Saudi Arabia Franchise Law and the Implications on Existing Franchise Agreements

By Melissa Murray, Eddie Chiu

02-2020

Introduction

Saudi Arabia has recently approved the Commercial Franchise Law 122/1441 (the New Franchise Law) which is due to come into force in April 2020. The New Franchise Law creates a regulatory framework for the relationship between the franchisor and the franchisee on a basis that promotes transparency.

Any franchise agreement implemented within Saudi Arabia shall be governed by the New Franchise Law, parts of which are intended to apply to franchise agreements in existence prior to April 2020. Of importance are the below with retrospective applicability:

  1. Obligations on the franchisee and franchisor (Chapter 5);

  2. Assignment of the franchise agreement (Chapter 7);

  3. Renewal or extension of the franchise agreement (Chapter 8);

  4. Termination or expiration of the franchise agreement (Chapter 9); and

  5. Compensation in either the event of an invalid refusal to renew or an invalid termination (Chapter 10).

Obligations on the franchisor

Some of the franchisor’s obligations to its franchisee listed under Article 8 along with the obligation to act in good faith under Article 10 will apply to pre-existing agreements. Although many of these obligations, such as a providing training, support and maintaining confidentiality are likely present in many pre-existing agreements, some of the less common obligations which franchisors should be mindful of include:

  • A requirement to respond to its franchisee’s request to provide details of the financial consideration due or paid by it concerning the exercise of franchise business.

  • An obligation to not create any establishment that exercises an activity similar to that of its franchisee in the geographical area specified in the franchise agreement, or grant the right therein throughout the term of the franchise agreement.

The franchisor must comply with its obligations in Article 8 unless otherwise agreed upon with its franchisee in writing. Adopting the above example, if a pre-existing agreement is silent on the issue of non-compete, then the franchisor will need to comply with the obligation as it appears in the New Franchise Law.

Assignment

Article 13 relates to the assignment of a franchise and applies retrospectively, unless the pre-existing agreement specifies its own procedure for assignments.
If the pre-existing agreement is silent on the issue, then the New Franchise Law will apply. If so, the franchisor may only withdraw its consent to assign based on its assessment of the prospective assignee’s suitability and capability. The only reason the franchisor may withdraw its consent having regard to its franchisee’s conduct is if they have failed to pay any consideration due.

Accordingly, franchisors should review the assignment provisions in their franchise documentation to ensure it covers any circumstance where the franchisor is desirous in withholding its consent to an assignment. For example, franchisors commonly seek to withhold their consent to an assignment because its franchisee is in subsisting breach of its franchise agreement (such as not submitting financial reports) and will use its withheld consent as commercial leverage to compel its franchisee to comply. Unless the franchise agreement has been drafted to allow this, it would not be possible for the franchisor to withdraw its consent on that basis nor make its consent conditional upon the remedying of the existing breach.

Under Article 14 of the New Franchise Law, the franchisor is deemed to have accepted its franchisee’s written request to assign if the franchisor has not responded in writing to that request. Whilst no timeframe for a response is set out in the New Franchise Law, it is hoped that clarification around the deemed acceptance is provided by the Implementing Regulations.

Renewal

The provisions relating to franchise renewals will apply to existing franchise relationships, unless the pre-existing agreement stipulates otherwise. This means that under Article 15 of the New Franchise Law, a franchisor is obliged to renew a franchise for a similar period and under similar conditions if its franchisee gives written notice at least 180 days before the expiry date, except in select cases.

Most of these cases which allow the franchisor to refuse the request to renew are likely present in many pre-existing agreements – for example, most franchise agreements already allow a franchisor to refuse to renew if its franchisee fails to pay any consideration due, or fails to comply with the provisions of the franchise agreement. However, additional cases covered by the New Franchise Law allow the franchisor to refuse a request to renew if:

  • the franchisor intends to exit the Saudi Arabia market; or

  • the franchisee does not conclude the renewal agreement at least 60 day before the expiry date.

It is recommended that franchisors review the drafting of the renewal provisions in their franchise agreements to ensure it addresses any circumstances that the franchisor would refuse to renew, particularly in circumstances where its franchisee is not in breach of its franchise agreement. For example:

  • a franchisee’s non-adherence to a development quota may not constitute a “legitimate cause for termination”, but the franchisor may nonetheless wish to not renew the franchise for a further term; and

  • there are no further renewal or further terms that its franchisee can exercise to extend the duration of the franchise relationship and the franchisor wishes to negotiate franchise fees for an additional term that are reflective of the market rate for the brand.

Importantly, unless the franchise agreement stipulates otherwise (such as an obligation that its franchisee sign the franchisor’s then-current franchise agreement), the New Franchise Laws require the renewed franchise agreement to be under similar conditions, which can be interpreted to mean having similar terms and conditions as the earlier agreement.

Most franchise agreements are for a lengthy duration of up to 10 years and, in practice, the franchisor has usually amended its franchise documentation substantially as their brand becomes more established and matures in the market. If the earlier franchise agreement is silent on the issue, then franchisors may be obliged to renew on similar terms and conditions without an ability to incorporate new provisions which are more favourable to the franchisor or which are necessary to protect the brand’s integrity.

Termination

Under Shariah Law, if a franchisee who is a natural person dies, the business will be split amongst the heirs of the estate. Although most franchise agreements contain a clause allowing for the termination upon the death or disability of the franchisee, in practice this can be difficult to enforce, especially where there may be minors within the determined heirs of the estate. However, Article 16 of the New Franchise Law allows for the termination of the franchise agreement upon the death, disqualification or emergence of a health impediment of the franchisee.

Article 18 of the New Franchise Law permits termination of the Franchise Agreement during the franchise term if there is a “legitimate cause” for termination. Whilst “legitimate cause” is an undefined term, the New Franchise Law sets out 9 cases that constitute a legitimate cause. These 9 cases would commonly be found in most franchise agreements, covering events such as voluntary abandonment of the franchise business (albeit for a lengthy period of 90 days), infringement of the franchisor’s Intellectual Property, or violation of its obligations under the franchise agreement which are unremedied within 14 days after receipt of the franchisor’s written notification regarding the same.

In addition to the 9 cases, a ‘catch-all’ provision enables a franchisor to terminate for “any other case stated as legitimate cause for termination in the Franchise Agreement”. It is recommended therefore that franchisors review the drafting of the termination provisions in their franchise agreements and ensure additional events that give rise to a termination are included in the agreement as a further “legitimate cause for termination”.

Compensation & Penalties

Under Article 20, an obligation to compensate can arise in franchise relationships which predate the introduction of the New Franchise Law:

  • The franchisor is obliged to compensate its franchisee if the franchise term is not renewed for reasons other than outlined in Article 15 (2) – (5). In those circumstances where the franchisor has invalidly refused to renew the franchise term, the franchisor is obliged to compensate its franchisee by re-purchasing all material assets that were used exclusively in the franchised business and that its franchisee had purchased either from the franchisor or the approved distributors.

  • If the franchise agreement is terminated without a legitimate cause, then in addition to the obligation to re-purchase, the franchisor shall also compensate its franchisee for “any loss incurred for the establishment, acquisition or operating of the franchise business in KSA, and for any other damage incurred by it”.

  • Another obligation to compensate arises if its franchisee terminates the franchise agreement due to the franchisor’s failure to comply with the disclosure or registration obligations. These however only apply to franchise agreements entered after the introduction of the New Franchise Law.

Conversely, the franchisor has the right to seek compensation from its franchisee under the New Franchise Law if they have terminated the franchise agreement in violation of the New Franchise Law.

The right to claim compensation is time limited. In the case of an invalid termination of the franchise agreement, a claim for compensation must be brought within three years from the date of termination. In the case of a violation of any other provision of the New Franchise Law or the franchise agreement, a claim for compensation must be brought within the earlier of: (1) 3 years from the date of occurrence of violation, or (2) 1 year from when the non-violating party becomes aware of the violation.

Besides an obligation to compensate, a violation may also be punishable under Article 24 by a monetary fine not exceeding SAR 500,000 and or publication of details, either of which may result in financial losses and reputational damage for the franchisor.

Conclusion

Parts of the New Franchise Law will apply retrospectively to existing franchise agreements. Therefore, franchisors should review their existing agreements to ensure that the assignment, renewal and termination clauses contained therein adequately address any additional circumstances that the franchisor would look to rely upon in: (a) withholding its consent to a request to assign the franchise agreement; (b) refusing to grant a franchise term renewal; or (c) terminating the franchise agreement prior to its expiry.

The Implementing Regulations are currently out for comment and we will be providing an update on the draft of those soon.

Should you have any questions relating to the above, please contact the authors.