Codes of ethics and international franchising: who cares?

Today in virtually every country in the world where there is any meaningful activity in franchising there is likely to be some type of informal set of standards, usually promulgated by local franchise associations, meant to articulate commonly understood best practices in franchising. The motivation is pretty clear: by adopting standards of conduct, the association hopes to persuade several audiences that membership in the association, with the attendant pledge of adherence to a "code," provides assurance of the ethical conduct of the franchisor.

The oldest and best known is the code adopted by the International Franchise Association. Also of impressive pedigree is the code adopted by the European Franchise Federation, applicable to all the member countries of the European Union. Because of the differences among member countries, some of the national associations in Europe have adopted additional provisions applicable to their own members. Similarly, the IFA Code of Ethics recognizes that "some franchise relationships cannot be implemented in complete accord with these principles and standards. Therefore, these principles and standards will be applied with flexibility, taking into consideration the wide range of structures, forms of agreement and reasonable business practices."

Code Application

To what transactions do these codes apply? IFA is clear in limiting the applicability of its code "... to all IFA members in their United States operations." What about the code of country X, into which a U.S.-based IFA member sells? If the country is in Europe, the EFF Code "shall not apply to the relationship between the Franchisor and Master-Franchisees." The code in the target country may in theory, apply to other arrangements, but in reality codes only attach to the transactions by members of the association promulgating the code. The British Franchise Association notes, "if a franchisor does not wish to become a member, and not everyone wishes to belong to associations, BFA hopes that it will publicly accept and comply with BFA ethical standards and guidelines." Wishful thinking?

So, should one conclude that in international franchising a franchisor can safely ignore the provisions of the code of the association in the country which it seeks to penetrate?

Hardly.

Liability Between Parties

It is true that some associations have gone to considerable pains to avoid any implication that the code itself is a source of liability between private parties. The IFA Code is explicit: the code does "not substitute for or supplement the franchise agreements between IFA members and their franchisees or create any rights for franchisees of IFA members." The British code "does not form any part of the contractual agreement between franchisor and franchisee."

But it would be a mistake to assume that codes have no practical effect upon the legal relations between parties. The Italian association stated of its own regulation: "it is inevitable that in the absence of other specific national rules, [the Code] will be taken into account by the judges when making a decision on a franchise relationship, thus placing a very useful additional tool in the hands of judges who often lack specific knowledge and expertise in franchising." In France, a prominent commentator on the French Code stated, "in coming years, the Code ... will be considered a customary business practice for the franchising industry incorporated into business law ... making it legally binding."

We have certainly not reached this point in France or elsewhere. But decisions of European courts have quoted provisions of the EFF Code with approval, and provisions of applicable codes are routinely offered into evidence in franchise disputes. Most franchisors recognize that as much as they may seek to limit the impact of codes via disclaimers, courts may very well look to them as representative of commonly understood standards of practice between parties to a franchise agreement.

It thus behooves any franchisor entering another marketplace to know the provisions of the code that is applicable there. Frustratingly, there is a considerable disparity in the subject matters covered, even between countries which have some similarities in their legal systems or cultures.

Codes or Regulation?

Several countries' codes seek to regulate the conduct of consultants or advisors, and even franchisees, as well as franchisors. The EFF requires a franchisor to "have operated a business concept with success, for a reasonable time, and in at least one pilot unit before starting its franchise network." This is in marked contrast to the IFA Code, which does not interfere in business decisions of this nature. The EFF Code controls private business judgement further, providing that "a Franchisor should select and accept as individual Franchisees only those who, upon reasonable investigation, appear to possess the basic skills, education, personal qualities, and financial resources sufficient to carry on the franchised business." Likely, most U.S. franchisees would accept the wisdom of both positions, but would bristle at the notion of being required to adopt them by any public or private body.

One explanation sometimes given for the differences between the scope and degree of detail of codes in various countries is the presence or absence of franchise legislation. Thus, the argument goes, franchisors in countries without legislation may go to greater lengths to engage in self-regulatory activity in an effort to ward off the threat of legislation. In countries where legislation already exists, the argument continues, franchisors are less pressured to have all-encompassing codes, because legislation has already been adopted. Up to a point, there is some evidence that this explanation is grounded in fact. In truth, however, many of the discrepancies which exist between codes cannot be explained in that fashion, and in some cases are simply a product of history. Binding or not, the codes can provide an illuminating look into the state of play in the market considered for entry.

For the franchisor engaged in cross-border franchising on a significant scale, codes and standards thus represent yet another set of mores to be mastered.

Philip Zeidman is senior partner of Piper Rudnick, a Washington, D.C. based law firm. He can be reached at [e-mail].