Saudi Arabia: The Draft Saudi Arabian Commercial Franchise Law

Last Updated: 24 January 2017
Article by Dr. Zaid Mahayni

1.      Introduction

On 3 Rabi Al-Thani 1438 (1 January 2017), the Ministry of Commerce and Investment ("MoCI") issued the draft Commercial Franchise Law (the "Draft Law") for public consultation. The MoCI invited the public to submit comments on the Draft Law by 27 Rabi Al-Thani 1438 (25 January 2016).

2.      Objectives of the Draft Law

The Draft Law articulates as its objectives:

  1. encouraging the conclusion of franchise arrangements in Saudi Arabia, by having in place a clear legal framework governing the relationship between franchisors and franchisees;
  2. protecting franchisees, particularly in the event of the termination of the franchise arrangement or its non-renewal;
  3. assisting potential franchisees in making sound investment decisions, based on the information disclosed by the franchisors; and
  4. granting to the MoCI authority to publish educative material and proposed templates for contractual arrangements.

3.      Scope of Application

The Draft Law excludes from its scope certain types of arrangements. The most notable of these exclusions are arrangements involving the distribution of products, the licensing of intellectual property, employment contracts, and lease contracts.

The Draft Law is intended to provide a stand-alone regime to cover franchise agreements. Under current legal practice, franchise arrangements are treated as commercial agency arrangements. They are subject to the registration process and requirements imposed in the Commercial Agencies Law.1 With the issuance of the Draft Law, such practice would cease and franchise arrangements would be entirely covered by the Draft Law.

4.      Implementing Regulations

The MoCI must issue implementing regulations which specify:

  1. the main matters that must be included in franchise agreements;
  2. the process that must be followed, requirements that must be met, and documents that must be submitted to the MoCI;
  3. the fees payable to the MoCI for registration applications; and
  4. any templates that must be utilized when concluding franchise agreements.

5.      Obligations of the Franchisee

As a default rule, the Draft Law requires the franchisee to:

  1. protect the reputation of the franchisor;
  2. allow the franchisor to inspect franchised premises;
  3. obtain the franchisor's approval prior to modifying the territory of the franchise; and
  4. update the franchisor on the franchised activities in order to help the franchisor in improving its systems.

That said, the franchisee and franchisor are free to depart from this and agree otherwise.

6.      Obligations of the Franchisor

As a default rule, the Draft Law requires the franchisor to:

  1. determine the standards and issue the directives by which the franchisee must comply;
  2. either directly or indirectly supply the franchisee with the franchised products and services; and
  3. refrain from the creation or the licensing of any establishment which practices an activity similar to that of the franchisee in the franchise territory.2

As above, the franchisee and franchisor are free to depart from this and agree otherwise.

7.      Disclosure Form

At least four months prior to the signing of the franchise agreement or the payment by the franchisee of any fees to the franchisor (whichever is set to occur first), the franchisor must prepare and submit to the franchisee a disclosure form. (the "Disclosure Form"). The Draft Law does not explain what information must be stated in the Disclosure Form, as the implementing regulations are expected to elaborate on this issue. The Draft Law only mentions that any performance-related information contained in the Disclosure Form must be substantiated and must disclose underlying assumptions. The Disclosure Form must also distinguish between information relating to the franchisor itself and that relating to any controlling parent companies, controlled subsidiaries, or other franchisees.

The Disclosure Form must be accompanied by a draft of the franchise agreement to be signed by the parties.3

If any changes are made to the Disclosure Form or to the draft franchise agreement before the franchise agreement is signed or any fees are paid, the franchisor must inform the franchisee as soon as possible of such changes. Failure to do so could expose the franchisor to indemnification claims from the franchisee. Such claims must be brought within five years of the occurrence of the alleged wrongdoing or the lapse of one year following the expiry or termination of the franchise agreement (whichever occurs first).

8.      Eligibility Requirements for the Granting of Franchise Rights

According to the Draft Law, franchisors may only grant franchise rights if:

  1. the franchised concept had been applied for at least one year by at least two companies, one of which may be the franchisor; and
  2. the franchise concept had been applied in two different territories, for a period not lesser than one year

In the case of a sub-franchisor, it may not grant sub-franchise rights if it is not registered or resident in Saudi Arabia, unless it has exercised the franchise activities for a period of no lesser than one year.

9.      Trademarks

The franchisor must register all trademarks that the franchisee may use as part of the franchise arrangement.

10.  Registration Process

The franchisor must register the franchise agreement with the MoCI. The registration process proposed under the Draft Law is significantly different than that under the Commercial Agencies Law. The Commercial Agencies Law gives a greater margin of laissez-faire and allows the submission of the registration application following the signing of the franchise agreement.

Under the Draft Law, the franchisor must send a draft of the proposed franchise agreement, evidence of the registration (or the application for registration) of the franchised trademark, and the completed Disclosure Form.

The MoCI must process the registration application within 30 days. Failure by the MoCI to respond within this period is deemed as acceptance of the application. If the application is rejected, the applicant may appeal within 15 days. This appeal would be made to the Minister of Commerce and Investment.

The franchisor must notify the MoCI of any material change to the Disclosure Form or the franchise agreement, except where these changes have been approved by the franchisee or do not negatively impact this latter. Notification must be made within seven days from the occurrence of the change in question.

It is notable that the Draft Law does not specify that the franchisor and franchisee must submit to the MoCI a copy of the signed and attested franchise agreements. It is hoped that the MoCI will reverse this in its revision of the Draft Law. The submission of signed copies would ensure that the MoCI is fully informed about the conclusion and ultimate content of all franchise agreements.

11.  Franchise Agreement: Mandatory Content

The franchise agreement must be made in the Arabic language or translated by a licensed translator.

The franchise agreement must mandatorily include the following details:

  1. a description of the franchised activities;
  2. details of the fees and royalties payable to the franchisor;
  3. the territory of the franchise arrangement;
  4. the duration of the franchise arrangement, which must be at least five years;
  5. renewal and termination terms;
  6. the obligation of the parties to train the staff of the franchisee;
  7. the obligation of the franchisee to protect the character of the franchised products or services;
  8. the obligation of the franchisee to abide by standard marketing instructions and processes;
  9. any obligation of the franchisor to supply particular products and/or services and any obligation of the franchisee to purchase such particular products and/or services;
  10. the right of the franchisee to utilize any trademarks relating to the franchise;
  11. any restriction on the franchisee's ability to assign any its rights to third parties; and
  12. any restriction on the parties to engage in competing activities.

12.  Franchise Agreement: Optional Content

The franchise agreement may also include the following details:

  1. whether the franchisee may appoint sub-franchisees;
  2. conditions regarding franchised sites;
  3. conditions regarding signage;
  4. restrictions on the utilization of trademarks;
  5. minimum performance (e.g. sales) requirements; and
  6. confidentiality requirements.

13.  Waiver of Rights

The waiver by the franchisee of any of its rights under the Draft Law is considered as null and void, unless such waiver is delivered as part of a final settlement with the franchisor.

14.  Resolution of Disputes

Disputes between the franchisor and the franchisee must be referred to the courts of Saudi Arabia. Nevertheless, it is possible instead to agree to resort to arbitration or mediation.

15.  Revocation of the Franchise Agreement

The franchisee has the right to revoke the franchise agreement within seven days from its signing. The Draft Law does not limit the exercise of such a right to particular circumstances. In the event of the revocation of the franchise agreement, the franchisor must return within 14 days all payments that it received, after deduction of reasonable expenses that it incurred in entering into the agreement.

16.  Assignment of the Franchise Agreement

The franchisor may not object to the modification of the person controlling the franchisee, except for a reasonable cause.

Also, the franchisor may not object to the assignment by the franchisee of any of its contractual rights except where:

  1. the assignee does not appear to have sufficient financial resources to perform the franchisee's contractual obligations;
  2. the assignee is incapable of fulfilling the assignor's reasonable conditions relating to the assignment;
  3. the assignee does not fulfill the criteria generally applied by the franchisor for the appointment of franchisees;
  4. the franchisee has not fully settled sums owed to the franchisor; or
  5. the franchisee does not remedy any breaches to its contractual obligations within required timeframes, if any are specified.

The franchisor is deemed to have approved requests for the modification of the person controlling the franchisee or for the assignment of the franchisee's obligations to third parties, if no response is conveyed within 60 days.

17.  Termination of the Franchise Agreement

The franchisor may not prematurely terminate the franchise arrangement, except for reasonable cause. Reasonable termination causes include circumstances where the franchisee:

  1. breaches any of its contractual obligations and fails to remedy such breach within 14 days from its receipt of a written remediation request;
  2. becomes insolvent or bankrupt;
  3. ceases practicing the franchised activities;
  4. carries out the franchised activities in a manner that poses public health and safety risks;
  5. fails to obtain required licenses and approvals;
  6. violates any regulations in a manner that undermines the reputation of the franchisor; or
  7. violates the intellectual property rights of the franchisor.

If the franchisor terminates the franchise for any other reason, it shall reimburse the depreciated value of assets it instructed the franchisee to purchase.

The franchisee may prematurely terminate the agreement without compensating the franchisor if:

  1. the franchisor fails to timely notify the franchisee of changes to the Disclosure Form or the franchise agreement, provided that the franchisee exercises its termination within 60 days from being notified of the changes; or
  2. the franchisor fails to register the franchise agreement and the Disclosure Form with the MoCI, provided that the franchisee exercises its termination within 24 months from the signing of the franchise agreement.

If the franchisee terminates the franchise agreement, in the manner mentioned in the previous paragraph, the franchisee shall be entitled to compensation for the losses incurred towards the setting up of the franchise activities.

18.  Renewal of the Franchise Arrangement

The franchisee shall have the right to renew the franchise agreement by way of a notice delivered to the franchisor at least 180 days prior to the expiry of the agreement. Such a right is lost if:

  1. a circumstance has occurred which justifies the termination of the franchise agreement by the franchisor;
  2. the parties agree on new conditions;
  3. the franchisor no longer wishes to continue the franchised activities or to grant franchise rights in Saudi Arabia in respect thereto; or
  4. the franchisee fails to agree to the franchisor's reasonable renewal conditions within 60 days from the expiry of the franchise agreement.

19.  Marketing Contributions

Sums received by the franchisor for the purposes of local marketing campaigns must be deposited by the franchisor in a distinct bank account. Within four months from the end of its financial year, the franchisor must report to its franchisee(s) on the marketing contributions that it received and the manner in which they were utilized.

20.  Sanctions and Penalties

A committee must be created by the MoCI for the application of any sanctions mentioned in the Draft Law. The Draft Law mentions that a sanction of up to one million Saudi Riyals may be imposed by the committee, in respect of the breach of certain provisions of the Draft Law.

Decisions of the committee may be appealed to the Minister of Commerce and Investment within 15 days from the notification date. Otherwise, and once validated by the Minister of Commerce and Investment, decisions shall be deemed as final.

21.  Entry in Force

The Draft Law would enter in force 180 days from its publication in the Official Gazette.

22.  Conclusion

As a first observation, the Draft Law assumes that franchisees are in a more vulnerable position than franchisors and aims to palliate such imbalance by attempting to provide greater systemic protections to franchisees. For instance, the Draft Law imposes on franchisors disclosure obligations towards franchisees and exposes them to liability in the event of misrepresentations. It remains to be seen what exact disclosures would be required under the implementing regulations. These, however, should not be burdensome to a point that they may dissuade franchisors.

The Draft Law should take into consideration that, as part of the NTP 2020 and the Vision 2030 initiatives, the Saudi Arabian private sector should encourage franchise arrangements involving local brands and local franchisors. We should not therefore assume that franchise arrangements will necessarily be conducted cross-border or that the franchisors will necessarily be foreign parties. The eligibility requirement for franchisors to have previously applied the franchise concept would act to block successful local brand owners from becoming franchisors.

Further, the Draft Law does not sufficiently describe how the franchise register would be operated and whether it would be available for public searches. The Draft Law also does not clarify whether franchise arrangements currently registered in the commercial agency register would be transposed and migrated onto the franchise register. 

Finally, there are insufficient demarcation lines between franchise and commercial agency arrangements and hence between the application scopes of the Draft Law and the Commercial Agencies Law. Also on this point, it is unclear whether the Saudi Arabian legislator intends to overhaul the Commercial Agencies Law, alongside (or following) the enactment of the Franchise Law.

Footnotes

1 Enacted pursuant to Royal Decree No. M/5 dated 11 Jumada II 1389 (24 August 1969).

2 Such a provision may be interpreted to imply that franchise arrangements must be exclusive.

3 This requirement supposes that franchise agreements are adhesion contracts. While this is true to some extent, there is usually a significant negotiation margin under current local practice. The law should require the submission of the negotiated version of the agreement.

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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Authors
Dr. Zaid Mahayni
 
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