Experience in franchising from the franchisor’s perspective

With numerous notable advantages, commercial franchising has become a more favored business activity and is gradually gaining prevalence. In the franchising relationship, the franchisor has the opportunity to expand their business and enhance brand recognition, while the franchisee can leverage products with an established market reputation, making it easier to attract customers and generate profits. For a franchisor looking to grow their business, achieving synchronization and consistency in brand operations is crucial, along with ensuring the protection of transferred or licensed commercial rights, such as trademarks or trade secrets. Drawing from our practical advice to companies engaged in franchise transactions, here are some legal considerations for franchisors entering into a franchise relationship.

1. Conditions on the subject and form of franchise agreements

1.1. The parties to franchise relationship

During the preparatory phase of establishing franchise relationships, the franchisor must ensure that potential partners meet the legal requirements for participation in such relationships.

According to Decree 35/2006/ND-CP, as amended and supplemented by Decree 08/2018/ND-CP, franchisors must adhere to specific criteria when establishing franchise relationships. Notably, the business system intended for franchising must have a minimum operating history of one year. Importantly, this requirement pertains to the business system itself, not the individual merchants. It is crucial for franchisors to be aware that compliance is contingent on factors such as obtaining the trading license and retail establishment license. For instance, in the case of a foreign-invested retail enterprise, if the first retail outlet has not obtained these licenses within one year from the anticipated franchise date, the business system might not meet the franchising requirements. On the other hand, for companies with an existing business system comprising two or more stores, business locations, or branches, the calculation of the business system's operating time is based on the date of issuance of the business operation license for the first store, business location, or branch.

On the flip side, for franchisees, Decree 08/2018/ND-CP has eliminated the previous condition that required franchisees to be registered traders in a business line compatible with the subject of the commercial rights. This move allows franchisees the freedom to enter into franchise relationships without being constrained by such conditions. Consequently, according to the law, franchisors are no longer obligated to consider the subject matter requirements of the franchisee.

However, in practice, we have observed that Judgement No. 03/2022/KDTM-PT of the Da Nang City People's Court, dated February 21, 2022[1] still makes reference to the requirement for franchisees to register in a business line compatible with the subject of their commercial rights. This is despite the fact that Decree 08/2018/ND-CP had already taken effect at the time of the dispute. The court's verdict, as mentioned in the above ruling, is based on an invalid legal provision. From our perspective, this verdict should only serve as a reference and should not be the basis for concluding that parties could not reach an agreement during the performance of commercial franchise activities.

While the law does not impose specific requirements for franchisee participation in franchising activities, franchisors have the option to establish additional conditions to safeguard their rights and interests. In our perspective, it is advisable for franchisors to consider requiring franchisees to register their business in a line compatible with the subject matter of the commercial rights[2]. This not only aligns with the franchisor's objectives in participating in franchise relationships but also contributes to the seamless operation of this activity.

Furthermore, collaborating with franchisees who hold rights in a compatible business line and possess some understanding of the franchise field provides the franchisor with greater confidence in the franchisee's ability to adhere to instructions and meet requirements for organizing and operating the business within the franchise system. Moreover, meeting current business registration requirements is generally feasible for franchisees in practice.

1.2. Conditions on the form of the franchise agreement

Beyond meeting the subject conditions, it is crucial for parties to recognize that franchise agreements must be formally documented in writing or in a legally equivalent forms[3]. In the previously mentioned judgment, despite the parties satisfying the substantive conditions for establishing franchise relationships, specific contract elements were deemed void because they were agreed upon orally. This contradicted the legal requirements for the formalization of contracts.

From the franchisor's standpoint, particular emphasis should be placed on the form of the franchise agreement. The legal ramifications of an invalidated franchise agreement typically involve the return of exchanged items between the parties. However, for assets like trade secrets and commercial know-how provided to the franchisee, recovering these assets is often impractical or challenging once they have been transferred.

Typically, franchisors are reluctant to document their trade secrets and business know-how in written or equivalent forms due to the risk of potential disclosure. However, as these elements constitute the core of a franchise agreement, they must be formally documented. To safeguard this sensitive information, franchisors can employ protective measures such as a non-disclosure clause or stipulate compensation in case of unauthorized disclosure by the franchisee to a third party. For a more in-depth understanding of these clauses and other contents within the franchise agreement, franchisors can refer to the following article: Vietnamese companies and the franchising puzzle – From a risk control perspective

2. Protecting trademarks before engaging in franchise activities

In the franchise business, the most important element is the transfer of commercial rights, such as trademarks, trade secrets, trade names, or business slogans, from the franchisor to the franchisee. The recent incident involving Pho Thin[4] in early 2023 serves as a valuable lesson for businesses to protect their brands. In connection with the content of this article, we emphasize that businesses should focus on registering trademark protection before engaging in franchising activities. Intellectual property rights for trademarks are only established when the franchisor applies for registration and receives a certificate of protection from the authorized agency. Only then can the franchisor become the exclusive owner with the right to control, exploit, transfer or license the use of that trademark to franchisees. However, once the process of applying for intellectual property rights for a trademark is initiated, the franchisor may enjoy priority rights based on the "first to file" principle. Therefore, the franchisor can have peace of mind regarding its trademark even though the examination process and issuance of the certificate of protection may take some time.

In addition to preventing potential future disputes, it is imperative for the franchisor to recognize that it cannot transfer or license the use of an item it does not already own. Consequently, completing the legal procedures to safeguard the trademark before initiating franchising activities is crucial. Additionally, the franchisor should remain mindful of the term of the protection certificate and initiate renewal procedures in a timely manner.

3. Transfer of commercial rights to intended sub-franchisees

In instances where the franchisee intends to transfer commercial rights to a sub-franchisee, such a transfer necessitates the approval of the original franchisor, with exceptions as outlined below. The act of transferring commercial rights to a potential sub-franchisee holds significant implications for the original franchisor. Achieving uniformity and consistency across the franchised chain and maintaining brand reputation are paramount objectives for the original franchisor in any franchise relationship.

It is essential for the original franchisor to ensure that the proposed sub-franchisee aligns operations, layout, and business organization with the franchisor's stipulated requirements. Failure to do so poses a risk of creating a negative impression with customers, directly impacting the franchise brand. Furthermore, once the transfer is finalized, the proposed sub-franchisee is generally released from further responsibilities.

During the approval process, the original franchisor must meticulously assess the proposed entity set to receive its commercial rights and provide feedback within the specified legal timeframe. According to current regulations, if the original franchisor fails to respond within 15 days of receiving the franchisee's request, it is presumed that the original franchisor has approved the assignment to the proposed sub-franchisee.

In summary, while franchising presents numerous benefits for all involved parties, it also comes with inherent risks and the potential for disputes, especially for the franchisor. Hence, thorough legal research and seeking advice from professional counsel are imperative steps for the franchisor before engaging in franchise transactions.