One of the most used legal instruments by companies in the retail sector, with the aim of increasing their turnover and expanding their market share, is the franchising agreement (or, according to Italian law, “affiliazione commerciale”).

1. Concept and legal-economic function of the franchise agreement

The franchising agreement can be included within the category of distribution agreements and can certainly be qualified as an “atypical agreement”, since it is not directly regulated by the Civil Code but by Law No. 129 of 6 May 2004, which came into force on 25 May 2004. This law is not the only source regulating the matter of franchising, in fact, in the legal landscape there is a large series of provisions that must be considered in the interpretation of a franchise agreement or in the solution of a problem arising therefrom: these are provisions contained in the Industrial Property Code (Legislative Decree 30/2005) or of Community derivation such as, in particular, the European Regulation on vertical agreements between companies (EU Reg. 330/2010) and the relevant guidelines (Guidelines 2010/C-130/01).

The legal definition of what a franchise is is provided by Article 1 of Law no. 129 of 2004, which qualifies this agreement as 'the contract, however named, between two economically and legally independent legal entities, whereby one party grants the other, in return for payment, a set of industrial or intellectual property rights relating to trademarks, trade names, signs, utility models, designs, copyrights, know-how, patents, assistance or technical and commercial consultancy, by including the franchisee in a system consisting of a plurality of franchisees distributed throughout the territory, for the purpose of marketing certain goods or services'. Following the normative dictate, the interpretative effort leads to qualify the franchise as a commercial collaboration agreement between two legally and economically independent entrepreneurs: on the one hand the so-called 'franchisor' (also called franchisor or parent company) and on the other hand the so-called 'franchisee' (also called franchisor or parent company). The franchisee, by entering into the franchise agreement, establish a direct collaboration for the marketing of goods or services with the same distinctive elements and with the procedures tested by the franchisor. The economic purpose of the franchise agreement is therefore to implement a distribution network with homogeneous organisational features, distinctive signs and trademarks that are easily identifiable by customers, a network managed by individual entrepreneurs operating under the supervision of a single supplier.

The regulation of the institution also provides for three distinct types of franchises:

• production franchising, in which the franchisor is a company that produces goods and distributes them on the market through its own network of franchisees;
• distribution franchise, in which the franchisor acts as a central purchasing agent. It buys large stocks of product from various manufacturers and redistributes them to franchisees;
• service franchises, in which there is precisely no distribution of products but merely an offer of services by the franchisor to its franchisees.

Lastly, in order to succinctly complete the legal framework of franchising, it is necessary to mention and describe the two elements of an economic nature that characterise the institution in question: the franchise or entry fee and royalties. The former is a one-off amount that finds its justification in the start-up of the business that the franchisee can take advantage of and in the expenses incurred by the franchisor for the testing of the system and the business formula; the latter represent the economic consideration, which may be fixed or variable, usually to be paid monthly or annually, that the franchisee is required to pay to the franchisor in order to enjoy over time the fame of the brand and the services provided in its favour.

2. The different ways to set up the international franchise business development

There are essentially three ways of developing a franchise network on foreign markets: the so-called 'master franchise' formula, the so-called 'area development' (or multi-unit franchise) formula and, finally, the so-called 'area representative' formula.

2.1. The so-called 'master franchise' formula

In the light of the typical economic function of the franchise agreement, such a legal instrument may certainly represent a valid solution for the subject that decides to expand its business across borders and, consequently, to be present on international markets by opening its own outlets abroad, availing itself of other subjects (in this case, the franchisees) that take care of directly managing the commercial activity on site through a distribution modality capable of enhancing its own brand and products, guaranteeing them a visibility that other forms of commercial penetration do not guarantee.

In such a case, the legal instrument of choice is the so-called 'master franchise', i.e. the agreement whereby a party (the so-called 'master franchisee') acquires from another party (the so-called 'master franchisor') the exclusive right to conclude sub-franchise agreements with other parties located in a certain territory (so-called 'sub-franchisees'), in return for a financial consideration (the so-called 'master fee'). The master franchisee is expressly attributed, through the stipulation of the agreement, certain powers normally reserved exclusively to the franchisor: the master franchisee may, in this way, develop franchise or sub-franchisee agreements with other local franchisees, belonging to the geographical area of its competence, replicating at a local level the type of control that generally exists between master franchisor and master franchisee. From a regulatory point of view, this institution is provided for by Law No. 129 of 6 May 2004, Art. 2, which states that 'the provisions relating to the commercial affiliation contract, as defined in Article 1, also apply to the master franchise contract whereby one undertaking grants the other, legally and economically independent of the first, for a direct or indirect consideration, the right to exploit a commercial affiliation for the purpose of entering into commercial affiliation agreements with third parties, as well as to the contract whereby the franchisee, in an area at its disposal, sets up a space dedicated exclusively to the performance of the commercial activity referred to in Article 1. Therefore, provided that the parties have decided to apply Italian law to the agreement, the discipline applicable to the master franchise agreement is the same as that applicable to the franchise agreement as defined in Article 1 of the same law.

2.2. The so-called 'area development' or 'multi-unit franchise' formula

The international franchise development formula known as 'area development' consists of granting the franchisee the right to open and operate several outlets in a given territory. Within this operating formula, a prominent role is assumed by the instrument that goes by the name of area development agreement, i.e. the agreement stipulated between franchisor and franchisee, on the basis of which the latter, who plays the role of area developer, takes upon himself the burden of opening and managing on an exclusive basis other direct outlets, located in a given territorial area, for a period of time defined by the agreement and according to a determined development plan agreed upon with the franchisor.

Unlike in the master franchise formula, in this case the franchisee does not have the right to enter into sub-franchise agreements with third parties but is granted the mere possibility of opening outlets owned and managed directly by him: thus, while the master franchisee acts as the franchisor's alter ego in a given geographical area, assuming a whole series of obligations and tasks typical of the franchisor and collecting the payment of entry fees and royalties from the sub-franchisees, the area developer remains a normal franchisee who is, however, given the right-duty to open and manage directly more outlets against the payment of the capital necessary to complete the investment envisaged in the area development agreement.

2.2. The so-called 'area representative' or 'direct franchising' formula

The area representative is an entity, present in the target market, to which the franchisor entrusts a number of tasks for the development of the network such as, for example, the search and selection of franchisees in a specific territorial area or commercial negotiations with potential franchisees. It operates, therefore, as an intermediary of the franchisor and always acts on behalf of the latter, which remains the only counterpart in contractual relations with franchisees. The area representative, for his intermediary activity, receives a remuneration that often coincides with a share of the entrance fee and royalties paid by the franchisees. The advantages for the franchisor who enlists the help of the area representative are the degree of direct control he can continue to exercise over the franchisees and the lower fixed costs but, on the other hand, the franchisor retains all contractual responsibilities under the franchise relationship with the franchisees.

author: Dott. Antonino Guarino