Incoterms_® and Commercial Contracts

ADAs are often employed to internationalize Systems. In business, however, the term MFA is also used for ADAs. However, ADAs differ considerably from MFAs. The terminological confusion is increased by the fact that people practicing law, consultants and even Franchisors, who should be more than familiar with ADAs, use this term for relationships that are more akin to agency agreements than to ADAs, such as ARAs.

As a consequence, it will be necessary to clarify the term ‘area development’ before outlining possible other ways to expand and internationalize Systems. The typical contents of ADAs will then be discussed.

8.1 DEFINITION AND DIFFERENTIATION

The term “area development” describes a Multi-Unit franchise relationship that is usually bound to a defined Territory by exclusive rights. For the purpose of international expansion, this Territory typically includes the development area of a whole country or group of countries.

ADAs provide that Area Developers have the right and the duty to establish a certain number of franchise Units in the assigned Territory. The Area Developer enters into a direct franchise relationship with the Franchisor, starting off with a single franchise Unit.

Sometimes, however, Area Developers may operate more than one franchise Unit at the beginning of the contractual relation as it is often the case when a new Area Developer steps into the contractual relation of its predecessor.

8.2 TYPICAL CONTENTS OF ADAS

As a rule, ADAs govern the special rights and obligations of the parties concerning the development of the Territory, particularly the right and the duty of the developer to establish a certain number of franchise outlets within the Territory. In the majority of cases, the rights and obligations of the parties concerning the setting up and operation of individual franchise outlets in performance of the ADA are laid down in separate UFAs between Franchisor and Area Developer. In these cases, the ADA serves as a kind of framework contract that governs those rights and obligations of the parties that are not included in the direct UFAs.

Alternatively, it is possible to set out the rights and obligations arising from the individual franchises as well as the rights and obligations in connection with the area development in one single document. This
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approach is particularly advisable if the parties have agreed that violations of the obligation to develop the contract Territory shall affect not only the continuation of the development relationship but also the contents or the maintenance of the franchise relation with respect to already established franchise outlets. In any case, whether the ADA is structured merely as a framework contract or as a document containing rights and obligations typical of a UFA, it will definitely contain provisions defining the Territory of the area development; setting out the rights and obligations to establish a certain number of franchise outlets; concerning exclusivity and duration; and setting out the remuneration of the Franchisor.

The following presentation of the typical contents of an ADA will not take into account the details of the UFAs that are usually concluded in application of the ADA. Readers are advised to consult the ICC Model International Franchising Contract⁵⁶ for details of such UFAs.

In a framework ADA the only rights typically granted are the reservation of the Territory and the right to develop the System in the Territory. A number of related issues, including Know-how, trademark, modification of the System, advertising and competition are typically addressed in the UFA.

8.2.1 Preamble

Since the contents of a typical ADA has a limited scope, the preamble is typically quite short as well. The preamble sets out the background information necessary for a reader to understand and interpret the contract, but typically a preamble is not considered to be binding on the parties. Important background information that will be set out in the preamble of an ADA includes the content and the text of the UFAs (sometimes appended in model form as an Annex to the ADA) that the Area Developer/Franchisee plans to conclude, as well as information on reservation, exclusivity and the right and duty to develop.

8.2.2 Territory

The Territory set out in the ADA must not be confused with the protected area defined in individual UFAs. The Territory of the ADA is the area in which the Franchisee/Area Developer has the right and the duty to develop the System and is reserved for expansion by the Franchisee/ Area Developer. The protected area of the UFA, by contrast, is limited to the area where the Franchisee has the right and the duty to run and to develop a single franchised outlet.

Often, the Territory of an ADA consists of the territory of a smaller country. Sometimes, however, the entire national territories of several smaller but homogenous countries are combined to form the Territory of the ADA. This is often the case, for example, with the Baltic States, Scandinavian countries and certain successor states of the former Soviet Union. And, it is also possible that a regional group of larger states form the contract Territory. In larger countries such as the United States, the territory may encompass a smaller defined area.

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By contrast, the protected area of individual UFAs frequently consists of merely a city or parts thereof.

8.2.3 Exclusivity and duration

Developers would hardly be willing to conclude ADAs that contain the obligation to develop, and, in case the development fails, the payment of contractual penalties, if they were not offered a certain degree of exclusivity in return. As a rule, such exclusivity is granted by Franchisors. In this context exclusivity means that the Franchisor stipulates that it will not establish other franchise outlets in the Territory, conclude any contracts authorizing third parties to establish franchise outlets within the contract Territory, or open its own units in the Territory.

Normally, such exclusive rights are closely linked to the achievement of certain objectives such as the establishment of a certain number of franchise outlets within a specified period of time. If an Area Developer does not achieve this objective, ADAs provide that the exclusive right to the Territory ceases to apply. In this context, it is necessary to distinguish exclusivity as provided by the ADA from the forms of exclusivity granted by those UFAs already concluded. In most cases, UFAs grant Franchisees exclusivity in the protected area of the UFA. ADAs usually provide that UFAs stay in force if the developer fails to reach the objectives and the ADA is terminated. Exclusivity granted by individual UFAs, which stay in force, is not affected by the failure to achieve the objectives under the ADA so only the exclusivity concerning the Territory of the ADA would cease to apply. As a consequence, the protected area of the franchise outlets established by the developer under the UFAs would remain protected whereas the exclusivity of undeveloped areas within the Territory specified by the ADA would cease. When an ADA is terminated, the Franchisor is permitted to reassign the available Territory or to establish franchise outlets on its own account.

Exclusivity in ADAs is frequently restricted to the duration of the agreement, which often ends when the last franchise outlet has been established in performance of the ADA. Area Developers may, however, request that the exclusivity under the ADA continue to stay in force beyond the term of the agreement to prevent the Franchisor or other Franchisees from operating in any “white spots” of the Territory not covered by the exclusivity provisions in the separate UFAs.

The principles outlined here can be applied if an Area Developer is supposed to open up a new Territory. However, it is sometimes the case that there are already franchise outlets in the Territory of the ADA that are operated by already existing Franchisees. In such cases, ADAs usually provide that the Territory that has been assigned to already existing Franchisees is excluded from the exclusive Territory of the Area Developer; special care should be taken that the exclusive rights of already existing Franchisees are not affected.

8.2.4 Obligations – Right and duty to develop – Development schedule

In an area development relationship the two parties have many obligations, but most of them derive from the UFA and are thus not specific to development relationships. The only obligation of the
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Franchisee/Area Developer consists of its duty to develop the System in the Territory according to the development schedule. The specific obligation of the Franchisor in an ADA consists of the obligation to grant a certain kind of exclusivity and reservation. This second issue was already outlined in the previous chapter on MFAs.

As a rule, ADAs provide that in the Territory the developer has the right and the duty to conclude a certain number of UFAs establishing an appropriate number of franchise outlets within a specified period of time. The Franchisor may be well advised to distribute the total number of required franchises over shorter sub-periods of time. If, for example, the parties have agreed to establish 20 franchise outlets within a period of 10 years, the agreements should provide that the developer has to open a new franchise outlet every six months. In this manner, the Franchisor will be able to check every six months whether the Area Developer is still on schedule and will be able to react quickly to provide necessary support. In many cases, ADAs contain clauses providing that a contractual penalty has to be paid if the Area Developer fails to establish the prescribed franchise outlets within a certain period of time.

It is important to note that ADAs provide that the Area Developer has not only the obligation but also the right to conclude the prescribed number of UFAs with the Franchisor. If this right did not exist, the Franchisor would be entirely at liberty to decide whether to conclude further UFAs with the developer. This right, however, may prove rather difficult to enforce if disputes with the Franchisor arise. As a matter of fact, the Franchisor usually has reasonable interest in including a clause in the ADA that provides that the Franchisor’s consent to the location contemplated by the Area Developer is required before entering into a UFA or before opening a franchise outlet. If, over time, the relationship between the developer and the Franchisor goes downhill, the Franchisor may be tempted to refuse consent to the contemplated location thereby complicating or even preventing the establishment of further franchise outlets. However, the Franchisor may only withhold consent if such refusal is advantageous for the System.

8.2.5 Term, termination, renewal and effects of termination

In many ADAs the provisions on term and renewal are not as important as in MFAs or in UFAs. In many ADAs the exclusivity ends when the Area Developer/Franchisee has opened the number of outlets provided for in the ADA. As the Area Developer/Franchisee has no more obligation or right to open further outlets and as the Franchisor has no more obligation to grant a reservation or an exclusivity, the ADA ends automatically with the achievement of the contractual development objective. Therefore, if the exclusivity ends with the opening of the last contractual development outlet, provisions on renewal and the effects of termination are not necessary in an ADA. It might be helpful to confirm that the exclusivity for the protected area of any franchised outlet ends only with the end of the relevant UFA.

There may be some Area Developers/Franchisees who are reluctant to accept that they lose exclusivity when they have achieved the contractually-stipulated development objectives and may thus ask for
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continuing protection. Franchisors will typically be reluctant to extend exclusivity for the entire Territory under the ADA until each of the related UFAs ends, so any extension of exclusivity under the ADA must be carefully thought out and drafted.

8.2.6 Fees

Franchisors are usually remunerated by Area Developers for the advantages granted under the ADA. The remuneration frequently consists of a reservation fee, which may be structured as an advance payment for the Initial Fee or a part of the entry fee due under the UFAs that, according to the ADA, the developer may have to conclude with the Franchisor. The reservation fee does not have to be a lump sum paid up front. In many arrangements the fee is divided into sub-components, paid in a variety of ways — for example, divided into equal tranches, or small first payment and then pay per-unit opened, or some other schedule — upon certain triggering events. Consider tax implications when structuring the reservation fee. (See § 4.5.)

In the majority of cases the parties agree that the reservation fee will be forfeited if the developer does not achieve the objectives laid down in the ADA.

8.2.7 IP rights

If the ADA is merely a framework agreement and requires the Area Developer to sign a UFA for each Unit it opens, the Area Developer will most likely not have the right to use the Franchisor’s marks, System or Know-how, and there will be no need to have an intellectual property provision in the ADA. The Franchisor’s intellectual property rights will be protected by provisions in the UFA.

On the other hand, if the ADA is structured as a document containing rights and obligations of a typical UFA, it must have provisions protecting the Franchisor’s intellectual property rights, including the use of any domain names based on the Franchisor’s marks. See §§ 4.3 and 7.2.4 above.

8.2.8 Choice of law and dispute resolution

It is advisable to include clauses on the choice of law and the choice of jurisdiction or choice of forum in an ADA, which should generally match those made in the UFAs. There is more detailed information on the issue of choice of law in § 4.4.8.

International commercial arbitration will typically be the most appropriate solution when a dispute arises under an ADA. Arbitration is generally less costly and time-consuming than litigation; offers a flexible, neutral forum and process; and allows the parties to choose an arbitrator or arbitrators with relevant subject matter expertise. Importantly, international arbitration results in a binding award that is generally more easily enforced than a judgment at the end of a court proceeding would be. The 1958 United Nations New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards requires courts of contracting states all over the world to give effect to private agreements
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to arbitrate and to recognize and enforce arbitration awards made in other contracting states.

Arbitration at the ICC International Court of Arbitration gives parties access to a range of unique services, including secretariat support at all stages of the arbitral process, scrutiny of awards, and tools to help parties predict and manage arbitration costs, such as a cost calculator (http://www.iccwbo.org/products-and-services/arbitration-and-adr/arbitration/cost-and-payment/cost-calculator/), and ICC’s brochure Techniques for Controlling Time and Costs in Arbitration (ICC publication N°843). A sample clause incorporating ICC arbitration into a contract can be found in this footnote⁵⁷.

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