INTERNATIONAL FRANCHISE ASSOCIATION LEGAL SYMPOSIUM

May 16-17, 2011

ENFORCING YOUR INTERNATIONAL AGREEMENT - WHAT CAN YOU REALLY DO?

Robert A. Lauer Haynes and Boone, LLP

Babette Marzheuser-Wood Field Fisher Waterhouse, LP

Jorge Mondragon Gonzalez Calvillo, SC

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TABLE OF CONTENTS

I. introduction .............................................................................................................. 1 II. Selecting International Dispute Resolution Mechanisms for International Agreements..................................................................................................................... 4

A. Typical Methods of Dispute Resolution ................................................................ 4 1. Arbitration.......................................................................................................... 4

a. Pros............................................................................................................... 4 b. Cons.............................................................................................................. 5

2. Jurisdictional Courts.......................................................................................... 5 a. Pros............................................................................................................... 6 b. Cons.............................................................................................................. 6

3. Mediation .......................................................................................................... 7 a. Pros............................................................................................................... 7 b. Cons.............................................................................................................. 7

4. Remedies For Breach of Jurisdiction or Arbitration Clause – A Practical Note . 8 a. Arbitration Systems ....................................................................................... 9

(i) International Chamber of Commerce (ICC) ............................................... 9 (ii) The American Arbitration Association (AAA)/International Centre of Dispute Resolution (ICDR) ..................................................................... 9 (iii) The London Court of International Arbitration (LCIA) ........................... 10 (iv) Stockholm Chamber of Commerce (SCC) ........................................... 10 (v) United Nations Commission on International Arbitration (UNCITRAL) . 10 (vi) Global spread....................................................................................... 10

5. Enforcement ................................................................................................ 11 III. A U.S. Franchisor’s Analysis Matrix Following an International Dispute............. 12

A. Typical Disputes that arise in International Franchise Transactions ................... 12 1. Non-payment of fees....................................................................................... 12 2. Development Schedule defaults ..................................................................... 13 3. Abandonment or Closure of Units ................................................................... 13 4. Breach of System Standards; Lack of Reports ............................................... 14 5. Breach of Confidentiality or Non-Competition Obligations .............................. 14

B. Conducting of Internal and External Analysis ..................................................... 15 1. Franchisor’s Rights Under the Agreements .................................................... 15 2. Franchisor’s Compliance with Agreement....................................................... 16 3. Franchisor’s Review of Legal Requirements In Local Country........................ 16

a. Trademark Status........................................................................................ 16 b. Trademark Licensed User Filings or Registrations...................................... 16 c. Agency Law Filings ..................................................................................... 17 d. Franchise-specific Relationship Laws ......................................................... 17

C. Typical Options Available to a U.S. Franchisor .............................................. 18 1. Pre-Termination Options vs. Post-Termination Obligations ............................ 18 2. Default Notices and Termination Notices........................................................ 18 3. Settlement Proposals...................................................................................... 19

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4. Requests for Business Meeting ...................................................................... 19 5. Informal or Formal Mediations ........................................................................ 20 6. Formal, Binding Dispute Resolution Proceedings ........................................... 20

a. U.S. Actions vs. In-Country Actions............................................................. 21 IV. Alternative Options for U.S. Franchisors ............................................................ 22

1. Remedial Plan .................................................................................................... 23 2. Renegotiation ..................................................................................................... 23 3. Franchisor Buy Out............................................................................................. 24 4. Transfer to a New Franchisee ............................................................................ 25

V. Conclusions ........................................................................................................... 27

2011 IFA Legal Symposium

Enforcing Your International Agreement – What Can You Really Do?

I. introduction We live in an increasingly global world, where not only large and multinational corporations, but also smaller-successful businesses, are looking to transcend boundaries and expand their brands worldwide. This expansion has resulted in multi-national commercial chains with internationally recognized trademarks, accelerated development of technology, global telecommunications, ever faster means of transportation and even the Internet, all of which have eased obstacles and paved the way for these businesses to expand to the international market place. As a result, over the last several decades, the development and assimilation of new legal structures has been sought all around the world in an attempt to meet the demands of the commercial relationships derived from this dramatic globalization. In many instances, previously insulated or insular legal systems have had no other choice but to internationalize, including by adopting legislation based on or derived from rulings created by international organizations. On the other hand, with the internationalization of businesses and commercial relationships, the level and complexity of disputes and controversies among contracting parties has equally expanded. Such complexity breeds a number of issues, not the least of which is the potential enforceability, or lack of enforceability, of those international agreements. The enforcement conundrum requires attorneys to reflect and focus on the importance of having well-drafted agreements that provide both legal and practical dispute resolution provisions that are thought out and prepared with enforcement in mind. Of course, the cynical may ask, what can we really do to enforce international agreements? To that end, this Paper will analyze some legal and practical contract options and provisions that are necessary or recommended in all international agreements to make them more enforceable and to provide legal certainty, but will also deal with situations where perhaps an agreement from long ago must be enforced today, and the parties must deal with the contract and dispute resolution provisions at hand, not a state-of-the art provision. It is of course true that no contract provision works for in all situations, and drafting in a vacuum without consideration of legal and practical issue in the international jurisdictions at issue creates new, avoidable issues. Thus, this Paper also focuses on the difference types of dispute resolution mechanisms that can be used in international agreements (the most common methods of dispute resolutions are before jurisdictional courts (traditional) or arbitration and mediation (alternative)), and the pros and cons of such dispute resolution options from both a global and local standpoint.

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In this day and age, arbitration is frequently the dispute resolution method of choice for international agreements and other forms of international trade disputes, mainly because it is so flexible and not so reliant of any given countries’ laws and procedures. Moreover, the contracting parties can adapt their arbitration agreement to take into account different laws, different requirements for arbitrators, language, enforcement and myriad other options that parties cannot necessary select when resorting to the courts in a given jurisdiction. Of course, in theory, arbitration also offers a great degree of enforcement across borders than court judgments. All that said, when the parties are left to their own devices to draft arbitration agreements, there are more options and more ways to create confusion for the parties, the arbitration body and/or the arbitrators. Thus, drafting is all the more crucial. Mediation also serves a purpose in the international dispute resolution realm. Mediation, which generally entails an independent and neutral third party who acts as a facilitator to reach communication between the parties involved in a dispute, can be a quicker and less expensive method to find a business resolution to a legal problem, but is of course does not produce a binding result so is only as viable as the parties allow it to be. The most common method of dispute resolution worldwide is still the courts systems of the contracting parties. Generally, the courts offer the best option for enforcement of the judgments or decisions issued by local courts, especially where the relief sought is temporary, preliminary, precautionary or other forms of mandatory or prohibitory injunctive relief to preserve the subject matter of the lawsuit or to compel an action or inaction by a party located in the specific jurisdiction. Of course, local courts are more problematic when the contracting parties are from different countries and two or more legal systems converge in the same dispute; the courts lose much of the enforcement viability due to lack of international treaties or agreements regarding cross border enforcement. Specifically, in connection with international franchise agreements, it is very important to comprehend and analyze in detail other ancillary provisions that can be used to bolster agreements for enforcement purposes; for example, the governing law. Choosing the governing law is a very sensitive issue; therefore, before selecting the governing law of a franchise agreement and its related documents, including personal guarantees, the drafting party must take into consideration the location of the franchisee, the location of the main assets of the franchisee (and of any personal guarantor) and the place where operations will occur. Knowing the who, what, where and how of the underlying contract can greatly reduce the risk of not being able to enforce an arbitral award or a court judgment. Likewise, the granting of guarantees by individual franchisees or corporate parents or affiliates has become a fairly common condition precedent for franchisors to enter into an international franchise agreement. There are different kinds of guarantees (i.e. personal or corporate guarantees, bank guarantees, letters of credits and deposits or escrows). To select which guarantees should be requested of franchisee, it is important to know first what type of franchisee we are dealing with. There are important variables that need analysis to reach a

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specific guarantee structure, such as the volume and quality of assets of the franchisee to secure the obligations assumed under the franchise agreement, the location of such assets, the characteristics and location of any other assets owned by the personal guarantors, and any legal requirements and formalities for the execution and enforceability of a guarantee under the local laws of the country where the assets are located, among other factors. All these questions will help franchisor to produce a final alternative and mechanism to request a guarantee to its franchisee. Other aspects that must be considered and analyzed to make international franchise agreements more enforceable include conventional liquidated damages or penalties that may be included in the event certain obligations are breached by the franchisee, non-competition and confidentiality obligations, and damages and waivers. To be able to determine which are the most appropriate provisions and dispute resolution mechanisms to be applicable to an international franchise agreement, it is essential to be aware of what type of disputes actually arise in international franchise transactions. All franchise agreements provide terms regarding payment of fees, development schedules, compliance with franchise system standards, reporting, confidentiality and non-competition obligations; therefore, the most typical disputes arising from franchise transactions are those related to the infringement of such provisions. Likewise, there are other kinds of common disputes, like those related to the abandonment or closure of the franchised units, without having the prior consent of franchisor. Once a dispute has arisen, what does a U.S. franchisor should do? What are the options available? A key initial step is for the franchisor to take a step back and see the big picture. It is in most cases pragmatic for a franchisor to initiate amicable settlement discussions with its franchisee before resorting to jurisdictional courts or arbitration tribunals. Such amicable settlement solutions may entail delivering written communications to the franchisee, as formal requirements or notices of default and/or initiating a formal or informal mediation process. In case of formal mediation, it is important to know how to select the most convenient venue, rules and timing to possibly reach a final settlement agreement. Additionally, this Paper reviews the different types of U.S. and in-country actions available for U.S. franchisors in case an international dispute has initiated; likewise, it provides an analysis of pros and cons for both scenarios. U.S. franchisors need to consider U.S. and/or an in-county action carefully, including with respect to the specific characteristics of the franchise agreement in place and the contracting franchisee (such as location of the main franchisee’s assets, location of the guarantor’s assets, place where the franchise agreement is effective, etc.). The foregoing will also ease the enforcement of an international franchise agreement. Finally, there are also other alternative options for international franchisors, including options that can be set forth in the franchise agreement and others that are outside the franchise agreement. Specific provisions that can be included in

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franchise agreements can include the right for the franchisor to buyout some or all of the assets used in the operation of the franchised business operated by the franchisee or to acquire the ownership interests of the company of the franchisee, and to require the franchisee to transfer the franchise agreement(s) and the franchised unit(s) to a new franchisee designated or approved by the franchisor. II. Selecting International Dispute Resolution Mechanisms for International Agreements.

A. Typical Methods of Dispute Resolution

In disputes arising from international franchise agreements, the question of forum is always important. There are a number of issues parties to international franchise agreements will need to consider, such as how long proceedings in a chosen forum will take, what powers, remedies and enforcement measures are available, where the evidence or witnesses are likely to be located, whether evidence will require translation, whether there is an issue about the competence or integrity of foreign courts or local lawyers, etc. Parties can take steps to guard against unpleasant surprises when a dispute arises by incorporating an appropriate dispute resolution mechanism into their international agreements, but should be aware of some of the practical limitations. The most commonly chosen forms of dispute resolution mechanism are arbitration or exclusive jurisdiction clauses, coupled sometimes with an express provision for mediation. The three forms are considered below in turn.

1. Arbitration

Arbitration is a dispute resolution mechanism used widely for resolving international franchising disputes. Arbitration is a process by which a dispute is determined judicially and with binding effect by application of law by an arbitrator or arbitral tribunal instead of a court of law. Most foreign countries are signatories to the New York Convention on the recognition and enforcement of arbitration awards (“New York Convention”) and this makes arbitration a viable option in countries where a US court decision may not be recognized. Whilst arbitration does not necessarily resolve disputes any faster or cheaper than litigation, it has certain distinctive features that can make it more appropriate than litigation in certain circumstances.

a. Pros

The most important of these features, and the reasons why parties may opt for arbitration rather than litigation, include: (a) the confidential nature of the process; (b) the procedural flexibility it offers parties; (c) the limited scope for challenge of the award and (d) the ease of enforcement of arbitration awards. Privacy - Whereas court actions are generally heard in public, arbitrations are conducted in private. The tribunal, the parties and their representatives are the only persons allowed to participate in the proceedings unless the parties agree

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otherwise. The award, likewise, is a confidential document. Arbitration is therefore particularly suited to parties who prefer to resolve their differences behind closed doors, for example because they wish to protect commercial practices, trade secrets or industrial processes or where they wish to protect business reputation by avoiding adverse publicity. Generally this is an important factor to consider for franchisors as they would not want the confidential know-how to become generally known. Further, franchisors generally have an interest in ensuring that their other franchisees do not hear prematurely about potential disputes. Flexibility - The other great attraction of arbitration lies in the flexibility of the process. Since arbitration, unlike litigation, is a consensual method of dispute resolution, parties have almost total freedom as to how they organize their arbitration and which set of rules, if any, to adopt. Parties can, for example, choose the seat of the arbitration, the language in which it is to be conducted and the arbitrator who is going to hear the dispute and can agree any aspect of the procedure between themselves. Finality - An arbitration award, despite being the result of a private arrangement and being made by a private arbitral tribunal, is final, binding on the parties and enforceable against any party who fails to comply with it voluntarily. There are extremely limited grounds on which an arbitration award can be challenged and the right to challenge for an error of law can be excluded altogether by agreement of the parties. Many parties value the finality of an arbitration award which avoids the uncertainty, cost and delay associated with appeals. Enforcement - One aspect of particular importance in international disputes is the ability to enforce an award obtained in one country against the opponent’s assets which may be in another jurisdiction. Arbitration awards can be enforced with far greater ease and speed in far more countries than court judgments. This is because over 130 countries have ratified the New York Convention 1958 which requires courts to recognize and enforce arbitral awards in their territory. No comparable convention exists in respect of court judgments.

b. Cons

Arbitration does have a number of drawbacks however and so will not be appropriate in every case. First, an arbitrator or tribunal generally has no power to join third parties to an arbitration and it is often impossible to consolidate proceedings. Second, by agreeing to submit to arbitration, a party waives the right to go to court. A party may later regret this choice when a dispute emerges where a summary or default judgment might be easily obtained in the courts, but not in the arbitration. Third, arbitration awards have no precedent value. More on these points later on.

2. Jurisdictional Courts

Where parties wish for any disputes arising from an international agreement to be referred to the courts, it is advisable to include an express jurisdiction clause into the agreement. An express choice of forum is particularly important where parties

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are unwilling to have disputes decided by the other party’s national courts because of concerns that litigating in the local courts will put them at a disadvantage. There are various forms a jurisdiction clause can take. An exclusive jurisdiction clause is the most stringent form of jurisdiction clause. It prescribes a particular jurisdiction in which the parties must then litigate. The clause can even choose specific courts within the jurisdiction. A non-exclusive jurisdiction clause enables either party to bring proceedings against the other either in the court of the chosen country, or in the courts of any other country which has jurisdiction over the dispute under their own jurisdictional rules. In addition, there are various hybrids of exclusive/non-exclusive jurisdiction clauses but those go beyond the scope of this lecture.

a. Pros

Summary Determination - Courts have more extensive case management powers than arbitrators. They can, and frequently do, dispose of meritless claims or defenses at an early stage or determine cases or issues summarily, which can lead so significant time and costs savings. Arbitral tribunals, although able to determine claims and defenses summarily, are in practice much less willing than courts to do so. Multi-party disputes – Courts have the power to consolidate proceedings or to join third parties to an action where it is appropriate to do so. Where there is a complicated chain of related parties to a dispute, courts will be better placed to manage them all in one set of proceedings which not only saves costs, but avoids the risk of inconsistent findings. This can be important where several international franchisees have raised the same complaint and the franchisor would like one consistent solution or in a master franchising situation where it can be best to involve the franchisor, the master franchisee and the sub-franchisees in the decision making process. This represents a considerable advantage over arbitration. Precedent – In cases where a final and binding ruling on a point of law and/or construction is required, litigation is the only feasible option. Arbitration awards, which are confidential, do not give rise to any binding precedent on other parties. This can again be important for disputes with multiple franchisees.

b. Cons

Cross-border enforcement can be problematic where the defendant’s assets are located in a jurisdiction which does not recognize or enforce US court judgments. That is still the case with a number of important trading partners of the United States with which no reciprocal enforcement arrangements for court judgments have been established. Fresh court proceedings have to be commenced in those countries in order to enforce a foreign judgment there.

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3. Mediation

Finally, a mention must be made of alternative dispute resolution (ADR) mechanisms. One of the most popular forms of ADR is mediation. A requirement to carry out good faith negotiations or to attempt mediation before formal legal proceedings are commenced is sometimes incorporated into dispute resolution clauses. Some courts will also actively encourage parties to explore mediation. Mediation is a process whereby a neutral third party (the mediator) assists the parties in reaching a negotiated settlement.

a. Pros

Mediation offers a range of benefits over formal adversarial processes such as litigation or arbitration. It is considerably faster and cheaper, is more likely to achieve a satisfactory result and it is conducted in private. Speed – A mediation can be set up relatively quickly and usually only lasts a day except in very complex cases. This means that a dispute has the potential to be resolved very quickly saving both legal costs and management time. Collaborative – Mediation minimizes the risk of damage to relationships and reputations. Instead of becoming ever more deeply entrenched in legal proceedings, in a mediation the parties can be engaged in constructive discussion in a manner that is rarely achieved through traditional, adversarial processes. A successful mediation will result in a settlement that is acceptable to all parties. In mediation, parties can work out a creative solution to their problem that works for both sides; that might well be a solution that a court or tribunal would not have the power to order. Confidentiality – The entire mediation process is confidential and is generally conducted on a without prejudice basis, so parties can make concessions and disclose matters to try and reach agreement and if no agreement is reached, those concessions and disclosures cannot be used in evidence against them in subsequent legal proceedings.

b. Cons

The mediation process is voluntary. No one can be compelled to participate in it and either party can withdraw at any time from a mediation or does not need to accept a proposed solution if it does not want to. Although mediation often tends to result in settlement of disputes, it cannot guarantee a result. The mediator has no power to make a final determination of the issues between the parties. Where mediation has been attempted but parties have failed to reach a settlement, they will then be left to pursue a formal legal process to reach a final resolution. Mediation cannot interrupt a time bar and will thus be inappropriate in cases where there are limitation issues. Similarly, where a party needs protective relief such as freezing orders, injunctions or search and seize orders to preserve assets

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for the purposes of enforcement or to preserve evidence for the fair resolution of the dispute, mediation will be wholly inappropriate and the party will need to resort to court to obtain the appropriate relief.

4. Remedies For Breach of Jurisdiction or Arbitration Clause – A Practical Note.

When contracting parties have agreed on a method of dispute resolution, there is an expectation that the contractually agreed mechanism will be adhered to in the event of a dispute arising. Where foreign court proceedings are commenced in breach of a valid local jurisdiction clause or arbitration agreement, two principal remedies used to be available: (1) application to the court in which proceedings have been commenced for a stay or dismissal or proceedings; (2) anti-suit injunction restraining the party in breach from commencing or (more commonly) continuing with the court proceedings. Whilst some courts are willing to grant anti-suit injunctions to restrain a party from commencing or pursuing proceedings in a foreign court in breach of a jurisdiction or arbitration agreement others may refuse to entertain this remedy. For example, the ability of national courts of EU member states to grant anti-suit injunctions has been severely limited by the European Court of Justice’s interpretation of the Brussels Regulation.1 Following the ECJ’s decisions in the cases of Gasser2, Turner3 and West Tankers4, it is now well established that where court proceedings are commenced in an EU member state in breach of a jurisdiction or arbitration agreement, the courts of the agreed forum may not grant an anti-suit injunction. Instead the parties need to apply to the courts where proceedings are pending for stay. This has produced a very unsatisfactory situation. The law, as it stands, means that there are very few options a party can pursue in practice if a counter-party commences proceedings in breach of a jurisdiction or arbitration clause in order to gain some tactical benefit. In recognition of this difficulty the European Commission recently issued a proposal for a radical overhaul of the law in this area.5 1 Council Regulation (EC) No 44/2001 of 22 December 2001 on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters.

2 Gasser GmbH v MISAT srl (Case C-116/02 [2003] ECR I-14693).

3 Turner v Grovit (Case C-159/02 [2004] ECR I-3565).

4 Allianz SpA v West Tankers Inc. (Case C-185/07).

5 Proposal for a Regulation of the European Parliament and of the Council on jurisdiction and the recognition and enforcement of judgments in civil and commercial matters published on 14 December 2010 (COM (2010) 748 final).

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a. Arbitration Systems. There are a multitude of different institutional arbitration systems throughout the world as well as established rules which provide the basis for ad hoc arbitration.

(i) International Chamber of Commerce (ICC).

The International Court of Arbitration is attached to the International Chamber of Commerce and is the most well-known and one of the most widely used institutions. The headquarter of the ICC is in Paris and there are now branches in Hong Kong and Singapore. Under the ICC Rules, if an arbitrator has jurisdiction over certain questions of law, and the parties do not specify the place or arbitration, then the ICC Court will select the place or arbitration, based on neutrality, convenience and to ensure, as far as possible, that any resulting award will be enforceable. All awards are automatically scrutinized before being approved. The ICC has an international centre for technical expertise which has a resource for providing technical experts to serve on arbitration panels or to provide expert testimony on technical issues. This may be useful to a franchisor, for example, in a know-how dispute. The ICC handles cases under all systems of law including civil law, common law and Islamic law. It applies the ICC Rules of Conciliation and Arbitration to its disputes. The ICC is often criticized on cost grounds as the administrative fees and arbitrator’s costs are linked to the amount in dispute rather than being related to time spent on the case (although they are adjusted to take account of the complexity of the matter). Furthermore, the ICC normally insists on an advance deposit from both parties in order to cover costs. This can be paid in two installments. No interest is awarded on that sum and the question of costs sometimes makes other institutions more popular.

(ii) The American Arbitration Association (AAA)/International Centre of Dispute Resolution (ICDR).

The International Centre for Dispute Resolution (ICDR) was created in 1996. It is a division of the AAA which has particular responsibility for international cases, and its roots arise from an attempt to rectify a perceived U.S. centric bent of the AAA. In other words, the ICDR is designed to be a more global-centric branch of the AAA. Arbitrators are paid by an hourly rate, which will be agreed by the ICDR and both parties at the outset. The administrative fees are based on the amount in dispute. The ICDR may ask claimants to pay a deposit at the outset to cover part of the cost of the arbitration. The ICDR may be cheaper than the ICC as it has recently set guidelines in order to monitor and limit costs incurred.

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The ICDR should be a good forum for resolving the majority of franchise disputes. (iii) The London Court of International Arbitration

(LCIA). This deals with disputes in a variety of areas of international commerce, including telecommunications, insurance, oil and gas exploration, construction, shipping, aviation, pharmaceuticals, shareholder agreements, IT, finance and banking. The LCIA may ask for deposits to be paid during the arbitration. However, unlike the ICC it pays interest to the parties on any sums deposited with it. Costs are not dependent on the amount in dispute. (iv) Stockholm Chamber of Commerce (SCC). Sweden has made a breakthrough on the international arbitration scene and the SCC applies its own rules to encourage the submission of transnational cases. The SCC deals with various commercial disputes. It was particularly popular in East/West disputes involving trade organizations from the CIS, Poland and Hungary on the one part, and from the UK, the US, Italy and France on the other. Parties particularly concerned about neutrality or bias often include arbitration clauses in their contracts referring disputes to the SCC. The SCC has special rules for expedited arbitrations and generally proceeds relatively quickly. Fees are based on the amount in dispute. (v) United Nations Commission on International

Arbitration (UNCITRAL). The UNCITRAL Arbitration Rules are designed to be flexible and provide expedited relief to parties in international business disputes. The UN Commission does not actually administer the arbitration itself but its rules are used by other bodies both in ad hoc and institutional arbitration. The rules are particularly popular in projects which involve developing countries, who may not wish to use arbitration systems funded by industrial countries. The parties should specify the number of arbitrators, the place of arbitration and the language of arbitration. If the parties do not specify these key aspects then three arbitrators will be appointed by the Secretary General of the Permanent Court of Arbitration at The Hague and this arbitration panel will determine other key aspects of the arbitration proceedings. Revised rules which were introduced in 2010 include a requirement for costs to be reasonable and a mechanism for their review. (vi) Global spread. Arbitration systems are available worldwide. There has been a spate of additions to the international arbitration scene in Africa and the Far East.

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The Hong Kong International Arbitration Centre uses a combination of UNCITRAL rules and a domestic regime, and has expanded to deal with international disputes. The China International Economic and Trade Arbitration Commission has become a leading arbitrational system. It features a ‘Summary Procedure’ which is a faster way of dealing with lower value claims. It has also offered online arbitration services since 2009. The Asia-Pacific Regional Arbitration Group consists of arbitration systems from over a dozen countries, including Australia, New Zealand, Dubai, India, Indonesia and Mongolia. The Kuala Lumpur Regional Centre of Arbitration under the auspices of the Asian African Legal Consultative Committee also uses rules based on UNCITRAL rules. African centers of arbitration include Cairo, Rabat and Tunis. 5. Enforcement. The 1958 New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards is the main treaty on enforcement. It requires courts of contracting states to enforce agreements made in arbitration proceedings, and imposes severe restrictions on any party seeking to resist the enforcement of an award. The formalities of enforcement are simple: the party seeking to enforce the award must go to the court of the forum he has chosen and present the award and the agreement under which it was made. The court will then generally have to enforce the award unless one of the grounds for refusal is satisfied. These grounds include incapacity of the parties or invalidity of the arbitration agreement, denial of a fair hearing, lack of jurisdiction, invalid award, procedural irregularities and public policy. Enforcement will depend upon whether the parties are signatories to the Convention. An arbitrational award, regardless of which country it was made in, can be enforced in any state which is a party to the Convention. However, the scope of the enforcement may be limited by article 1(3) of the Convention which provides that states can make two reservations. The first of these reservations is the ‘reciprocity reservation’. This allows states to limit the applicability of the Convention to awards made in other contracting states. It is therefore helpful if both the state in which enforcement is desired, and the state where the award was made, are contracting states. Out of the 145 state parties to the Convention, 73 use this reservation including the USA. A list of the contracting states is set out at the end of this paper as Appendix A, and a list of the states with the reciprocity reservation is set out as Appendix B.

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The second reservation further limits the applicability of the Convention by providing that a state can agree to apply the Convention only to commercial matters. Forty-five states have taken advantage of this reservation. If a party is seeking recognition or enforcement of any award which was not made in a state which is a signatory to the New York Convention, it will need to establish whether the state where enforcement is sought, has entered into any other international treaty governing enforcement of arbitral awards.

III. A U.S. Franchisor’s Analysis Matrix Following an International Dispute. Disputes happen. No matter how great an international candidate may have seemed when they knocked on your door, it is nearly inevitable that a dispute will arise during a long term franchise relationship, especially an international relationship where culture, custom, language and distance are each greater factors than in a domestic franchise relationship. The dispute may be minor and easily resolved, or it may be material and substantial, with no outward appearing practical resolution. This Section of the Paper describes a U.S. franchisor’s typical analysis matrix when a dispute occurs, focusing first on the type of dispute and then on the potentially available options that U.S. franchisors are likely to consider. Importantly, no two agreements, relationships or disputes are the same, but the end game for most U.S. franchisor’s is the generally the same – can I recoup monies owed, can I keep units open (or close then efficiently) and can I protect my brand? A. Typical Disputes that arise in International Franchise Transactions.

1. Non-payment of fees.

Franchisors would not franchise at all unless they knew they were going to be paid for their efforts. That is of course true internationally, but the obstacles to getting paid in the international realm are greater. While historically some franchisors demanded seven or high six figure initial fees as a way to mitigate the payment risks, those days are largely over as there are both more options for qualified franchisees and a larger pool of experienced and qualified international franchisees that know the market price for franchise sales in the U.S. While some Franchisors still mitigate costs by shifting cost burdens to the international franchisees, including as to, among other things, translation costs; purchasing infrastructure; travel and transportation costs; communication costs; transaction costs such as legal documents, advertising and promotional programs, government approvals, trademark registrations, and others; and support costs such as on-site training, this is getting more difficult for most U.S. franchisors. And certain techniques used in the U.S. (such as controlling the billing and accounting for franchisees), is exponentially more difficult in an international context, especially in terms of being able to replicate the same process across a number of countries. Still, continuing royalties and/or proprietary product purchases are the lifeblood of franchises, and if an international franchisee does not timely pay its fees, it will be subject to default and potential termination – and this is the single most prevalent

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default in the international context. While the non-payment of the fees is generally the easiest default to cure if the franchisee has the money available, or can readily obtain it, there are certainly instances of international franchisees (or their owners and guarantors) withholding payments as a means of defiance even when the funds are available, with the franchisee taking a “come and get me on my home turf if you dare” attitude toward enforcement. 2. Development Schedule defaults. Development schedules are made to be broken, or at least it might seem like that in the domestic and international franchise context.6 Whether the parties are trying to justify a large initial fee, a grant of an entire country or the market (or other third party observers such as public stock owners), international master franchise or development agreements tend to cover greater territories and require greater number of units to be developed. When you combine a larger territory with a larger number of units and then add in the complexity of international development, even the best laid plans and most well thought out development schedule can be too optimistic or subject to failure. One needs only look at events in Egypt, Libya and Japan during the first half of 2011 to know that planning for all contingencies is nearly impossible. Still, regardless of whether a development schedule is well thought out or drawn out on a napkin, the failure to meet the development schedule will, in most instances, provide the franchisor a default mechanism and give rise to a dispute of some manner, because even if the franchisor does not act on the default, the franchisee is likely to be cognizant of the default and in a defensive posture. Most U.S. franchise lawyers have encountered U.S. franchisor clients that, for whatever reason, are unsatisfied with their current franchisee and are more than willing to use a development schedule default to either push the franchisee to develop more or push the franchisee out of the system. Thus, development schedule defaults are the second most likely default scenarios in international transaction. 3. Abandonment or Closure of Units. While there are certainly exceptions to the rule, in most instances the control and oversight a U.S. franchisor exercises over site selection, openings and operations will be less than in the United States and, especially in the context of master franchise relationships or larger development deals with more sophisticated international franchisees, it is not unusual for international franchisees to open and close locations based on their own timetables and without the same amount of oversight or consent that would be applicable in a domestic U.S. situation. The reasons for this phenomenon range from shorter lease periods (for instance in Hong Kong), to smaller unit locations (for instance in Tokyo), to cultural

6 Milford Prewitt, Cornell Study: franchisors’ growth goals inflated; franchise vets mull implications for domestic expansion, Find Articles (2005), available at http://findarticles.com/p/articles/mi_m3190/is_51_39/ai_n15967661/. See also Jennifer Dolman, Robert A. Lauer and Lawrence M. Weinberg, Structuring International Master Franchise Relationships for Success and Responding When Things Go Awry (ABA Forum on Franchising 2007).

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differences (for instance in warmer climates (where towns shut down in August). While in some instances these closures are temporary and disputes can be resolved with the franchisor, in other instances they are permanent and it is not at all unusual for a franchisor to learn that an international franchisee has closed locations from a third party, and not the franchisee itself. Finally, there have of course been political or market-driven financial occurrences that have lead to franchisee closures or even franchisee disappearances. The authors of this Paper have lived through instances in Argentina, Indonesia and Venezuela where seemingly good franchisees were swallowed up by outside forces and units were closed or abandoned without notice or follow up. 4. Breach of System Standards; Lack of Reports. There is an inherent conflict between the regimented system a U.S. franchisor desires to replicate across the globe and the different tastes, cultures, norms and traditions of the various target markets in which franchisor desires to expand. While there are surely at least a couple instances where a deal was signed and then it was learned that a key component of the system was not viable in the target market (for instance alcohol, pork, sandwich bread), most franchisors going international understand this key point, have researched it at least to some extent and are willing to adapt their systems, products or services accordingly, but it is fairly common that the parties agree in the franchise agreement to agree in the future on what such adaptations may actually entail. This is of course ripe for dispute, and while both parties have a vested interest in obtaining the right balance of market sensitivity and system consistency, striking that balance can be difficult and many U.S. franchisors have thought they had reached an understanding on system changes only to find out that the local franchisee has “tweaked” (or overhauled) a product or specification in a way that causes the franchisor to take umbrage with the franchisee’s choices (and corresponding failure to adequately inform the franchisor of the changes).7 Of course, not all system standards issues are based on cultural or other differences, and sometimes it is simply a matter of lack of training, lack of access to the correct materials or lack of attention (or even desire) to follow the franchisor’s system to the letter, especially when there is a cheaper alternative that is “just as good” in the franchisee’s mind. Thus, in many instances, a systems standards issue is the product of a franchisee thinking with their wallet and a franchisor thinking with their heart. While not an inherently international dichotomy, the conflict is certainly exacerbated by distance, culture and perceived goals of the two parties.

5. Breach of Confidentiality or Non-Competition Obligations.

In recent years, there has been an influx of what some have termed “brand collector” franchisees that have well-funded backing, professional management and an insatiable appetite for U.S. brands across varying segments of a business

7 Jordan Furlong, Setting up Overseas Franchises Poses Challenges, Lawyers Weekly, Dec. 1995.

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market. While most often seen in the restaurant/food & beverage context, these larger, more sophisticated franchisees often take the position that they know the business, they have suppliers and they have infrastructure so all they really need from a franchisor is a U.S. brand name and signature product, and therefore confidentiality and non-competition provisions should not be applicable to them (or greatly reduced in scope and time). While this is normally addressed in negotiations, it would be naïve to think that all franchise agreements are perfectly crafted to address all scenarios, or that all franchisees adhere to their agreements. In any event, it is not at all uncommon for disputes to arise when franchisors learn about new operations that the franchisor believes to be derivative or competitive, and that the franchisee believes to simply be part of their diversification plan. Nor it is at all uncommon for a franchisor to discover after a termination or abandonment that the franchisee is operating a knockoff or other competitive unit at the prior franchised location. B. Conducting of Internal and External Analysis. Once a dispute has surfaced (actually preferably before a franchise agreement is signed or at least before a dispute arises), a U.S. franchisor needs to have conducted an internal and external analysis of it legal and business rights, obligations and options. This Section of the Paper addresses the nature and extent of that initial U.S. franchisor centric analysis. 1. Franchisor’s Rights Under the Agreements. While covered in greater detail in Section III.C. below, when a dispute arises, a franchisor needs to locate and review its franchise agreements with the international franchisee and determine its rights and obligations with respect to the substantive issues at hand and the dispute resolution mechanisms in place in the agreement to resolve the disputes. Unfortunately, this can sometimes be more difficult than it would seen, especially in a master franchise context where agreements are signed and even held abroad, or where a branch office of the Franchisor manages a region. More often that not, the agreement at issue is older and materially different than “the then current form” such that regardless of the best practices the franchisor is following today in new deals, the agreement at issue has difference provisions or terms, and the franchisor must focus on the agreement at issue and not its ideal form that it may have just overhauled. It is crucial that the franchisor work with in house or outside counsel and international franchise counsel to determine the parties rights and obligations. Still, franchisors may have provided for certain enforcement or leverage mechanisms in their agreements, which can be useful when a dispute arises. For instance, one of the most common ways that U.S. franchisors can help guarantee payment and performance of other contractual obligations is to require a personal or corporate parent guaranty, letter of credit and/or bank guaranty throughout the term of the franchise agreement. A letter of credit or bank guaranty can be used

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in lieu of a personal guaranty where the franchisor’s ability to enforce the guaranty is dubious. A letter of credit or bank guaranty permits a franchisor to take specific action – that is, draw down on the letter of credit – without having to pursue formal litigation or other dispute resolution activities. In some instances, a letter of credit is tied to liquidated damages amounts for specific breaches that might not otherwise lend themselves to quantifiable damages, including breaches of confidentiality, non-competition, transfer and non-solicitation provisions as well as premature termination/lost profit damages or improper post-termination operations. Having these types of contractual leverage points in a contract can be an extremely persuasive tool when attempting to cause the franchisee see your point of view. 2. Franchisor’s Compliance with the Agreement. Cleans hands is a fairly simple concept to understand for most. Internationally, the risk that a franchisor who goes on the offensive in a dispute can quickly be on the defensive is an inherent risk. Franchisors considering defaulting, terminating or suing an international franchisee need to perform internal due diligence with respect to their own performance under the agreement before they act, or else they risk opening a can of worms that, in the international context, can be extremely difficult to re-seal. 3. Franchisor’s Review of Legal Requirements In Local Country. It cannot be stressed enough in this Paper that no two foreign jurisdictions are identical, and when it comes to disputes, litigation, arbitration, court systems and the like, having experienced and knowledgeable local counsel is crucial. That said, for franchisors that are used to U.S. precedent and predictability (to the extent such exists), international jurisdictions can and will seem like the Wild West and it is equally important to have experienced U.S. counsel that can help digest and decipher advice and options from local counsel is equally important. Below is a short list of the local law issues that merit review at the time of a dispute.

a. Trademark Status

Trade dress and trade secret rights and restrictions that U.S. franchisors might take for granted domestically run the gamut internationally. In most instances, a franchisor’s saving grace is a registered trademark. So, confirming that the franchisor’s trademark registrations are live and valid is a first step in confirming that the franchisor is in position to escalate a dispute.

b. Trademark Licensed User Filings or Registrations

Trademark license filings are pervasive across international jurisdictions. While many are voluntary, a number of countries require that trademark license agreements (which, of course, includes franchise agreements), be registered with and/or approved by a national trademark office. While in many cases ministerial in nature (most are designed to give third parties notice that the licensee has a right to use the marks), in a dispute scenario they can be an added hurdle for a

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franchisor because these licenses can at times be burdensome to cancel if the relationship terminates or expires, especially if the termination is contested. c. Agency Law Filings Outside of the U.S., so called commercial agency laws commonly apply to franchise relationships, particularly if the franchisee will be located in a Middle Eastern or Latin American country. If agency laws apply to a franchise relationship, the franchisee will often be granted additional rights and may be entitled to compensation upon termination of the relationship. It is crucial when a dispute arises to confirm if an agency law exists in the jurisdiction and if the franchisee has previously registered for protection under the law (with or without the franchisor’s knowledge and consent). If an agency law is applicable, it can change the paradigm of the dispute. In most instances, a franchisor can obtain confirmation from the local authorities as to whether a particular franchisee has registered as a commercial agent, but it normally can take some time to obtain the results as counsel will likely need a power of attorney and one or more personal trips to the authorities to obtain definitive information. d. Franchise-specific Relationship Laws Several countries regulate or restrict a franchisor’s right to terminate or refuse to renew a franchise agreement without good cause and prior notice. For example, such laws may require a franchisor to describe the conditions governing termination in the agreement, provide opportunity to cure breaches of the franchise agreement and have good cause to terminate the franchise agreement. In addition, Franchisors often place significant restrictions on transfer in their U.S. franchise agreements. When franchising in a foreign country, it is often difficult for a U.S. franchisor to enforce such restrictions and prevent an unauthorized transfer. But in most jurisdictions, franchisors are free to impose reasonable conditions and restrictions upon transfer of the franchise. Other countries may mandate that the local law govern the franchise and other agreements with a foreign franchisee, or that the jurisdiction in which the franchisee is domiciled be the sole venue for disputes. For such countries, it is even more important for the franchisor to consult local counsel to determine how a court within a country that requires mandatory choice of law and forum is likely to interpret the franchise and other agreements. (e) Good Faith Requirements Most U.S. franchisors know enough about good faith and fair dealing requirements to be concerned about them, but many foreign jurisdictions actually impose a duty of good faith on franchise and other contractual relationships by law. For instance, in Ontario, Canada, the Arthur Wishart Act8 requires by law that every franchise agreement imposes on each party a duty of fair dealing in its performance and enforcement. A party to a franchise agreement has a right of

8 Ontario Franchises Act, Bus. Franchise Guide (CCH) ¶7050.

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action for damages against another party to the franchise agreement who breaches the duty of fair dealing. The law specifically defines fair dealing as including the duty to act in good faith and in accordance with reasonable commercial standards. All discretion exercised by franchisors is subject to a requirement that they act in good faith, and honor the fair dealing requirement. C. Typical Options Available to a U.S. Franchisor. It is fairly typical that the first reaction in any international dispute is for the franchisor to want to come after the franchisee with guns blazing. That is normally the worst thing that can happen, especially when a hastily prepared and poorly researched letter (or email these days) is quickly generated and sent to the franchisee before in house, outside or local counsel is consulted. This Section of the Paper describes typical options available to a franchisor once internal due diligence has been completed and local counsel has weighed in; providing the franchisor a picture of its rights and obligations, and of the potential outcomes and costs. 1. Pre-Termination Options vs. Post-Termination Obligations. While it seems counter-intuitive, in the international context, whether a U.S. franchisor has the right to terminate a franchisee or actually terminates a franchisee may at times have little to do with the actual outcome of the parties ultimate relationship and dispute resolution. While termination of course connotes finality, especially in the international context, international franchisees at times treat a termination notice as an invitation for further discussions and simply the U.S. franchisor’s attempt to get the franchisees attention. This is especially so in long term relationships where there are multiple existing units and neither party has any practical desire to see the units close. This can of course be the source of consternation and frustration for the franchisor, causing resolution to be even more difficult. If is most definitely preferable to resolve differences prior to or outside the context of termination (even if such resolution takes formal dispute resolution), and it should be stressed that just about any type of relief you may want to seek (short of permanent closure and de-identification) can be sought without having first resorted to termination of the franchise agreement. But, at the same time, termination can sometimes be used as a tool to promote settlement or resolutions on the basis that the termination is the only action that will provoke the franchisee to act or come to the negotiation table. With this in mind, the options discussed below can in most instances be pursued before or after termination without too much differentiation, but again each situation is unique so the determination as to whether to terminate or retain the right to terminate must be analyzed at the time with the full context of the dispute and the parties’ positions in mind.

2. Default Notices and Termination Notices.

The first step is preparing a default notice to state the U.S. franchisor’s legal position under the franchise agreement. It seems axiomatic, but the default notice is sometimes given short shrift. U.S. franchisors need to carefully consider not

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only the substantive content of the default notice, but also its tone and demands for cure, especially in an international context where perhaps a full cure is unlikely and the U.S. franchisors good faith (or lack thereof) could later be dispositive. Generally speaking, the default notice covers all the key defaults and reserves all rights, but it can also be used in many instances to provide a form of settlement proposal or offer. The authors of this Paper generally prefer to keep default notices as clean as possible, and even if a concurrent settlement proposal is made, that it be made in a separate document marked as confidential and for settlement purposes only. 3. Settlement Proposals. As noted above, in many instances, a franchisor that is sending a default notice to an international franchisee knows that the franchisee may not be in position to fully cure, but might be amenable to some form of workout and is looking for the franchisor to make the initial foray into negotiations. It is fairly common for a default notice to be sent along with a concurrent but separate proposal for a cure that entails, for instance, an initial partial cure, an agreement on a plan for a longer term full cure along with continuing compliance with the agreement and a general release. The concept is that the franchisor has reserved its rights with the formal default notice, but then concurrently reaches out with a practical proposal to resolve the dispute and continue with the relationship. While a franchisor’s first proposal is normally one-sided in favor of the franchisor, the proposal in and of itself can in most instances open up a dialogue while a cure period is running on the default notice, and put the franchisor in position of at least having made an effort to resolve the differences if the parties cannot agree on settlement terms. This can be important if before a judge or arbitrator later on, and the franchisor is attempting to deflect arguments that it was intolerant or hardheaded to the detriment of the local franchisee (which again can be especially important in good faith jurisdictions). 4. Requests for Business Meeting. In-person meetings between key persons with the franchisor and franchisee can be difficult to arrange in the U.S., and much more difficult to arrange in an international context, especially without the mandates of a mediator, arbitrator or judge. However, voluntary in-person meetings remain the most effective method to resolve differences at the onset of a dispute, and even if a full resolution is not ironed out, it will normally crystallize the true issues between the parties and perhaps make a settlement more viable in the future. Thus, it cannot be overstated enough that a franchisor strongly consider making an overture to a franchisee to meet in person on or near the franchisee’s home jurisdiction. While there are certainly safety, cost and time factors to be considered, the alternatives are not too appetizing and the potential ability to resolve a dispute without the lawyers is in many instances too good an opportunity to pass up. Of course, the meeting needs to have a structured agenda, include persons with decision-making authority who (hopefully) do not have an overly antagonistic past and, finally focus on practical resolutions going forward (versus the past differences that brought the parties to this point). It may be surprising to some how a U.S.

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franchisor making the effort to literally come to the franchisee can smooth over what seemed to be an unresolvable situation, especially since in many international jurisdictions business is best conducted in person and perceived respect (or lack of respect) is on par with financial considerations when resolving differences. In this context, the position and stature of the person the U.S. franchisor sends for this meeting is crucial, as the sending of an underlying or person that the franchisee (for whatever reason) does not feel is on par with them can be taken as an insult and actually hinder the discussions and potential settlement. 5. Informal or Formal Mediations. Written settlement offers and business meetings do not always distill or resolve the issues. As discussed in Section II of the paper, many international franchise agreements call for or promote informal or formal mediation as a precursor to escalating to mandatory dispute resolution forums. Mediation offers certain benefits to parties involved in an international franchise dispute.9 First, it allows the parties to bring in a talented, unbiased professional to help the parties crystallize their issues without personal emotion or agendas that are inherent in direct business to business meetings. Second, mediation allows the parties to develop and state their cases and positions without fear of a third party arbitrator or judge making an ultimate decision. Third, mediators are supposed to be expert at developing creative solutions to the parties particular needs, including those not contemplated by the franchise agreement and those beyond the authority of the courts in any one jurisdiction.10 Mediation is particularly well suited to international commercial disputes because parties reticent about the courts in the other parties jurisdiction do not have to worry about home cooking treatment. Mediation is also confidential. Of course, mediation is not binding and if the parties are too far apart or too set in their positions it can simply be an additional time-consuming and costly roadblock on the way to litigation or arbitration. Franchisor considering a mediation in an international dispute need to take all these factors and possibilities into consideration, and in some instances key decisions such as the selecting of the mediator, the location of the mediation and the bearing of the cost of the mediation is too much to overcome and one or both parties drop mediation in favor of formal, binding dispute resolution methods available to them. 6. Formal, Binding Dispute Resolution Proceedings.

9 See generally, Jennifer Dolman, Robert A. Lauer and Lawrence M. Weinberg, Structuring International Master Franchise Relationships for Success and Responding When Things Go Awry (ABA Forum on Franchising 2007).

10 Id.

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There comes a time in any international dispute where all avenues for an amicable resolution have been exhausted, or there exists an impasse that requires intervening action by a third party authority. Of course, deciding to litigate or arbitrate simply opens up a brand new set of options to be analyzed. a. U.S. Actions vs. In-Country Actions While it is of course crucial for a U.S. franchisor to have done its homework to determine what its franchise agreement(s) require or provide for in terms of arbitration vs. litigation, venue, damages limitations, liquidated damages, injunctive or declaratory relief, letters of credit or other forms of securities and other bolstering provisions, it is a bit less black and white in an international context and so in some ways franchisors have to analyze what they want to accomplish and where they want to accomplish it just as much as they analyze what the letter of their agreements requires. In some instances, the analysis is as simple as the U.S. franchisor deciding that it has no intention of bringing an action or appearing in the franchisee’s jurisdiction regardless of what the franchise agreement may say. In other instances, the U.S. franchisor may decide that it needs to pursue relief in the courts of the jurisdiction where the franchisee’s principal office is located if it is going to have any potential success or meaningful enforcement of its rights, again regardless of what the franchise agreement might require and what may be more convenient, comfortable or affordance. Section II.A. of this Paper outlines specific types of dispute resolution options set forth in typical international franchise agreements, and the pros and cons associated with those options, but at the time a dispute actually occurs the dispute resolutions requirements evolve into a means to an ends, or in some cases an obstacle to a desired result. 11 While always a difficult analysis, in the international context, it is sometimes prudent for a U.S. franchisor to disregard the letter of its contract to bring an action or arbitration in a venue that is advantageous to it, and let the franchisee make a call whether to focus on procedure or the substance of the claim.

For instance, if a U.S. franchisor has a unit that has been terminated and it wants it to close, U.S. action (whether litigation or arbitration) is not likely to present the quickest or most effective route unless the franchisee or a guarantor has assets or interests in the U.S. and the U.S. action is designed to leverage indirect pressure on the franchisee to act. Thus, even if the franchise agreement may call for arbitration in the U.S. and only have no carve-outs or limited carve-outs for actions in other venues, a U.S. franchisor may decide to bring an action in the franchisee’s jurisdiction on the premise that it is likely the quickly route to relief and the local franchisee may be loath to attempt to move the action out of its home jurisdiction. Conversely, perhaps in an abandonment context the international franchisee closed the unit unilaterally owing $400,000 in unpaid royalties (not to mention lost

11 Franklin C. Jesse Jr. & Andrew P. Loewinger, Planning for Dispute Resolution in International Franchising Relationships, 25 International Business Lawyer 221, 222 (1997).

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profit or liquidated damages amounts) so the U.S. franchisor is simply seeking monies owed, and the franchise agreement calls for local law and venue in the franchisee’s hometown. But, the franchisee is known to be very powerful in its hometown and the courts are known to be fairly slow and corrupt. The franchisor knows that the franchisee’s guarantor also has assets in the U.S. or a neighboring country with a more advantageous legal system to the U.S. franchisor so, again, the U.S. franchisor may elect to disregard the venue designation and sue for monies owed in the jurisdiction in which the franchisee is located on the premise that the suit will either lead to a judgment or persuade the franchisee to come to the settlement table. The options in any given dispute are so numerous as to make discussion of all the potential variables impossible within the confines of this paper, but the key is that U.S. franchisors that find themselves in a situation where they will need to bring an action in arbitration or court must think outside the box because the deck is initially stacked heavily against them, and they must utilize all potential avenues available to them to attempt to level the playing field. IV. Alternative Options for U.S. Franchisors. It is of course a tenant of franchising that franchisor’s must enforce the obligations of franchisees to observe franchise standards. In an international franchise system, enforcement overseas is far more problematic than in a purely domestic forum. The risk of non-compliance and the consequential damage to the entire system will increase when the franchisor decides to take its franchise system overseas. If a franchisee is in breach of its commitments to the franchisor action should be taken quickly as failure to do so may encourage other franchisees to breach their commitments. If this were to happen the universal image and goodwill in the system will be in danger of collapse. Disputes may also be initiated by franchisees who are seeking legal excuses for non-compliance, for example, alleging unfair trade practices, breach of anti-trust laws or oppressive operational standards. When dealing with these issues, the Franchisor also needs to have in mind its long term international strategy. If a Franchisor terminates its franchise in a foreign country and a sizeable number of units have to close, it can be difficult to re-enter that market later. It is therefore very important to deal with the matter correctly and ensure that things are done properly as there is a risk that if the franchisor wants to ultimately re-enter the territory at a later date the way the previous franchise has been terminated can cause substantial problems and potential brand damage. The termination of a long term agreement, such as a franchise, is inevitably viewed by the market as a failure. It therefore may well be preferable for the franchisor to try to renegotiate and maintain the current relationship even if that results in some short term loss of royalty or service fees. Often termination followed by litigation is not the best way forward when disputes arise in international franchising. Therefore, alternative options need to be explored.

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Those include: 1. Remedial Plan 2. Renegotiating the Agreement 3. Franchisor Buy – Out 4. Transfer to a New Franchisee Each option is considered below in more detail:

1. Remedial Plan.

Most franchisors initially react with anger when faced with non payment or other breaches committed by overseas franchisees. However, once the breaches are investigated it often transpires that there are solutions available which are less drastic than termination. In particular the franchisee is often given a number of opportunities to cure before termination is seriously taken into consideration. The franchisor needs to balance its desire to enforce quality standards with the problems likely to arise from closure of overseas units. Those problems can range from refusal on the part of the franchisee to recognize the termination as valid to counter claims for damages and open trade secret theft. Before embarking on the long and costly litigation which often follows termination many franchisors prefer to agree a remedial plan with problem franchisees, allowing them to cure the various breaches which may have been committed. Non-payment is frequently the reason for threats to terminate. When franchisees encounter financial difficulty they will generally prefer to pay the rent and staff wages to avoid immediate insolvency but they will frequently ask for extra time to pay the franchisor. Many franchisors also supply products and equipment to franchisees and again these are often supplied on credit. This can result in a situation where the franchisor cannot move to termination of the franchise agreement without writing off most of the outstanding receivables which can involve very considerable sums. The reason for this problem arising is that termination of the franchise agreement will often cause the franchisee to become insolvent. Accordingly franchisors frequently agree a remedial plan with overseas franchisees that are in default. This can be done by:

• A payment plan where by overdue fees are paid off by installments over a period of time (generally several years)

• Freezing historic debt whilst insisting that future fees must be paid on time

• Taking some form of security over franchisee assets to protect the franchisor

• Delivery of new products only against advance payment

This can give the franchisee the necessary breathing space to resolve its financial difficulties. 2. Renegotiation.

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When faced with a situation where an international franchisee is in financial difficulty or otherwise needs to be terminated it can be very difficult to find a substitute licensee to take an assignment of the franchise agreement and the business as an ongoing concern particularly the franchisee is a Master Franchisee. There is then a substantial risk that the Franchisor is confronted with a group of “orphaned” sub franchisees or “look alike” stores. It is therefore important to explore continuation of the current relationship between the Franchisor and the Franchisee, even if that means making concessions. This often leads to the parties re-negotiating the agreement in relation to payment of royalties or the development schedule. When the franchise and development agreements are originally drafted, they are often very ambitious and the most common issue is that the franchisee cannot meet the development schedule that has been imposed. It is often this failure which leads to the renegotiation of the agreement in order to maintain the current relationship without having to resort to a termination. Generally renegotiation of this kind involves changes to the commercial targets, not the legal language. The parties will look at:

• A new development schedule • A smaller territory • Additional training and support

Once the parties have recalibrated their expectations it is not unusual for the franchisee to become successful. 3. Franchisor Buy Out. A well drafted franchise agreement should state that the franchisor (or its nominee) has the right to step into the shoes of the franchisee and take over any units in the event of the Franchisee’s financial failure or indeed upon termination for any reason. However, the main issue is a practical one which is that it is often very difficult to find a substitute Franchisee to take over the business. Franchisors often do not want to step into a foreign territory and take over the business themselves because of the complexities and risks involved in setting up, staffing and operating a local subsidiary in a foreign country. Generally the reason why companies appoint franchisees is because they are not equipped to themselves service a network of local unit franchisees in foreign markets. To minimize risk franchisors sometimes reserve to themselves a right to cherry pick units in the territory so the franchisor can buy out only profitable units and close others in the event of the franchisee’s failure. Where the franchisee is a master franchisee the franchisor should insist that the unit Franchise Agreement contains an acknowledgment of the franchisor’s interests and provides that the Unit Agreements can be transferred if the master falls away. In Master Franchising the other option is for a unit franchisee or group of unit franchisees to buy out the Master Franchisee. This is unusual but there are situations where the Master Franchisee’s business has failed and unit franchisees join together as a group to buy the business from the liquidator or administrator. The primary issues in a situation such as this are how does the group of unit franchisees manage themselves and how do they fund not only the initial

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purchase but the continuation of the business? It can be difficult for individual franchisees to obtain sufficient third party funding to perform a successful buy-out and an independent franchisor may well have better access to proper funding than a group of disparate franchisees. Other considerations when considering whether to take over are that in some countries there can be a risk of the franchisor potentially being liable to the unit franchisees if the Master Franchisee fails and the franchisor simply abandons the unit franchisees due to the fact that there could be a fiduciary relationship between the franchisor and the unit franchisees. In a master franchise situation it may also be difficult to enforce restrictive covenants against unit franchisees. If a unit franchisee carries on trading, the ultimate franchisor may have no direct right of action against the unit franchisee. The franchisor would have the right to take action if the unit franchisee was still using the franchisor’s intellectual property rights, such as its trade mark, and the franchisor may also be able to enforce confidentiality provisions (although enforcement of such provisions can be difficult in view of the challenge of proving that the unit franchisee is actually using the franchisor’s confidential information) but restrictive covenants may not be enforceable. Another option may be for the Franchisor to offer to purchase the franchisee’s business at a price to be agreed. This is usually done pursuant to a contractual call option. A termination option will contain a mechanism for valuation of the Franchisee’s business and for payment of a purchase price. This is particularly important in International Development Agreements where an assignment of local units may not be possible without executing a new lease. A well drafted international franchise agreement should therefore give the franchisor the right to purchase the business of the franchisee upon termination. Often a Termination Option will provide for the Franchisor to pay the net asset value as the purchase price. Sometimes it is agreed that the “fair market value” must be paid, but in such cases it can be difficult to agree a valuation formula. EBITDA multiples or profit multiples are sometimes used. It can be difficult to secure the transfer of vital leases for units under local law. Lease and real property are always governed by the laws of the country where the franchised unit is located. Some countries recognize that leases can be assigned but many civil law jurisdictions do not allow the unilateral assignment of leases. Rather, in those countries, the landlord needs to consent to the transfer of the lease. It can be impractical to obtain such consent in advance before the parties even know if the Franchisor will exercise a buy out option. Local landlords may not be comfortable giving advance consent unless the franchisor is a major global brand. In some countries where leases can be subcontracted without landlord consent this may be an option. However, this is only feasible if the franchisee entity survives as otherwise the lease will terminate following liquidation or insolvency of the franchisee or when the franchisee defaults under the lease. Franchisors also need to consider that employees enjoy a protected status in various countries and may transfer automatically to the person taking over the lease and stock in trade. As a result a “Termination Option” is a complex legal document that is best drafted as a separate schedule to the franchise agreement. 4. Transfer to a New Franchisee.

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“Termination of an international franchise is without doubt one of the most difficult issues for a franchisor to face.”12 It can be a commercial disaster. The franchisor needs to work out carefully in advance what should happen to the franchise in the territory, following termination. The best way of handling this problem is to seek to avoid it through sensible corporate planning. Key factors to be taken into consideration include the value and the potential of the affected market. If there are a number of profitable outlets established in the overseas market the franchisor will want to find a way to preserve them. One way of achieving this is to allow a third party to take over the territory. This can be done in a number of ways depending on the franchisor’s preferred strategy and depending also on what the legal agreements say:

• The existing franchisee can be given permission to continue operating the profitable outlets. At the same time exclusive rights in respect of the territory come to an end and the right of the franchisee to open new outlets is terminated. • Alternatively the franchisor could - if the agreements allow - ask for the existing franchisee to transfer his existing outlets to a new party. This second option is only viable if a new franchisee has been found. Sometimes a combined approach is used.

A territory that has been unsystematically developed is rarely attractive to a third party. They will not want to compete with the former franchisee and they will be concerned about uniform quality and about their ability to control the entire region. If, however, the territory is large, and the first franchisee has only developed a distant part, then it may be possible to carve up the territory into two parts that are both attractive to a franchise partner. One could even take the view that the existence of a certain number of branded outlets in the territory is a positive step as it shows that the concept has been tried and tested locally. The problems with appointing a new franchisee to take over the territory are mainly practical. It is unlikely that the ideal candidate is already on stand-by. Rather, there is likely to be an interim period during which the franchisor is looking to secure a successor franchisee and in the meantime it needs to ensure that no local business continues to operate. The franchisor thus needs to make suitable arrangements to cover the gap which may mean seconding head-office staff to the territory or hiring an interim manager.

12 Mark Abell “The International Franchise Option” Waterlow 1990.

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Sometimes one of the better local sub-franchisees or a regional manager of the franchisee’s head office will be interested to take over the operations. But often such candidates do not have the necessary financial resources. They do, however, bring to the table a thorough understanding of the operational requirements of the business. If no suitable successor can be found in the short to medium term, the franchisor will be forced to abandon the territory. V. Conclusion. Despite anecdotal statements or rumors to the contrary, U.S. franchisors can enforce their international agreements. But, the timing and cost of enforcement can actually be more prohibitive than the actual courts or arbitration bodies that provide enforcement mechanisms. Today, more than ever, U.S. franchisors need to be practical and flexible to enforce their agreements. This can mean use of alternative enforcement mechanisms such as guarantees, letters of credits and the like, or this can mean proactive attempts to prime the pump for a business resolution such as a sale to another franchisee. If a U.S. franchisor knows the facts, the law and has competent in-house, outside and local counsel, no dispute is ever too big to tackle, but U.S. franchisors much go in with their eyes wide open and their quiver of arrows full or else they are likely to be overwhelmed by the time, cost and sheer unpredictability of international dispute resolution options and proceedings.

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Appendix A Parties to the New York Convention

Afghanistan Côte d’Ivoire Albania Croatia Algeria Cuba Antigua and Barbuda Cyprus Argentina Czech Republic Armenia Denmark Australia Djibouti Austria Dominica Azerbaijan Dominican Republic Bahamas Ecuador Bahrain Egypt Bangladesh El Salvador Barbados Estonia Belarus Fiji Belgium Finland Benin France Bolivia (Plurinational State of) Gabon Bosnia and Herzegovina Georgia Botswana Germany Brazil Ghana Brunei Darussalam Greece Bulgaria Guatemala Burkina Faso Guinea Cambodia Haiti Cameroon Holy See Canada Honduras Central African Republic Hungary Chile Iceland China India Colombia Indonesia Cook Islands Iran (Islamic Republic of) Costa Rica Ireland

28

Israel Italy Jamaica Japan Jordan Kazakhstan Kenya Kuwait Kyrgyzstan Lao People’s Democratic Republic Latvia Lebanon Lesotho Liberia Lithuania Luxembourg Madagascar Malaysia Mali Malta Marshall Islands Mauritania Mauritius Mexico Monaco Mongolia Montenegro Morocco Mozambique Nepal Netherlands New Zealand Nicaragua Niger Nigeria

Norway Oman Pakistan Panama Paraguay Peru Philippines Poland Portugal Qatar Republic of Korea Republic of Moldova Romania Russian Federation Rwanda Saint Vincent and the Grenadines San Marino Saudi Arabia Senegal Serbia Singapore Slovakia Slovenia South Africa Spain Sri Lanka Sweden Switzerland Syrian Arab Republic Thailand The Former Yugoslav Republic of

Macedonia Trinidad and Tobago Tunisia Turkey

Uganda Ukraine United Arab Emirates United Kingdom of Great Britain and

Northern Ireland United Republic of Tanzania United States of America Uruguay Uzbekistan Venezuela (Bolivarian Republic of) Viet Nam Zambia Zimbabwe

A-241697_3 1

Appendix B Parties to the New York Convention with the Reciprocity Reservation

Afghanistan

Algeria

Antigua and Barbuda

Argentina

Armenia

Bahrain

Barbados

Belgium

Bosnia and Herzegovina

Botswana

Brunei Darussalam

Bulgaria

Central African Republic

China

Croatia

Cuba

Cyprus

Czech Republic

Denmark

Djibouti

Ecuador

France

Germany

Greece

Guatemala

Holy See

Hungary

India

Indonesia

Iran (Islamic Republic of)

Ireland

Jamaica

Japan

Kenya

Kuwait

Lebanon

Luxembourg

Madagascar

Malaysia

Malta

Mauritius

Monaco

Mongolia

Montenegro

Morocco

Mozambique

Nepal

Netherlands

New Zealand

Nigeria

Norway

Pakistan

Philippines

Poland

Portugal

Republic of Korea

Republic of Moldova

Romania

Saint Vincent and the Grenadines

Saudi Arabia

Serbia

Singapore

Slovakia

Trinidad and Tobago

Tunisia

Turkey

Uganda

United Kingdom of Great Britain and Northern Ireland

United Republic of Tanzania

United States of America

Venezuela (Bolivarian Republic of)

Vietnam