the ruling, and the Canadian International Trade Tribunal (CITT) held a public hearing to consider the appeal on October 24, 2013.2 This is not the first appeal Costco has made of a CBSA classification decision of Costco products. For example, Kirk- land Signature Trail Mix, a Costco brand trail mix, was the subject of an appeal drawn out over time from 2003 until finally concluding in 2005.3 This update will discuss the applicable legislation and regulations for the origin of goods, as well as provide a background of the CBSA and the classification process it employs in determining whether a product originates within a NAFTA member country. The background of the CBSA will conclude with a discussion of the CBSA appeals process. The update will then provide a background of the CITT and its functions, with particular emphasis on the CITT appeals process. Finally, the update will provide a summary of a previous CITT decision involving NAFTA coun-

* Vanessa Humm is a third-year at SMU Dedman school of Law. She is currently serving as the NAFTA Reporter for the International Law Review Association. Prior to beginning law school, Vanessa received a Bachelor of Arts from TCU. She would like to thank her family and friends for the continued love and support they have given her throughout her time in law school. 1. Brian Flood, Costco Appeals Canadian Tariff Ruling on Imports of Cashew Nuts from U.S., BNA, Oct. 22, 2013 (on file with author). 2. Id.; Notice for Public Hearing, Costco Wholesale Canada Ltd. v. President of the Canada Border Services Agency, Notice No. HA-2013-011, Appeal No. AP-2013- 003 [2013] (Canadian International Trade Tribunal) [hereinafter Notice for Public Hearing]. 3. Appeals Order and Reasons, Costco Wholesale Canada Ltd., Application No. EP- 2005-008 [2005] (Canadian International Trade Tribunal).

149 150 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 try of origin classifications in order to illustrate a likely analysis the CITT will take for the appeal of the classification of Costco cashews, and provide a possible outcome of the appeal based on this analysis.

II. RELEVANT LEGISLATION AND REGULATIONS NAFTA provides for preferential tariff treatment for products originating within a NAFTA member country. NAFTA provides for a phase-out of tariffs on goods produced by the three member countries: Canada; the United States; and Mexico.4 Based on this phase-out, none of the party countries may increase or adopt a customs duty on a good produced by a NAFTA country—an originating good5—and each country must follow the schedule provided to eliminate its customs duties on these originating goods.6 NAFTA provides rules of origin in order to assist the member countries in determining whether a good qualifies as an originating good.7 For example, a good is an originating good if it is “wholly obtained or produced entirely in the territory of one or more of the Parties . . . .”8 However, an originating good does not have to trace its origin exclusively to Canada, the United States, or Mexico. A good can be an originating good under the NAFTA rules of origin where “each of the non-originating materials used in the production of the good undergoes an applicable change in tariff classification . . . as a result of production occurring entirely in the territory of one or more of the Parties . . . .”9 At issue in this update, to be discussed in further detail later, is what constitutes an applicable change in tariff classification, according to NAFTA. In addition to NAFTA, Canada has key legislation to the issue of originating goods and the Costco cashew dispute. The Customs Act is one such piece of legislation, which governs the CBSA.10 When the Act was first enacted in 1867, it was meant to: “ensure the collection of duties;” “control the movement of people and goods into and out of Ca- nada;” and “protect Canadian industry from real or potential injury caused by the actual or contemplated import of dumped or subsidized goods and by other forms of unfair competition.”11 The Act provides the legislative authority “to administer and enforce the collection of duties and taxes that are imposed under separate taxing legislation.”12 The Act has been revised over time, all while maintaining its three original purposes. The amendments have been made with the intent of supporting a

4. North American Free Trade Agreement, U.S.-Can.-Mex., Dec. 17, 1992, 32 I.L.M. 289, art. 302 (1993) [hereinafter NAFTA]. 5. Id. art. 302(1). 6. Id. art. 302(2). 7. Id. ch. 4. 8. Id. art. 401(a). 9. Id. art. 401(b). 10. Customs Act, R.S.C. 1985, c. 1 (2nd Supp.) (Can.). 11. CAN. BORDER SERVS. AGENCY., Acts, Regulations and Other Regulatory Informa- tion, http://www.cbsa-asfc.gc.ca/agency-agence/actreg-loireg/legislation-eng.html (last modified Apr. 3, 2013). 12. Id. 2014] AMERICAN TRADE NEWS HIGHLIGHTS 151

Canadian goal “to strengthen security and facilitate trade.”13 The Act provides relevant rules, procedures, definitions, and other pertinent provisions for the classification of goods as originating or not. It defines “certificate of origin” as “the proof of origin form for goods for which preferential tariff treatment under a free trade agreement is claimed.”14 Important for purposes of this update is the provision for redetermination and further redetermination by the president.15 Under this provision, a person has ninety days upon receiving notice of the classification decision to “request a re-determination or further re-determination of origin, tariff classification, value for duty or marking.”16 When such a request is made, the President of the CBSA may, among other options, “re-determine or further re-determine the origin . . . [or] affirm, revise or reverse.”17 The Act further provides for appeals beyond those made to the Presi- dent of the CBSA. Once the President of the CBSA has reached his decision, a person may then appeal the decision to the Canadian Interna- tional Trade Tribunal.18 The CITT must provide for a hearing and pub- lish a notice of the hearing before making any decision regarding an appeal.19 Canada has enacted regulations to assist in the implementation, and enforcement, of the Customs Act and the NAFTA preferential tariff provisions. One such regulation is the Proof of Origin of Imported Goods Regulations, originally enacted in 1997 and since amended.20 These regulations correspond to section 35.1 and section 164(1)(i) of the Customs Act.21 Section 35.1 of the Act requires proof of origin to be furnished for all imported goods;22 section 164(1)(i) simply states that the Governor in Council may make regulations prescribing anything that the Act states the Governor is to prescribe.23 The Proof of Origin regulations require the importer, or owner of goods who is claiming preferential tariffs under NAFTA, to provide proof of origin via a Certificate of Origin for the goods.24 The regulations provide for various exemptions from this requirement.25 Another set of regulations relating to the Customs Act and the NAFTA preferential tariff provisions is the NAFTA Rules of Origin Reg- ulations.26 These regulations were originally enacted in 1993, and are in-

13. Id. 14. Customs Act § 2(1). 15. Id. § 60. 16. Id. § 60(1). 17. Id. § 60(4). 18. Id. § 67(1). 19. Id. § 67(2). 20. Proof of Origin of Imported Goods Regulations, SOR/98-52 (Can.). 21. Compare id., with Customs Act § 35.1, § 164(1)(i). 22. Customs Act § 35.1. 23. Id. § 164(1)(i). 24. Proof of Origin of Imported Goods Regulations § 6(1). 25. Id. §§ 6(2)–(4). 26. NAFTA Rules of Origin Regulations, SOR/94-14 (Can.). 152 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 tended to provide uniform interpretation, application, and administration of the NAFTA rules of origin.27 The Rules of Origin Regulations provide clear explanations as to when a good is an originating good for purposes of the NAFTA preferential tariff provisions.28 For example, the regulations provide that a good originates in a NAFTA country where it is “(a) a mineral good extracted in the territory of one or more of the NAFTA countries; (b) a vegetable or other good harvested in the territory of one or more of the NAFTA countries; [or] (c) a live animal born and raised in the territory of one or more of the NAFTA countries.”29 Beyond these more obvious originating goods, the regulations explain a good can still be of NAFTA origin where: [E]ach of the non-originating materials used in the production of the good undergoes the applicable change in tariff classification as a result of production that occurs entirely in the territory of one or more of the NAFTA countries, where the applicable rule in Schedule I for the tariff provision under which the good is classified specifies only a change in tariff classification, and the good satisfies all other applicable requirements of these Regulations.”30 Finally, the Customs Tariff Act was originally enacted in 1997, with respect to the imposition of customs duties and other charges to give effect to an international coding system, to provide relief against certain customs duties or charges, and “to provide for other related matters.”31 All of these acts and regulations, combined, assist the CBSA in making its determinations on how to classify goods.

III. THE CANADA BORDER SERVICES AGENCY The CBSA’s mission is to “ensure Canada’s security and prosperity by managing the access of people and goods to and from Canada.”32 It is a border agency with a president who manages all Agency matters and reports directly to the Minister of Public Safety Canada.33 The CBSA is responsible for “providing integrated border services that support national security and public safety priorities and facilitate the free flow of persons and goods, including animals and plants, that meet all requirements under the program legislation.”34 With a workforce of approximately 13,000 employees, including over 7,200 uniformed CBSA officers, the CBSA manages 119 land-border crossings, is present at 13 international airports, and has services at approximately 1,200 Canadian loca-

27. Id. 28. Id. §4. 29. Id. § 4(1). 30. Id. § 4(2)(a). 31. Customs Tariff, S.C. 1997, c. 36 (Can.). 32. CAN. BORDER SERVS. AGENCY, OUR CHARTER (2010), available at http://www. cbsa-asfc.gc.ca/agency-agence/charter-charte-eng.pdf. 33. About Us: Who We Are, CAN. BORDER SERVS. AGENCY, http://www.cbsa-asfc.gc. ca/agency-agence/who-qui-eng.html [hereinafter Who We Are] (last modified July 14, 2011). 34. Id. 2014] AMERICAN TRADE NEWS HIGHLIGHTS 153 tions and 39 international locations.35 The CBSA investigates, detects, and apprehends violators of Canada’s immigration act, conducts investigations, and administers more than ninety acts, regulations, and international agreements, among other duties.36 As an agency, the CBSA has legislative, regulatory, and partnership duties including administering the governing legislation, preventing threats to Canada, removing people from Canada, protecting food safety, promoting Canadian business and economic benefits through trade agreements and legislation, enforcing trade remedies that protect Cana- dian industry, administering fair and impartial redress, and collecting duties and taxes on imported goods, among other responsibilities.37 The CBSA provides for appeals and reviews of its decisions.38 In 2011, there were approximately 3,500 requests for review of enforcement actions or trade decisions.39 When applying for review, a business or individual must first determine whether the CBSA “actually took a formal action or made a decision” relating to the business’s or individual’s goods.40 Possible actions by the CBSA include enforcement actions in the form of penalties and trade decisions.41 The CBSA did make a decision and take action if the business or individual was provided with a form or letter.42 The CBSA website lists “various forms and letters relating to CBSA enforcement actions and trade decisions for . . . commercial goods crossing [the] border and the associated actions taken.”43 Exam- ples of CBSA decisions include seizure of goods, payment of monetary penalty, disagreement with origin or tariff classification, and foreclosure of goods from entering Canada.44 CBSA decisions about the origin of a good under the Customs Act can be appealed.45 This type of appeal is called a “request for re-determination (or further re-determination) by the President of the Canada Border Services Agency.”46 It asks for review of the appropriateness of the deci-

35. Id. 36. Id. 37. Id. 38. Appeals/Review, CAN. BORDER SERVS. AGENCY, http://www.cbsa-asfc.gc.ca/recourse-recours/menu-eng.html (last modified May 14, 2012). 39. Id. 40. First Steps, CAN. BORDER SERVS. AGENCY, http://www.cbsa-asfc.gc.ca/recourse- recours/firststeps-premieresetapes-eng.html (last modified May 14, 2013). 41. How to Request a Review, CAN. BORDER SERVS. AGENCY, http://www.cbsa- asfc.gc.ca/recourse-recours/howto-commenfaire-eng.html (last modified May 14, 2013). 42. First Steps, supra note 39. 43. Id. 44. Id. 45. How to File a Review, CAN. BORDER SERVS. AGENCY, http://www.cbsa-asfc.gc.ca/ recourse-recours/howto-commentfaire-5-eng.html [hereinafter How to File a Re- view] (last modified May 14, 2013). 46. Id. 154 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 sion.47 These appeals are made when the business or individual believes the CBSA “has misunderstood the facts or has applied the law incorrectly or there is another reason to request a review.”48 A full and impartial review is conducted.49 If the reviewing official agrees there was a mistake, the requesting individual or business will receive notice of the decision approving the request for appeal.50 Further, if the official agrees with the argued for classification or even another alternative classification or origin from that decided by CBSA, it will notify the requesting party of a reversal or revisal of the ruling.51 For reviews of disputes on NAFTA origin, of importance for this update, “the CBSA will share the report, which explains the CBSA’s findings and decision in response to [the] dispute, with U.S. Customs and Border Protection,” with any confidential business information remaining confidential.52 Upon completion of the CBSA review process, the business or individual has yet another right to an appeal. This appeals option is through the Canadian International Trade Tribunal.

IV. THE CANADIAN INTERNATIONAL TRADE TRIBUNAL The Canadian International Trade Tribunal’s mission is “to render sound, transparent and timely decisions in trade, customs and procure- ment cases for Canadian and international businesses and to provide the Government with sound, transparent and timely advice in tariff, trade, commercial and economic matters.”53 The CITT is made up of up to nine full-time members, appointed by the Governor in Council for five-year terms.54 The CITT is the main “quasi-judicial institution in Canada’s trade remedies system.”55 It has a great deal of authority as far as the issues it may hear. Of importance for this update is its authority to “hear appeals of decisions of the Canada Border Services Agency . . . made under the Customs Act.”56 The CITT hears appeals “relating to CBSA tariff classifications and . . . to the origin of goods imported from the United States, Mexico . . . under the Customs Act.”57 An appeal before the CITT begins when a person files a notice of ap-

47. Ministerial or President’s Review, CAN. BORDER SERVS. AGENCY, http://www.cbsa- asfc.gc.ca/recourse-recours/ministerial-ministeriel-eng.html [hereinafter Ministe- rial or President’s Review] (last modified May 14, 2013). 48. How to File a Review, supra note 45. 49. Id. 50. Id. 51. Id. 52. Id. 53. Strategic Plan, 2010-2013, CAN. INT’L TRADE TRIBUNAL, http://www.citt-tcce.gc.ca/ index_e.asp (last modified Sept. 24, 2012). 54. Organization, CAN. INT’L TRADE TRIBUNAL, http://www.citt-tcce.gc.ca/ organization/index_e.asp (last modified Feb. 14, 2014). 55. Mandate, CAN. INT’L TRADE TRIBUNAL http://www.citt-tcce.gc.ca/mandate/index _e.asp (last modified Jan. 18, 2010). 56. Id. 57. Id. 2014] AMERICAN TRADE NEWS HIGHLIGHTS 155 peal with the CITT, within ninety days of the CBSA decision.58 The appellant is required to file a brief that describes the goods at issue, the issue between the appellant and the CBSA, and an argument for why the CBSA’s decision is incorrect.59 Similarly, the CBSA must submit a brief in response.60 Once the CITT has received both briefs, a hearing is scheduled.61 Generally, the hearing is before the CITT members and the public, with notice of the hearing being published to give interested persons the opportunity to attend the hearing.62 The circumstances of the issue determine whether the appeal will be decided by a one-person panel or a three-person panel.63 Similar to a court setting, third parties are allowed as interveners, the appellant may be represented by counsel while the CBSA is generally represented by the Department of Justice, both parties can call witnesses who are questioned under oath, and evidence is presented in support of arguments.64 The CITT usually issues its decision within 120 days of the public hearing; the decision is accompanied with the CITT’s reasoning as well.65 Following this decision, both the appellant and the CBSA, and even an intervener, have the right to judicial review.66

V. CITT ANALYSIS OF NAFTA COUNTRY OF ORIGIN CLASSIFICATIONS The appeal will be based on section 67(1) of the Customs Act.67 This section gives persons aggrieved by CBSA decisions of determination or re-determination of the origin of goods the right to appeal to the CITT.68 The governing legislation and regulations for origin of goods, as explained in detail above, are the Customs Tariff, the Customs Act, the Proof of Origin of Imported Goods Regulations, and the NAFTA Rules of Origin Regulations. MRP Retail, Inc. v. President of the Canada Border Services Agency is an example of an appeal addressing the NAFTA country of origin issue.69 The case concerned women’s clothing imported from a United States clothing company.70 The CITT divided its reasoning into three parts: the

58. Customs Act § 67(1); Canadian Int’l Trade Tribunal Rules, SOR/91-299 § 31 (Can.); Appeals, CAN. INT’L TRADE TRIBUNAL, http://www.citt-tcce.gc.ca/publicat/ apeal_e.asp [hereinafter CITT Appeals] (last modified Apr. 28, 2009). 59. Canadian Int’l Trade Tribunal Rules § 34; CITT Appeals supra note 58. 60. Canadian Int’l Trade Tribunal Rules § 35; CITT Appeals supra note 58. 61. Canadian Int’l Trade Tribunal Rules § 36.1; CITT Appeals supra note 58. 62. Customs Act § 67(2); Canadian Int’l Trade Tribunal Rules § 37.1; CITT Appeals supra note 58. 63. CITT Appeals, supra note 58. 64. Can. Int’l Trade Tribunal Rules § 11, 21, 39–41; CITT Appeals, supra note 58. 65. CITT Appeals, supra note 58. 66. Id. 67. Customs Act, R.S.C. 1985, c. 1, § 67(1) (2nd Supp.) (Can.). 68. Id. 69. MRP Retail Inc. v. President of the Canada Border Services Agency, 2007 CanLII 55912 (Can. CITT). 70. Id. para. 2. 156 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20 facts, the law, and the analysis of the issue.71 Under the facts section, the CITT discussed the production of the goods in issue and the shipment of the goods back and forth between manufacturers and clothing producers located in the United States and Mexico.72 Further, the CITT noted that in each shipment the clothing manufacturer included a certificate of origin where it claimed to be the producer of the goods and certified that the goods were of Mexican origin.73 The CITT then discussed the CBSA’s investigation into the manufacturing process of the goods and the CBSA’s ultimate decision to deny the goods preferential tariff treatment under NAFTA.74 Following this discussion of the facts, the CITT explained the relevant law. The CITT noted that under subsection 24(1) of the Customs Tariff, an importer must meet two conditions before it can qualify for the preferential tariff.75 The importer must first produce proof of origin, as required by the Proof of Origin of Imported Goods Regulations;76 then the importer must show “that the goods comply with the rules of origin prescribed by regulation for the goods.”77 The CITT turned to the first step—proof of origin—noting that the Customs Tariff, under paragraph 24(1)(a),78 allows preferential tariff treatment “only if proof of origin of the goods is given in accordance with the Customs Act.”79 This refers to using the certificate of origin required by the regulations.80 The CITT then explained the second step—rules of origin—referencing the NAFTA Rules of Origin Regulations.81 The CITT began its analysis of the issue by stating that it must determine whether the appellant “has provided proof of the origin of the goods in issue and their compliance with the applicable rules of origin.”82 The CITT addressed the CBSA’s argument that the exporter in this case had not properly completed the certificate of origin because it had not filled it out as producer of the goods, arguing therefore that the certificate

71. Id. para. 5. 72. Id. para. 9. 73. Id. para. 10. 74. Id. paras. 11–22. 75. Id. para. 26. 76. Id. 77. Id. 78. Customs Tariff, S.C. 1997, c. 36 para. 24(1)(a) (Can.). 79. MRP Retail para. 27. 80. Proof of Origin of Imported Goods Regulations, SOR/98-52 § 6.1 (Can.). 81. MRP Retail para. 28 (the CITT referenced subsection 4(1) of the Regulations, however the relevant subsection for the Costco cashew appeal is subsection 4(2), which states “a good originates in the territory of a NAFTA country where . . . (a) each of the non-originating materials used in the production of the good undergoes the applicable change in tariff classifications as a result of production that occurs entirely in the territory of one or more of the NAFTA countries, where the applicable rule in Schedule I for the tariff provision under which the good is classified specifies only a change in tariff classification, and the good satisfies all other applicable requirements of these regulations.”); NAFTA Rules of Origin Regulations, SOR/94-14 § 4(2) (Can.). 82. MRP Retail para. 31. 2014] AMERICAN TRADE NEWS HIGHLIGHTS 157 of origin requirement had not been met.83 The CITT rejected this argument, noting that the regulations do not prescribe the form the certificate must take and that the exporter had submitted certificates, therefore sat- isfying the first requirement.84 The CITT noted that the threshold imposed by section 24 of the Customs Act is low in terms of formal requirements.85 The CITT turned to the second step of its analysis—rules of origin. It noted there was a two-step process to determine whether the goods were originating goods: first, the cotton making up the clothing must have been grown in the United States or Mexico and second, the fabric must have also been assembled into the finished clothing in the United States or Mexico.86 This portion of the CITT’s analysis is not entirely applicable to the Costco cashew case, because the relevant Customs Act subsections differ between the two cases. But the CITT’s weighing of the evidence is relevant. The CITT weighed the competing evidence and determined which side presented more persuasive evidence.87 Further, the CITT referenced section 35 of the Canadian International Trade Tribunal Act, which provides that hearings before the CITT “shall be conducted as in- formally and expeditiously as the circumstances and considerations of fairness permit.”88 The CITT admits evidence liberally, while giving each piece of evidence only “the weight that it deserves.”89 For example, the CITT admitted hearsay evidence into the hearing in order to have the “fullest picture of the facts” and preserve the goal of expediency.90 The CITT weighed the evidence from different witnesses, concluding that because one was based on a first-hand communication versus a recollection of a communication, it was inherently more reliable.91 The CITT concludes by stating what the appellants’ standard of proof will be in challenges raising NAFTA country of origin issues. According to the CITT, the appellant “must prove by a preponderance of evidence, but not beyond all possible doubt . . . that the goods in issue were originating goods.”92 Holding an appellant to a standard of proof of beyond all possible doubt “would be to impose an even heavier burden than that placed upon a prosecutor in a criminal case, where the accused’s liberty is at stake.”93 Such an “onerous requirement” should only be imposed by express legislation and there is nothing in the relevant legislation and regulations to indicate such a burden was intended.94

83. Id. para. 33. 84. Id. para. 34. 85. MRP Retail para. 36. 86. Id. para. 37. 87. Id. para. 46. 88. Id. (citing Canadian International Trade Tribunal Act, R.S.C. 1985, c. 47 (4th Supp.) § 35 (Can.)). 89. Id. para. 51. 90. Id. 91. Id. para. 56–57. 92. Id. para. 65. 93. Id. 94. Id. 158 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20

VI. POSSIBLE OUTCOME AND CONCLUSION The issue in the case of the Costco cashews is “[w]hether the goods in issue qualify as originating goods under [NAFTA] and whether they are entitled to the United States Tariff preferential tariff treatment pursuant to NAFTA.”95 The cashews are produced and exported by a company in North Carolina, which receives the raw cashews from India and Viet- nam.96 Accordingly, in order to be an originating good and therefore qualify for preferential tariff treatment under NAFTA, Costco must prove that the non-originating materials, the cashews, undergo “an applicable change in tariff classification.”97 That the change occurs in a NAFTA country, also a requirement of proving this kind of originating good, is not at issue because the production occurs in North Carolina.98 Rather, the amount of change the cashews undergo in the United States is at issue. Both Costco and the CBSA agree that transforming “raw nuts, salt, and peanut oil” into the finished roasted cashew product satisfies this requirement.99 However, the Canadian Rules of Origin Regulations state that nuts “prepared or preserved merely by . . . roasting, either dry or in oil . . . shall be treated as an originating good only if the fresh good were wholly produced or obtained entirely in the territory of one or more of the NAFTA countries.”100 Accordingly, the dispute is whether the cashews are simply roasted, or whether more production is involved in order to provide the necessary applicable change in tariff classification.101 The CITT will analyze the facts, the law, and make an analysis in order to reach its decision. As indicated in the MRP Retail case, Costco will only need to prove by a preponderance of the evidence that the cashews do indeed undergo more than simply roasting. Arguments in support of this include that “the nuts are screened, aspired, cooled, laser sorted, salted, packaged and packed.”102 However, the CBSA is arguing that these steps are only “incidental” to roasting, and do not provide the applicable change in tariff classification. According to the CBSA, salting “merely adds flavor,” rather than changing the nature of the cashew.103 But based on the CITT’s analysis in MRP Retail, in rejecting the CBSA’s reading of the regulation as requiring the exporter to properly fill out the certificate as the producer and instead basing its analysis on what the regulation actually requires, it is possible the CITT will take a similar analysis in the cashew case.

95. Notice for Public Hearing, supra note 2. 96. Flood, supra note 1. 97. NAFTA, supra note 4, art. 401(b). 98. Flood, supra note 1. 99. Flood, supra note 1. 100. NAFTA Rules of Origin Regulations, supra note 26, ch. 20. 101. NAFTA supra note 4, art. 401(b). 102. Flood, supra note 2. 103. Flood, supra note 2. 2014] AMERICAN TRADE NEWS HIGHLIGHTS 159

The CBSA argues that salting is only incidental, however the Canadian regulations only state that nuts prepared only by roasting either dry or in oil will not qualify as an applicable tariff change. The regulations do not state that salting will not qualify. Accordingly, based on the CITT’s refusal in MRP Retail to read more into the regulations than the text itself, the CITT may reject the CBSA’s argument and accept Costco’s argument that the cashews do undergo the applicable change in tariff classification and the cashews will be considered an originating good entitled to the preferential tariff treatment under NAFTA. 160 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 20