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Friday, May 01, 2009

Global Giants Wade Through Middle East Franchise Deals

The Middle East is a cesspool of political turmoil and missed opportunities.

Every political manoeuvre is equalled by a reaction having huge economic repercussions. For instance: Oil-rich Iraq continues to have sanctions imposed 11 years after it invaded Kuwait. Formerly one of the more highly developed countries in the region, it is now dependent on economic handouts. But the obstacles apart, some Middle East countries have opened their markets to western transnationals. So how did these global giants adapt to the business climate and work around bureaucratic red-tape? The answer is they have involved local businesses - i.e., franchising.

Understanding the nuances is a different ball-game altogether.

Says Reema Ali, managing partner in a Washington DC firm Ali & Partners, which handles commercial law via affiliates around the Middle East: “A franchise deal in the Middle East is a marriage with very high alimony. If the franchiser and franchisee disagree, it is very difficult to come out of the relationship without having to pay compensation.”

But that doesn’t mean franchise operations are not opening in that region. According to Ms Ali, the most lucrative markets are Egypt and Saudi Arabia. She adds, “For the franchiser, the overriding strategy is to build the cost of a potential disagreement into the business plan.” But she and other lawyers who handle franchise deals in the region suggest that some additional general legal strategies are beneficial.

Opening franchises in the Middle East have gained popularity because many Middle Easterners perceive this business as ‘prestigious and lucrative’ says John E Xefos, managing partner of the Baker & McKenzie office in Riyadh. “The franchisee, especially the smaller operator, has probably been hearing get-rich stories for years. He is primed for disappointment.” Many aspects of running a franchise operation in the Middle East is more difficult than in Europe or the US. For eg: more of the component product may need to be imported and - at least in Saudi Arabia construction costs could be higher.

Another setback that a franchisee overlooks is that the franchiser expects to pocket his royalty under any circumstances. Mr Xefos recommends “that the franchisee understand upfront that there are no guaranteed profits and the franchiser expects the royalty will be paid regardless of what happens to the bottomline.” This kind of disclosure tends to keep misunderstandings at bay. He also suggests that franchise agreements be adhered to because it is not possible to apply the franchise’ parent country’s laws in the Middle East. Problems too could arise if the franchiser comes out with a new logo or marketing campaign and expects his Middle East partners to tote the line. If they don’t, then shutting down the operations or removing the sign may not be an available option.

Among Middle Eastern jurisdiction, Israel is a case unto himself. Its legal system is similar to the United States and is based on British rather that French, Turkish and Islamic law.

Andrew P Loewinger of Buchanan Ingersoll in Washington DC says: “Israel does have antitrust laws, although my experience is they don’t create problems for franchisers.” He adds, “ There are no laws specifically circumscribing the franchise relationship, its pretty much contractual.”

But the biggest difference between Israel and many Arab countries is that Israel has no commercial agency laws. Mr Loewinger says,”The main purpose of these laws was to protect the agent through a compensation arrangement. If the agreement is terminated by the foreign party, the agent is entitled to some compensation by statute or regulation - that is separate form the contract.” The compensation varies from country to country. It could be more than a year’s net profit or payment for unused inventory. But in any form, it can have a major effect on the franchise deal and should be incorporated as cost of doing business.

Of course there are ways to sidestep this as well. Some franchisers don’t register the transaction. A relationship that is not registered is not enforceable. But more common is adding a “foreign choice-of-law “ clause. This means one could set up a franchise in Turkey and specify in the contract that New York law will apply. This is by no means fool-proof because “ for certain kinds of issues that come up, no matter what you say, Turkish law will apply.”

Mr Loewinger added, “There is a tendency in Middle Eastern countries for courts to either assume jurisdiction, or as a matter of policy not to recognise the awards of foreign bodies.” So to sort out problematic issues in such situations, agree to local arbitration but select an impartial arbitral authority and specify the arbitration venue in the initial agreement itself.

In countries such as Bahrain and the UAE, there is more willingness to accept and enforce foreign awards. But pushing the envelope too far may not be a good idea. So if the franchiser is US-based, then it might be better to specifically request a European arbitral authority, rather than a home-based one.

Written for The Financial Express

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