Hotel Franchising Internationally – The Challenges Of Franchising In The US

26th January 2017 by

Franchising is one of the quickest, most cost efficient and widely accepted means of expanding a hotel brand globally. If a brand is strong, the hotel design and services attractive and the delivery of reservations robust, there should be a  substantial demand  from franchisees for  franchises outside the home country of the franchisor and abundant hotel guests wanting to stay at those franchised hotels.  

The US is one of the largest global hotel markets globally and franchising of hotels is the pervasive and established means for expansion for hotels in the US market.  Although there are many advantages to franchising in the US, there are also a number of regulatory challenges. This article will review some of the most significant ones.

Franchise Disclosure Laws

In the US, franchises may not be sold or even meetings held to discuss franchise sales until the franchisor has provided to the prospective franchisee a franchise disclosure document (“FDD”), compliant with federal  law requirements.

Franchising is regulated at both the federal and state level in the US. At the federal level, the Federal Trade Commission is empowered by Congress as the regulator. The relevant law is known as the FTC Franchise Rule. The FTC Franchise Rule requires franchisors to provide each prospective franchisee with an  FDD, early in the process of offering and selling a franchise. Specifically, the franchisor must give the FDD to the prospect at the earliest of: the first face-to-face meeting with the prospect involving a discussion about the sale of a franchise; or at least 10 business days before the prospect signs any agreement with the franchisor or; at least 10 days before the prospect pays any money to the franchisor.  The franchisor must also provide the prospect with a complete version of the franchise agreement (with all the blanks filled in) at least 5 business days before the prospect signs any agreement or pays any money. Failure to comply with the FTC Franchise Rule is a federal criminal offense.

The FTC franchise Rule does not require any registration of a franchisor with the Federal Trade Commission. Various states however require registration of the franchisor before franchises can be sold in the state. These states are: California, Hawaii, Illinois, Indiana, Maryland, Michigan, Minnesota, New York, North Dakota, Rhode Island, South Dakota, Virginia, Washington and Wisconsin. Some states require the franchisor to file certain information about each person who will sell franchises in the state. These states include California, Hawaii, Illinois, Indian, Maryland, Minnesota, North Dakota, Rhode Island, South Dakota and Washington. Failure to comply with the state franchising laws is also a state criminal offense.

Mandatory provisions in franchise agreements

The natural preference for a franchisor would best to have provisions that reflect the way it does business in its own jurisdiction and the law governing the franchise agreement and the venue to dispute resolution to be the law of the country of the franchisor. For example a UK franchisor would prefer English law to govern the franchise and English courts to hear any disputes.

A problem with this approach is that choice of law as well as certain provisions of a franchise agreement may be superseded by US state law.  Some US states have laws that mandate  the inclusion or omission of certain provisions in  franchise agreements. These include mandatory provisions for choice of law or dispute resolution, restricting power with respect to grounds for franchise terminations, notice and cure period before termination, grounds for not renewing a franchise, refusal to allow transfers without good cause and equal treatment of franchisees  such as restrictions of transfer of the franchise. States requiring registration will require a copy of a compliant franchise agreement proposed to be used to be included with its registration documents, and the franchisor may not deviate from the form of franchise agreement approved by the state regulator.

Enforcement of judgements

 A franchisor outside the US may wish to enforce franchise agreement provisions or a guarantee with a US franchisee. Having the courts of its own jurisdiction for dispute resolution, it obtains a judgement in its home courts which it wishes to enforce in the US. Unfortunately, enforcement of a  judgement awarded in the franchisor’s home jurisdiction is not a simple and inexpensive procedure  in US state courts in US  states that have not enacted the  1962 Uniform Foreign Money-Judgments Recognition Act (“ UFMJRA”).

UFMJRA, which has been  enacted in 32 States, requires participating States to recognise and enforce  judgements in countries party to the Convention. UFMJRA enables a UK franchisor to obtain a judgement in English courts against a franchisee in a participating State and then enforce it in those State courts without the State courts having to have personal jurisdiction over the defendant or re-examining the merits.

However, in states that have not adopted this, where a franchisor in the UK and wanted to sue a franchisee in  a US state, the franchisor would first have to obtain a judgement in the UK and then sue again to enforce it in the US state court, where the entire merits of the dispute would have to be reheard by local courts.

One solution to this adopted by some international hotel companies is to designate international arbitration for dispute resolution. Unlike for court judgements foreign, arbitral awards may be enforced in any US state under the New York Convention.

Franchisor as joint employer

Another recent concern is that a foreign franchisor could be viewed  in the US as a joint employer of the employees of the franchisee.

In the US, a government agency, the National Labor Relations Board has consolidated a number of employee complaints against McDonalds Corporation. The employee complaints included discriminatory discipline, reduction in hours, discharges and coercive conduct in response to union and protected concerted activity. The NLRB is claimed that McDonalds through its extensive and far reaching controls in the relationship with its franchisees effectively dictates and controls wages paid to the franchisee’s employees, controls all other variables of employment and dictates the franchisee’s labour relations policy. McDonalds is alleged to have the ability to electronically monitor sales, suggest work schedules, control inventory, assist customer order fulfilment and similar. The NLRB position is that because of these extensive controls, meaningful collective bargaining of the franchisee employees could not occur without including the franchisor and that it is therefore acting as a joint employer.

The NLRB McDonalds case has yet to come to judgement in any case and legal commentators have pointed out that the assertion of the NLRB that McDonalds is a joint employer runs against the entirety of judicial precedent on the law of franchising, the legal definitions of franchise under federal and state law, the Lanham Act and the independent contract relationship, as affirmed by hundreds of courts. A recent California case, also involving McDonalds, Ochoa V McDonalds, 25 September 2015,  confirms this and holds that under California employment law, the franchisor is not a joint employer.

Despite the likelihood of ultimate success for McDonalds, this is a worrying legal development. Franchisors in the US should ensure that their franchise agreements do not have such extensive controls over franchisee employees that such a challenge could be made.

Conclusion

Franchising in the US is heavily regulated, and non-compliance can lead to criminal penalties against franchisors and their directors.  It is important to get competent professional legal advice on franchising before entering the US market.  The pearl is worth the dive, however. In most cases, the rewards of setting up in the massive market that is the US outweighs the regulatory burdens and costs of compliance.

David Schollenberger is a Partner and heads the Hotels & Gaming team at Healys LLP solicitors in London. He is a tri-qualified UK/US/Australian commercial and corporate lawyer who focuses on providing legal services relating to the hotel and gaming industries. He spent several years as a senior in-house lawyer for three multinational hotel companies, Wyndham Worldwide, Choice Hotels International and Holiday Inns International. Email: david.schollenberger@healys.com