Master Franchisee Buyouts Become More Popular Internationally

MFBOs are a new phenomenon in international franchising. Previously, franchise buyouts such as those seen in the UK in the Athena and Pierre Victoire chains were a method of releasing franchisees from an insolvent domestic franchisor. MFBOs are an entirely different animal. They are a way of taking a successful business to the next level when the franchisor does not have either the will or resources to do so, yet does not wish to divest itself of its domestic business.

MFBOs require a sophisticated master franchisee; indeed, the master franchisee's resources and capabilities can exceed those of its franchisor. Take the ChipsAway deal as an example. Under the original master license between ChipsAway UK and ChipsAway Inc., ChipsAway UK had the global rights to franchise the system and IPRs, excluding only North America. The current management of ChipsAway UK had, during its tenure, built the franchise to around 380 UK unit franchisees; this included a number of master franchisees in countries as diverse as Russia, South Africa, and Germany, to name but a very few. On the other hand, ChipsAway, Inc. was primarily limited to its home state of Pennsylvania. The balance of power and resources was hardly typical of the common franchisee/franchisor relationship.

In the international arena, it is not unusual for the franchisee to be a more sophisticated and well-resourced business than its franchisor. A number of master franchises in the Middle East, for example, are owned by extremely wealthy families or businesses that own whole stables of franchises for high-profile Western brands. In these types of relationships, the balance of power is very different from that found in the relationship between a franchisor and its domestic unit franchisees. This difference in the balance of power leads to more balanced commercial agreements between the parties than the one-sided unit franchise agreement that can lead to conflicts. However, the equal power of both parties (or greater power of a master franchisee) can lead to a divergence of views and ambitions and, ultimately, to disputes.

A Real Alternative to Litigation

While both the ChipsAway and MRI deals were positive commercial responses to the wish by all those involved to exploit the full potential of the business globally, MFBOs also could be a positive alternative to litigation between the franchisor and its master franchisee. Many franchisors rush into international expansion via franchising before they are ready and without proper thought and advice, often when someone visiting the franchisor's country from abroad sees and likes the concept and approaches the franchisor to take it back to his own country. As a result, it is often only after the master franchisee has started trading that the franchisor realizes that it does not have the resources and expertise to run an international franchise business.

The sophisticated master franchisee might start to view its less-ambitious franchisor as a hindrance, rather than a source of help and support. The terms of the master license can restrict the master franchisee's expansion plans and frustrate the master franchisee. At this stage, the master franchisee might want freedom from the master license and unrestricted ownership of the IPRs.

This frustration could lead to the parties falling out, which in turn can lead to litigation. An MFBO would most likely be a better solution.

Providing for an MFBO in the Master License

Forethought on the part of franchisor, master franchisee, and counsel can bring MFBOs into consideration at the start of a business relationship. Master franchisees should give serious consideration to seeking from the franchisor a pre-emptive right to purchase the franchisor's business when initial negotiations are conducted. This may come as a surprise to the franchisor and receive an initially frosty reception, but if it is merely a pre-emptive right of first refusal (rather than the right to unilaterally require the sale of the franchisor's business) the franchisor is giving very little away, but the master franchisee is obtaining a real benefit.

Raising the purchase rights at the outset of the negotiations is likely to result in the best terms for the master franchisee, as, at that stage, it may appear an unlikely scenario for the franchisor. One option is to include a small fee within the initial fee by way of consideration for the pre-emptive right. The right would usually be limited for the term of the master franchise agreement and, say, six months following expiration (although note that the right may be lost if the master franchisee is in breach).

Structuring an MFBO

There are a number of ways in which an MFBO can be structured. It could be a full buyout of the franchisor's business, a division of the ownership of the IPRs on a global basis via a coexistence agreement (for example one party having ownership of the IPRs in the Americas with the other having Europe, Middle East, and Africa), or a buyout and a license back by the master franchisee of the IPRs to the franchisor (a complete reverse of the relationship). However, in the latter case, the franchisee-turned-franchisor will need to ensure that it complies with local franchise disclosure laws. For a non-U.S. franchisor that suddenly owns a franchise brand in the United States, for example, the disclosure laws can come as a surprise. There is no one best structure for such a deal as it will depend in part upon both the nature of the franchise business and the respective tax positions of the parties.

Conclusion

An MFBO is not a simple nor quick transaction, and it needs careful thought and specialist expertise. Yet it can be a very useful tool for dispute resolution or to allow a frustrated master franchisee to fully exploit the brand internationally. It is also a further example of the great flexibility of franchising as a method of international growth.

Mark Abell is a partner and Victoria Hobbs is a solicitor in the Franchising & Licensing Group at Field Fisher Waterhouse LLP, London. Abell can be contacted at [email protected], and Hobbs can be reached at [email protected].

Franchise attorneys are quite familiar with management buyouts ('MBOs') and have perhaps assisted or consulted in such transactions. Now comes along a new phenomenon in international franchising: master franchisee buyouts ('MFBOs'). An introduction to MFBOs follows, using examples of two recent transactions.

In May 2007, the owners of the Master Franchise for ChipsAway in the United Kingdom, ChipsAway International Limited ('ChipsAway UK'), signed a deal with its U.S. franchisor, ChipsAway, Inc., under which ChipsAway UK bought the global intellectual property rights ('IPRs') from ChipsAway, Inc., including the ChipsAway trademarks and the 'secret formula' for its paint and lacquer products which make the ChipsAway repair system unique. ChipsAway, Inc. retained the IPRs for use in North America only. ChipsAway UK can therefore now exploit the entire global market, excluding only North America. This deal not only substantially increases the value of the UK business, but it also provides more stability for the UK franchisees and boosts the value of all their businesses, while relieving the U.S.-based franchisor of the unwanted burden of running an international franchise network.

Deals such as ChipsAway are becoming more common. Last year, Field Fisher Waterhouse acted in a similar deal for another UK master franchisee, MRI Worldwide Network Ltd., in its buyout of the global business of franchisor MRI Worldwide Inc. Under that deal, the parties split the global ownership of the MRI IPRs into U.S. and rest-of-the-globe companies.

MFBOs are a new phenomenon in international franchising. Previously, franchise buyouts such as those seen in the UK in the Athena and Pierre Victoire chains were a method of releasing franchisees from an insolvent domestic franchisor. MFBOs are an entirely different animal. They are a way of taking a successful business to the next level when the franchisor does not have either the will or resources to do so, yet does not wish to divest itself of its domestic business.

MFBOs require a sophisticated master franchisee; indeed, the master franchisee's resources and capabilities can exceed those of its franchisor. Take the ChipsAway deal as an example. Under the original master license between ChipsAway UK and ChipsAway Inc., ChipsAway UK had the global rights to franchise the system and IPRs, excluding only North America. The current management of ChipsAway UK had, during its tenure, built the franchise to around 380 UK unit franchisees; this included a number of master franchisees in countries as diverse as Russia, South Africa, and Germany, to name but a very few. On the other hand, ChipsAway, Inc. was primarily limited to its home state of Pennsylvania. The balance of power and resources was hardly typical of the common franchisee/franchisor relationship.

In the international arena, it is not unusual for the franchisee to be a more sophisticated and well-resourced business than its franchisor. A number of master franchises in the Middle East, for example, are owned by extremely wealthy families or businesses that own whole stables of franchises for high-profile Western brands. In these types of relationships, the balance of power is very different from that found in the relationship between a franchisor and its domestic unit franchisees. This difference in the balance of power leads to more balanced commercial agreements between the parties than the one-sided unit franchise agreement that can lead to conflicts. However, the equal power of both parties (or greater power of a master franchisee) can lead to a divergence of views and ambitions and, ultimately, to disputes.

A Real Alternative to Litigation

While both the ChipsAway and MRI deals were positive commercial responses to the wish by all those involved to exploit the full potential of the business globally, MFBOs also could be a positive alternative to litigation between the franchisor and its master franchisee. Many franchisors rush into international expansion via franchising before they are ready and without proper thought and advice, often when someone visiting the franchisor's country from abroad sees and likes the concept and approaches the franchisor to take it back to his own country. As a result, it is often only after the master franchisee has started trading that the franchisor realizes that it does not have the resources and expertise to run an international franchise business.

The sophisticated master franchisee might start to view its less-ambitious franchisor as a hindrance, rather than a source of help and support. The terms of the master license can restrict the master franchisee's expansion plans and frustrate the master franchisee. At this stage, the master franchisee might want freedom from the master license and unrestricted ownership of the IPRs.

This frustration could lead to the parties falling out, which in turn can lead to litigation. An MFBO would most likely be a better solution.

Providing for an MFBO in the Master License

Forethought on the part of franchisor, master franchisee, and counsel can bring MFBOs into consideration at the start of a business relationship. Master franchisees should give serious consideration to seeking from the franchisor a pre-emptive right to purchase the franchisor's business when initial negotiations are conducted. This may come as a surprise to the franchisor and receive an initially frosty reception, but if it is merely a pre-emptive right of first refusal (rather than the right to unilaterally require the sale of the franchisor's business) the franchisor is giving very little away, but the master franchisee is obtaining a real benefit.

Raising the purchase rights at the outset of the negotiations is likely to result in the best terms for the master franchisee, as, at that stage, it may appear an unlikely scenario for the franchisor. One option is to include a small fee within the initial fee by way of consideration for the pre-emptive right. The right would usually be limited for the term of the master franchise agreement and, say, six months following expiration (although note that the right may be lost if the master franchisee is in breach).

Structuring an MFBO

There are a number of ways in which an MFBO can be structured. It could be a full buyout of the franchisor's business, a division of the ownership of the IPRs on a global basis via a coexistence agreement (for example one party having ownership of the IPRs in the Americas with the other having Europe, Middle East, and Africa), or a buyout and a license back by the master franchisee of the IPRs to the franchisor (a complete reverse of the relationship). However, in the latter case, the franchisee-turned-franchisor will need to ensure that it complies with local franchise disclosure laws. For a non-U.S. franchisor that suddenly owns a franchise brand in the United States, for example, the disclosure laws can come as a surprise. There is no one best structure for such a deal as it will depend in part upon both the nature of the franchise business and the respective tax positions of the parties.

Conclusion

An MFBO is not a simple nor quick transaction, and it needs careful thought and specialist expertise. Yet it can be a very useful tool for dispute resolution or to allow a frustrated master franchisee to fully exploit the brand internationally. It is also a further example of the great flexibility of franchising as a method of international growth.

Mark Abell is a partner and Victoria Hobbs is a solicitor in the Franchising & Licensing Group at Field Fisher Waterhouse LLP, London. Abell can be contacted at [email protected], and Hobbs can be reached at [email protected].