Legal restrictions on franchise contracts and the relationship between the parties

Are there specific laws regulating the ongoing relationship between franchisor and franchisee after the franchise contract comes into effect?

The Commercial Code, the Federal Civil Code and the general principles applicable to contracts and of contractual liberty are the laws and principles applicable to the ongoing relationship between the franchisor and franchisee; therefore, such a relation will be mainly governed by the terms and conditions of the franchise agreement.

What mechanisms are commonly incorporated in agreements to ensure operational compliance and standards?

It is a common practice to include in franchise agreements the right of franchisors to carry out inspection visits to the premises of the franchisee, as well as to audit the books and records of the franchisee. The foregoing is to determine if the franchised business is in compliance with the minimum operational and quality standards imposed by the franchisor and the relevant system, and to verify that payments made by franchisees are being correctly calculated pursuant to the provisions of the franchise agreement. Depending on the volume and structure of operations of the franchisor, it may also be common for franchisors to hire the services of a local third party to take care of some of such tasks on its behalf, in which case this alternative will need to be contemplated in the corresponding agreement.

May the franchisor unilaterally change operational terms and standards during the franchise relationship?

It is possible for the franchisor to unilaterally modify the operational terms and standards of the franchise system, provided that this right is expressly contemplated in the agreement and that the franchisor assumes the obligation to notify the franchisee with certain anticipation, in order for the franchisee to have enough time to implement the applicable changes. In our opinion, if the implementation of these changes may imply a very high cost for the franchisee, we consider that the franchisee must have the right to terminate the franchise agreement without any liability for both parties.

Do other laws affect the franchise relationship?

In addition to the laws regulating a franchise relationship mentioned in question 27, the Federal Law for Personal Data Protection Possessed by Private Persons may have a direct and significant impact on the operation, structure and risk administration of companies involved in the franchising industry that process personal data. According to this law any collection, treatment or transfer of personal data must be carried out with the prior consent of its owner (except in those cases specifically mentioned in the law).

In franchise operations, in most cases franchisees must collect and process personal data from their customers in Mexico, and then transfer such personal data to franchisors for their own purposes (ie, marketing, analysis and similar activities). Consequently, it is important for franchisors to verify that their Mexican franchisees comply with the Federal Law for Personal Data Protection Possessed by Private Persons and its regulations, and obtain the prior consent from their customers for transferring their personal information to franchisors abroad; otherwise, customers may initiate a legal action against the franchisee, which may result in the imposition of a fine, which in the end may affect the franchisee’s operations and the goodwill of the trademark and the franchised system, possibly damaging the franchisor’s image and its franchisees.

Do other government or trade association policies affect the franchise relationship?

No other government or trade association policies affect the franchise relationship.

In what circumstances may a franchisor terminate a franchise relationship? What are the specific legal restrictions on a franchisor’s ability to terminate a franchise relationship?

If there are no specific circumstances detailed in the franchise agreement for the anticipated termination or rescission of that agreement, then the provisions of the Federal Civil Code shall apply. These establish that if a party to a contract is in breach of its obligations derived from the corresponding agreement and the other party is in compliance with its own contractual obligations, the non-defaulting party shall have the right to request from the courts having jurisdiction over the matter the rescission of the contract based on the breach by the defaulting party, as well as the payment of corresponding damages and losses.

In addition, if, as a result of an event that is not attributable to any of the parties (that is, due to force majeure or acts of God), the performance of the obligations derived from the agreement is deemed to be impossible, any of the parties may request from the corresponding judicial authority a declaration of termination of the agreement without fault on any side.

Finally, if the agreement is executed for an undetermined period of time, any of the parties will have the right to terminate the agreement at any time, though prior notice must be given to the other party. Although there is no specific term for the anticipation of the delivery of the termination notice, the custom in Mexico is to deliver the said notice at least 30 calendar days before the effective date of termination.

In what circumstances may a franchisee terminate a franchise relationship?

In addition to the specific circumstances provided by the IPL that basically refer to the lack of veracity of the information disclosed, a franchisee may terminate a franchise agreement in the same circumstances applicable to a franchisor (see question 32).

How are renewals of franchise agreements usually effected? Do formal or substantive requirements apply?

Renewals of franchise agreements are usually effected through either the execution of an amendment to the existing franchise agreement, especially to its duration and any other applicable provisions that would need to be modified, in which case no disclosure obligation would be triggered, or by means of executing a new franchise agreement, under the terms of the form of agreement being used at that time by the franchisor; this second alternative would definitely have as a direct consequence the obligation for the franchisor to comply with its disclosure obligation under Mexican law. There are no specific formalities or other requirements that would apply to either of those two possibilities.

May a franchisor refuse to renew the franchise agreement with a franchisee? If yes, in what circumstances may a franchisor refuse to renew?

If there are no renewal provisions or rights detailed by the franchise agreement, upon expiration of the duration of the agreement the franchisor may freely refuse to renew the agreement.

May a franchisor restrict a franchisee’s ability to transfer its franchise or restrict transfers of ownership interests in a franchisee entity?

Pursuant to the provisions of the Federal Civil Code, a franchisee would not be authorised to assign its obligations derived from a franchise agreement without the previous consent of the franchisor. The parties may regulate the transfer of rights and obligations in the franchise agreement with the understanding that they may agree on restrictions for the franchisee to assign or transfer its rights and obligations in the franchise agreement and to subject such transfer to the prior written authorisation of the franchisor, which may be granted or denied at its sole discretion.

With respect to the transfer of ownership interests in the entity appointed as franchisee, the franchisor shall only have the right to restrict such a transfer if, as a consequence, it may modify the personal characteristics of the franchisee that were foreseen by the franchisor as the main motive for entering into the franchise agreement. Therefore, it is advisable to reflect in the franchise agreement that the franchisee must obtain the prior written authorisation of the franchisor for such a transfer.

Are there laws or regulations affecting the nature, amount or payment of fees?

There are no laws or regulations affecting the nature, amount or payment of fees. All the same, depending on the nature of the goods or services for which payment is being made, the tax treatment may have different implications. Normally, the international tax treaties to which Mexico is a party distinguish different concepts of payment such as royalties, technical assistance and business profits that have different withholding rates. Therefore, specific tax analysis of the concepts of payment that may derive from a franchise agreement is strongly recommended before entering into the agreement.

Are there restrictions on the amount of interest that can be charged on overdue payments?

The franchise agreement is a contract of commercial or mercantile nature, regulated by mercantile laws such as the Commercial Code. As a consequence, according to the provisions of the Commercial Code, there are no restrictions on the amount or percentage of interest that may be charged by a franchisor to a franchisee on overdue payments, even if the franchisee is a natural person or a civil partnership.

If the parties fail to include the applicable default interest on overdue payments in the franchise agreement, then the franchisor will be entitled to charge the legal interest of 6 per cent per annum set forth in the Commercial Code.

Are there laws or regulations restricting a franchisee’s ability to make payments to a foreign franchisor in the franchisor’s domestic currency?

Parties to a franchise agreement can agree in the corresponding contract or agreement to make payments in any currency. But if according to the corresponding contract or agreement the payment is to be made within the territory of Mexico, then, pursuant to the provisions of the Monetary Law, the party obligated to make the corresponding payment may freely elect to make such a payment either in the foreign currency agreed in the contract or agreement or in Mexican currency (pesos) according to the exchange rate published by Mexico’s Central Bank in the Official Gazette on the date of payment. If it is agreed that payments are to be made abroad, then the party obliged to make such a payment cannot elect to make it in Mexican currency based on the provisions of the Monetary Law.

Are confidentiality covenants in franchise agreements enforceable?

Confidentiality covenants can be enforced in Mexico, especially if violation of the confidentiality obligation under the agreement is sanctioned through the payment of a conventional penalty (a figure similar to liquidated damages) and if the contractual breach constitutes a violation of the IPL. Pursuant to the provisions of the IPL, violation of a confidentiality obligation through the non-authorised disclosure of a trade (industrial) secret may be considered a felony and can be criminally prosecuted.

Is there a general legal obligation on parties to deal with each other in good faith during the term of the franchise agreement? If so, how does it affect franchise relationships?

In accordance with the provisions of the Federal Civil Code, the consent of a party to an agreement will not be valid if that party was in ‘error’ when granting its consent. A legal or factual error nullifies the agreement when such an error exists with respect to the mistaken party’s main motive for entering into the franchise agreement. In this regard, the Federal Civil Code describes ‘bad faith’ as the dissimulation of an error by a party to an agreement that was known by the said party. As a consequence, and interpreting the above-mentioned provisions of law in a contrary sense, the parties to an agreement such as a franchise agreement must deal with each other in good faith, not only when executing the agreement, but also during the term thereof.

Does any law treat franchisees as consumers for the purposes of consumer protection or other legislation?

In principle, under the Federal Consumer Protection Law a ‘consumer’ is considered to be the natural person or entity that acquires or enjoys goods, products or services as the final beneficiary of the same, and a ‘supplier’ is considered to be the natural person or entity that regularly offers, distributes, sells, leases or grants the use of goods, products, services or a combination of these. In terms of the Mexican legislation, a franchisee is normally considered to be a supplier and not a consumer. An exception to the above is that when a transaction between a franchisee and a third-party supplier (such as the franchisor) involves a claim equal to or less than 367,119.59 pesos, a franchisee could be considered a consumer under the Federal Consumer Protection Law and, therefore, the franchisee may benefit from the protection provided by such statute. In this regard, if the franchisee is an entity, it shall only be considered as a consumer if, in addition to complying with the aforementioned condition, the franchisee is considered to be a micro-entity or a micro-industry in terms of the Law for the Development of Competitiveness of Micro, Small and Medium Entities and the Federal Law for the Promotion of the Micro-Industry and Handicraft Activity.

Must disclosure documents and franchise agreements be in the language of your country?

The IPL does not impose any obligations for the disclosure documents and franchise agreements to be prepared in Spanish; however, the summary of the franchise agreement that should be recorded with the IMPI (see question 7) must be in Spanish.

Describe the types of restrictions placed on the franchisees in franchise contracts.

As a result of the amendments to the IPL that came into effect on 26 January 2006, franchise agreements must be executed in writing and comply with the minimum requirements indicated in question 12.

Likewise, none of the parties to a franchise agreement are entitled to terminate or cancel (rescind) the agreement unless it is entered into for an undetermined period of time or except in the event of a just cause that can be foreseen in the agreement.

According to the contractual freedom principle provided by Mexican civil and commercial laws, the parties to a franchise agreement (it being an agreement of a commercial nature) are allowed to include any type of restrictions, covenants and obligations applicable to the relationship between the parties, provided that the restrictions, covenants and obligations are not against any specific legal limitation or public order. It is a common practice for franchisors to include in franchise agreements territorial restrictions for the franchisee to operate the franchised business; the obligation for the franchisee to acquire goods or services only from the franchisor or from those sources or suppliers expressly authorised by the franchisor; the ranges of prices under which the franchisee must offer goods or services to the public, as well as other terms and conditions normally contained in commercial agreements, such as governing laws and mechanism for dispute resolution. Non-compete obligations and those restrictions for non-solicitation of employees of the franchisor or other franchisees must be carefully reviewed, since they could be against constitutional principles and, in consequence, null and void.

Describe the aspects of competition law in your country that are relevant to the typical franchisor. How are they enforced?

As explained above, the law applicable to competition matters is the Federal Economic Competition Law (see question 12). In accordance with the provisions of this law, there are some restrictions to the general principle of contractual freedom. If agreements, arrangements or a combination of acts between economic agents diminish, harm or impede the production, processes, distribution or commercialisation of goods and services, pursuant to such law, this would be deemed to be monopolistic practice.

Infringements of the provisions of the Competition Law may result in the nullity of the violating acts and agreements, the imposition of administrative fines and the payment of damages and losses to third parties. For example, the obligation imposed on a franchisee by a franchisor to sell its products at determined prices could be considered a monopolistic practice, and, therefore, it is advisable to include in franchise agreements that the franchisor will provide the franchisee with a list of suggested retail prices that will not constitute an obligation on the franchisee, but merely a recommendation.

Describe the court system. What types of dispute resolution procedures are available relevant to franchising?

If a dispute arises under a franchise agreement that is considered as a commercial or mercantile agreement, and if the parties to it decide to submit themselves to the applicable laws and competent courts, an ordinary commercial or mercantile procedure may be initiated. The final resolution issued by the corresponding local judge in the first instance may be appealed before the local court of appeals. The final resolution issued by the court of appeals in the second instance may be challenged before a federal court through a constitutional procedure, also known as amparo, but only if during the process specific constitutional rights were violated or if the final resolution is issued against the principles of Mexico’s Constitution. The resolution issued by the court in the amparo procedure would be final and definitive.

An alternative dispute resolution mechanism is arbitration, which may be subject to Mexican or foreign law. Awards that are issued under the law of a country that is party to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards will be recognised and enforced in Mexico as long as such awards are not contrary to Mexico’s public order laws. Foreign judgments and arbitration awards that do not contravene public order laws are enforced in Mexico through a recognition and enforcement procedure before a judge, by means of a homologation process, given that Mexico is a party to the United Nations Convention.

The dispute resolution alternatives (jurisdictional and arbitration) are in addition to and independent from any administrative infringement action that may be initiated by a franchisor against any person violating the provisions of the IPL, in which case the IMPI is authorised to impose provisional or precautionary measures that include the seizure of merchandise and the closure of premises.

Describe the principal advantages and disadvantages of arbitration for foreign franchisors considering doing business in your jurisdiction.

In general, arbitration may have more advantages than disadvantages, especially when the foreign franchisor does not have a local subsidiary and operations in Mexico. Arbitration has proved to be time-efficient, and if Mexican law is governing the franchise agreement and the resolution of the dispute, it should be possible to enforce an arbitral award. Arbitration in the franchise industry also carries the advantage of allowing the resolution of a problem to be carried out by one or more arbitrators with the necessary expertise and knowledge in franchising, which is a subject not necessarily known or explored by the courts. The most important possible disadvantage is that in certain cases the related costs and fees could be much higher than those applicable in a jurisdictional procedure, depending on the agency administering the arbitration, its rules and the profile of the arbitrators.

In what respects, if at all, are foreign franchisors treated differently from domestic franchisors?

From a legal and practical view, domestic and foreign franchisors have equal treatment in Mexico and are equally protected and restricted in terms of Mexican legislation, but lack of knowledge of the domestic laws, administrative restrictions and commercial and operational customs, as well as the lack of legal advice from a competent Mexican law firm, are important elements that could hamper foreign franchisors’ entry into the Mexican market.