Brazil: Franchise And Distribution: Which Is The Right Model For Your Business Under The Brazilian Law

Except for Law No. 6729/79, which regulates the commercial concession between producers and distributors of land automotive vehicles, before 2002 there were not in Brazil specific legal rules for distributorship agreements, and they were regulated by their own terms and conditions and by the general principles of contractual law.

However, in 2002, a new Brazilian Civil Code (Law 10406/2002) was enacted, containing specific provisions related to distributorship agreements. According to the new Brazilian Civil Code, the distributor is a person who "assumes, in a non-occasional basis and without subordination, the obligation to promote, on behalf of another person and upon remuneration, certain transactions, within a given area, whereas the things to be traded must be available to such person".

On the other hand, the franchise in Brazil is ruled by a specific law, that is, the Brazilian Franchise Law (Law 8955/94), which establishes that such activity includes any system in which a franchisor licenses to a franchisee the right to use a trademark or a patent, along with the right to distribute products or services on an exclusive or semi-exclusive basis, possibly including the right to use technology or operating system for the business establishment and management, in exchange for a compensation.

Many companies have been experiencing difficulties in deciding which of such models will really meet their demands, considering the complexity of both structures and the rights and obligations involved. Also, some peculiarities that must be noted while negotiating the proper agreement, as described below.

I. FRANCHISE AGREEMENTS

Under a franchise agreement, franchisee is subordinated to franchisor's business model. In other words, franchisee must develop its activities with strict observance of the general guidelines and specific determinations of the franchisor. Nevertheless, the mentioned subordination is inherent in franchises and is not confused with employment or work subordination.

Such subordination, in general lines, consists in the franchisor's right to supervise and control the franchisee's activities to verify if all the specific demands and determinations of franchisor are being fully fulfilled. In consideration of all support, supervision and training provided by franchisor to franchisee, as well as the right to use franchisor's trademark or patent, franchise agreements usually provide for (i) a franchise fee, which is a fixed amount paid in the beginning of the negotiation; (ii) royalties fees, usually calculated according to franchisee's net sales revenue; (iii) publicity fees, also calculated based on franchisee's sales revenue; and (iv) other fees to be calculated as provided in the agreement to be entered into between the parties.

A particularity provided for in the Brazilian Franchise Law is the franchisor's obligation to provide franchisee with the document named "Franchise Circular Offer" at least ten (10) days prior to the execution of the franchise agreement or the payment of any amounts due by franchisee. Brazilian Franchise Law expressly defines the information which must be necessarily supplied in the Franchise Circular Offer, such as (i) balance sheets and financial statements of the franchisor for the two (2) preceding years; (ii) detailed description of the franchise, general description of the business and the activities that will be performed by the franchisee; (iii) estimated initial investments necessary for the acquisition, implementation and operation of the franchise, estimated affiliation fee or franchise fee, as well as estimated cost of the facilities, equipment and initial inventory and respective payment conditions; and (iv) status before the Brazilian Patent and Trademark Office ("BPTO") of trademarks and patents which franchisor will authorize franchisee to use.

Franchisor's failure to comply with such condition may cause the agreement annulment by franchisee and franchisor will be required to refund franchisee the royalties and affiliation amounts that may have been paid, plus losses and damages.

Finally, the BPTO will register the franchise agreement, for purposes of remittance of royalties, as the case may be, and for the payments associated with the agreement to be deducted by the franchisee for income tax purposes. According to Law 9279/96 (Brazilian Industrial Property Law), registration of such franchise agreements with the BPTO is also necessary for third parties to be legally bound.

II. DISTRIBUTORSHIP AGREEMENTS

On the other hand, under the distribution model, distributor generally obtains limited rights to use proprietary information, technology or trademarks of the supplier, considering that subordination and/or control over distributor's activities may be characterized by the Brazilian courts as an employment relationship. Moreover, in this model, distributor pays only for the products effectively purchased, and, consequently, no variable fee or compensation is due.

While negotiating a distributorship agreement, it should be noted that, according to the new Brazilian Civil Code, except where agreed by the parties, supplier cannot designate more than one distributor to operate at the same time in a same zone, with identical assignments, nor can the distributor assume the responsibility of doing any business of the same kind therein on behalf of other suppliers. In this regard, the new Brazilian Civil Code establishes that, except where agreed by the parties, distributor will be entitled to be paid a compensation corresponding to the transactions completed within its zone, even if without its participation.

In other words, it is presumed that the distributor's activities and zone are exclusive, differently from franchise agreements. However, a distributor is not prevented from representing several principals, nor is the principal prevented from appointing another distributor to operate in a zone previously designated, provided that the non-exclusivity is expressly provided for in the agreement.

Another particularity regarding distributorship agreements is established in the Brazilian Competition Law (Law 12529/11). According to such law, to impose, in the sales of goods or services, on distributors and retailers, resale prices, discounts, payment conditions, minimum or maximum quantities, profit margin or any other trading conditions related to their or any third parties' business is a violation of the economic order. In other words, under the Brazilian legislation, distributors are free to determine the prices for which they will sell the products to their clients and/or consumers. The Brazilian Competition Law however does not place restrictions on franchise agreements, and in such model it is usual for franchisors to determine the fees to be charged for franchisee's services or products.

III. CONCLUSION

Considering the foregoing, when deciding which model should be implemented, it should be taken into consideration:

(i) If supplier will exert full control over the other party's activities, including possibility of determination of prices and charging royalties and other variable fees, the franchise structure should be adopted. In this model, the main particularities that should be noted are: (i.1) the franchisor's obligation to provide franchisee with the "Franchise Circular Offer", on penalty of annulment of the agreement and franchisor being required to refund franchisee the royalties and affiliation amounts that have been paid, plus losses and damages; and (i.2) the registration of the agreement with the BPTO, for purposes of royalties remittance, taxes deductibility and effects on third parties; and

(ii) If supplier will not provide assistance, such as provision of business plans, materials and/or trainings, the distributorship agreement may be an adequate structure. In relation to such agreement, the particularities that should be considered when negotiating are: (ii.1) it is presumed that the distributor's activities and zone are exclusive, therefore non-exclusivity must be expressly provided for in the agreement; and (ii.2) resale prices, discounts, payment conditions, minimum or maximum quantities, profit margin or any other conditions for sales must not be imposed by supplier or otherwise established in a written instrument, as it is violation of the economic order under the Brazilian Competition Law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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