The credit crunch and globalization have driven the recent growth of international franchising, and as companies expand abroad through this model, system participants must be aware of increased FCPA and anti-bribery risks.
A franchise is generally seen as a continuing commercial relationship in which an independent party (franchisee) operates a business or distributes goods under the seller/franchisor’s trademark, the franchisor receives initial and periodic payments, and the franchisor exercises significant control or assistance over the franchisee’s methods.
Franchising is an attractive international expansion model for many businesses because there is usually less risk than a company-owned direct foreign investment; each franchisee handles its own day-to-day operations. Franchises also offer benefits to emerging (and developed) markets by providing a tested model and support structure to entrepreneurs who then operate small businesses with multiplied resources.
As of December 2014, there have been no public FCPA enforcement actions by the DOJ or SEC against a U.S. franchisor for franchisee-related conduct. However, franchises have been linked to various enforcement actions, as have businesses operating under similar models. Consequently, it is not far-fetched to foresee more direct FCPA enforcement affecting international franchising in the future. This post and the next two posts will discuss particular antibribery risks of international franchising, including potential agents and frequently-faced foreign officials, along with best practices.
First, global franchising models should be explained. Master franchising, the most common method for international franchising, gives a “master franchisee” not only the right to operate a specific number of units in a defined area, but also the right to sell franchises to others (sub-franchisees) in the area. On the other end of the spectrum is direct unit franchising, which is licensing one franchise per owner at a time. Some additional methods include area development agreements (master franchises without the right to sell additional franchises) and other variations on the relationship. Each model seeks to increase a brand’s presence in a foreign territory, and each entails different risks.
For example, direct unit franchising may be a difficult way to penetrate an unfamiliar foreign market. This method also requires more local involvement with the franchisee, which could expose the franchisor to FCPA liability more easily than some other methods. By contrast, a master franchisee takes over many franchisor-related duties for the sub-franchisees, thus weakening the connection between the domestic franchisor and the sub-franchisees.
Whatever method is chosen, one of the main FCPA concerns facing franchisors is potential vicarious liability, shaped by the degree and manner of control over its foreign business representatives. The doctrine of vicarious liability, where a corporation can be held liable for the conduct of its agent, is a familiar one in the franchise industry. There is often litigation in the United States involving vicarious liability claims between franchisees, employees of franchisees, customers, and franchisors. Some courts have held that franchisees can act as “agents” of the franchisor under certain circumstances, such as where there is significant franchisor control over the subject matter of the litigation.
Given the FCPA’s long jurisdictional reach, foreign franchisees, and even sub-franchisees, could act as franchisor agents. In addition, many international franchise systems have participants other than franchisees acting as intermediaries abroad. Sales brokers, distributors, preferred vendors, and others connected to the franchisor (and benefiting the franchisor) could all be “agents” for purposes of FCPA liability. Moreover, a franchisee’s or intermediary’s actions could be imputed to a franchisor even if the franchisor does not have actual knowledge of the improper payments. Liability may attach if a franchisor consciously avoided knowing about the franchisee’s or intermediary’s illicit activity.
In the next post (Part Two: A Flock of Foreign Officials), I’ll discuss particular types of foreign officials that may create antibribery risks in cross-border franchising, illustrated by case examples.
Erik King is a Law Clerk/Contractor Attorney with Lockheed Martin supporting a government client. He focuses on deceptive trade practices and financial-related fraud (often with cross-border dimensions), and is interested in international law and regulatory compliance. The opinions expressed herein are solely those of the author in his individual capacity, and in no way reflect the views of Lockheed Martin or the government. Erik can be contacted here.