I am often asked about franchisor liability under the Foreign Corrupt Practices Act (FCPA). Franchising has been a successful model in the US and now many corporations are looking at overseas expansion opportunities. Franchise law has become well developed across the US, with many states developing laws to protect the rights and obligations of both parties in a franchise agreement. According to an International Franchise Association survey of nearly 1,600 franchise systems, “nearly two-thirds (61 percent) of respondents currently franchise or operate in non-U.S. markets and three-fourths (74 percent) plan to begin international expansion efforts or accelerate their current ventures immediately.”

There are no reported FCPA enforcement actions regarding franchisors. However, the factors in a franchise relationship would appear to lead to clear FCPA responsibility of the franchisor for its overseas franchisee’s actions. Additionally, court interpretation of the FCPA has held that it is applicable where conduct, violative of the Act, is used “to obtain or retain business or secure an improper business advantage” which can cover almost any kind of advantage, including indirect monetary advantage even as nebulous as reputational advantage. As everyone knows, the FCPA prohibits payments to foreign officials to obtain or retain business or secure an improper business advantage. Nevertheless many US companies view franchisees as different from other types of more direct sales representatives, such as company sales representatives, agents, resellers or even joint venture partners, for the purposes of FCPA liability.

I believe that such an analysis is misguided as the DOJ takes the position that a US company’s responsibilities extend to the conduct of a wide range of business venture partners, including franchisors. It does not take too great a leap of imagination to see that a franchise relationship could be contained within this interpretation. It does not take too many legal steps to see that a franchisee’s actions can impute FCPA liability to a US franchisor.

There are other factors, unique to the franchise relationship, which would point towards FCPA liability of the US franchisor. A US franchisor’s intent and the degree of control it exercises over its overseas franchisees’ operations are factors the DOJ/SEC might consider in determining whether to pursue a FCPA case against a franchisor for bribes made by one of its foreign franchisees. It is always in the financial interest of a US franchisor for its franchisees to be successful businesses. Additionally, most US franchisors require its overseas franchisees to use the same company name for branding. Of course, not only the initial franchise fee but the franchisee’s monthly royalty payment roll up into the books and records of a franchisor so that might well catch the attention of the SEC if there is a FCPA books and records violation.

Most franchisors have thorough financial vetting requirements before allowing any person or business to become a franchisee. However, how many of these same businesses perform FCPA compliance due diligence on their prospective overseas franchises? How many US franchisors have FCPA compliance training programs? How many evaluate, on an ongoing basis, the FCPA compliance and program of their overseas franchisees? How many US franchisors have a compliance hotline or other reporting mechanism for any compliance violations made against their franchisees?

Victor Vital and Jessica Parker-Battle, writing in the Franchise Law Journal, Winter 2012 Issue, in an article entitled “Implications of the Foreign Corrupt Practices Act for International Franchising”, identified several different types of franchising models, all of which demonstrate potential FCPA risks.

The direct-unit franchising model is perhaps the most commonly used model in the United States in which a franchisor sells one of its units at a time and has direct involvement with the franchisee. There is no third party involved in the operations between the franchisor and franchisee. Therefore, it is the franchisor’s responsibility to handle training, marketing, supplies, and other support to the franchisee. Here the FCPA exposure is direct.

The area development franchising model is used where the franchisor contracts with an area developer who operates multiple local franchises in a specified geographic area. It may or may not be exclusive. The area developer will have a contract agreement with the franchisor and then separate agreements with the area franchises. Here the FCPA exposure is both direct and indirect.

Master Franchising model is typically the most used model in international franchise expansion. It generally revolves around a master franchise agreement between the US based franchisor and a master franchise agreement in a specific geographic territory. This master franchisee then contracts with third-party sub-franchisees within the specified territory. Typically, the US-based franchisor will have no contractual relationship with the international sub-franchisees. The master franchisee acts as the franchisor in the local market recruits, trains, and provides other support in the local area on behalf of the US franchisor. Here the FCPA exposure is both direct and indirect.

The authors believe that a franchisor may not have direct involvement in conduct prohibited by the FCPA, as there may not be the requisite corrupt intent required under the statute. However, I believe unless a franchisor has an adequate compliance program in place, a franchisor may well find itself in the shoes of Frederick Bourke and sustain a finding of conscious indifference.

Three Key Takeaways

  1. Consider the different types of international franchise agreements to help assess your compliance risk.
  2. There are no reported FCPA enforcement actions involving international franchisors, yet.
  3. Franchisors must conduct thorough research in both the foreign market they hope to enter and on their potential franchisees.

 

This month’s podcast series is sponsored by Michael Volkov and The Volkov Law Group.  The Volkov Law Group is a premier law firm specializing in corporate ethics and compliance, internal investigations and white collar defense.  For more information and to discuss practical solutions to compliance and enforcement issues, email Michael Volkov at mvolkov@volkovlaw.com or check out www.volkovlaw.com.

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