Analysis of Certain Provisions Commonly Contemplated in Franchise Agreement Under A Mexican Law Perspective
Jorge Mondragón -
Oscar Moreno -
In Mexico, franchising is governed and regulated by the Mexican Industrial Property Law (IPL) and its regulations. The governmental agency in charge of applying the IPL is the Mexican Institute of Industrial Property (IMPI).
In addition, there are other laws that may apply to franchising, depending on the type of activity performed in Mexico, such as the Commerce Code, the Consumer Protection Federal Law, the Economic Competition Federal Law (Antitrust law), the General Law of Business Organisations and the Federal Civil Code.
According to the IPL (article 142) a franchise exists whenever, in conjunction with a licence to use a trademark granted in writing, technical knowledge is transmitted or technical assistance is provided in order to enable the franchisee to produce or sell goods or render services in a uniform manner. The holder of the trademark (franchisor) establishes the operating, commercial and administrative methods with the goal of maintaining the quality, goodwill and image of products or services distinguished by the trademark.
The provisions of the IPL must be observed in the territory of the United Mexican States, in addition to the provisions of international treaties to which Mexico is a party. The IPL applies to franchises located in or operating within the Mexican territory, regardless of the nationality of the entities or individuals participating in the franchise agreement. The IPL does not apply merely because the prospective franchisee is a resident of or domiciled in Mexico; the offer to sell originates in Mexico; or the offer is directed to, or accepted from, Mexico.
The franchisor-franchisee relationship is governed by the Commerce Code and the Federal Civil Code. In accordance with Mexican law, franchisors and franchisees are free to contract on a number of issues as a result of the principle of contractual freedom provided in article 78 of the Commerce Code, as long as the parties comply with the provisions of the IPL on franchising matters and the general principles of commercial contracts and do not agree on any stipulations that violate public order law or moral standards. Under such principle, franchise agreements in Mexico often include provisions common in franchise agreements worldwide, such as termination for convenience, rescissions, conventional penalties (similar to the concept of liquidated damages under the laws of the US), non-compete, non-solicitation, joint obligations or parent company guarantees, alternative dispute resolution mechanisms, etc. However, it is important for the parties stipulating such kinds of provisions to be verified and be legally certain that the same may be enforceable in accordance with the jurisdiction and laws to which the corresponding contract is subject and that the remedies and consequences contemplated by the agreement of the parties are available in the relevant jurisdiction.
An analysis of the provisions that are commonly used or contemplated by franchise agreements governed by Mexican law, including the specific remedies that may be available in Mexico, are discussed below.
TERMINATION FOR CONVENIENCE
As a general principle and in accordance with the provisions of article 1797 of the Federal Civil Code, the validity and fulfilment of agreements in Mexico cannot be determined unilaterally by one of the parties to the agreement.
In line with the principle of contractual freedom contained in article 78 of the Commerce Code, and in consideration that the provisions contained in article 1797 of the Federal Civil Code are not considered public order law, we consider the provisions contained in a franchise agreement granting the franchisor the right to terminate the agreement early to be valid; however, for franchise agreements that are subject to Mexican law, it is advisable to make specific reference to the principle contained in the aforementioned article 78 of the Commercial Code.
RESCISSION OF AN AGREEMENT
Any party to a bilateral agreement is entitled to rescind (cancel) such agreement in the event of a default of the other party. What must be particularly noted under Mexican law is that an agreement can expressly include the right of a party to rescind said agreement in the event of any default of the other party by means of a simple notice given to the defaulting party, without the need to obtain a prior judicial, administrative or arbitral resolution.
Under this scenario, the drafting of the provisions of the "expressed agreement to rescind" (pacto comisorio expreso), a contract in the event of any default is extremely important due to the fact that it will be most likely to have the defaulting party contesting the determination of the default made by the non-defaulting party, as well as the right to rescind the contract attributed to the non-defaulting party.
In the event that such right to rescind the agreement is not expressly contained in the agreement, then the non-defaulting party shall have to request from the jurisdictional courts or the arbitration panel that has jurisdiction over the matter, a declaration of the rescission of the agreement based on the breach alleged by the non-defaulting party.
In addition to the above, it is also important to bear in mind that according to Mexican law, when a party breaches an agreement, the non-defaulting party is entitled to seek specific performance or the rescission of the agreement and, in both cases, the non-defaulting party has the right to claim payment to be indemnified for the damages and losses caused by the default, or if it was expressly agreed in the contract, to claim payment of the conventional penalties (only for breaches that the conventional penalties have been agreed upon).
CONVENTIONAL PENALTIES
Mexican law allows the parties to an agreement to stipulate one or more conventional penalties in the event a party breaches a specific provision of a contract or the contract itself. As mentioned above, one of the specific remedies for a non-defaulting party following the default on the agreement by the other party is to claim payment for indemnification of damages and losses.
In such regard, Mexican law establishes that such damages and losses must be a direct and immediate consequence of the breach and the party who claims the indemnification must prove, evidence and provide the relevant support of the damages or losses actually incurred by such party due to the breach of the other party. In most cases this is difficult to obtain, particularly because of the reluctance of the courts to determine real amounts of indemnification.
In any event, it is advisable for parties entering into a franchise agreement to agree upon on those provisions which, if violated, will be subject to conventional penalties. But the amount to be agreed as the conventional penalty by the parties should not be higher than the total amounts that the franchisee will be paying to the franchisor under the relevant franchise agreement, otherwise the conventional penalty could be considered null and void.
It is also important for the parties who are agreeing on a conventional penalty to use clear language in the provision in order to avoid a court or arbitral panel ruling that such conventional penalty is an overall cap of liability instead of a penalty for a specific breach.
NON-COMPETE/NON-SOLICITATION AND OTHER NEGATIVE COVENANTS
It is common practice to include in franchise agreements certain negative covenants. These are most likely to be related to the obligation of the franchisee not to use the licensed marks or system for purposes other than those contained in the franchise agreement. In this respect, it is extremely important to previously analyse and determine the level of enforceability of those negative covenants, especially those related to non-compete and non-solicitation.
As a general rule, Mexican law establishes that in the event a negative covenant is breached the remedy available in law for the non-defaulting party is to seek indemnification for damages and losses arising from such default (in addition to the possibility to rescind the agreement).
Since some of the negative covenants agreed upon in franchise agreements are related to industrial property rights, under Mexican law certain specific actions or measures may be found, which are intended to stop or prevent any infringement or violation of industrial property rights. These kinds of measures are known as provisional or precautionary measures and the same may be obtained from a judicial or administrative authority, depending on the measure that is pursued.
With respect to other negative covenants such as non-compete or non-solicitation and any other negative covenants not related to industrial property rights, it is most likely that the parties will be subject to the general principle contained in Mexican law about the specific consequence of a breach of such negative covenant. Therefore, the parties who are willing to include negative covenants in their franchise agreements may be willing to establish a specific conventional penalty in the event of a breach of such negative covenant.
JOINT OBLIGORS/PARENT COMPANY GUARANTEES
It is also common practice to include within the provisions of a franchise agreement the obligation of the franchisee to provide the franchisor with a parent company guarantee of its principals. In this respect, in most occasions the language used in such parent company guarantee may provide the principal of the franchisee with certain rights or remedies that are not available to the franchisee under the franchise agreement. As a consequence, the enforceability of the guarantee may face certain obstacles prior to the principal complying with the obligation that was breached by the franchisee.
Under Mexican law it is possible to appoint one or more joint and several obligors, who would comply with every obligation assumed by the franchisee under the franchise agreement. Since Mexican courts are more familiar with the legal figure of the "joint obligor", this specific type of guarantee could be more effective than a personal or corporate guarantee contained in a separate agreement.
Some of the advantages of having one or more joint obligors may be:
• the joint obligor will be actually bound under the agreement as a main obligor;
• the joint obligor is not a guarantor and, therefore, it is not necessary, following a breach of the agreement by the franchisee, for a franchisor claim compliance directly to the joint obligor; and
• the jurisdiction and laws the joint obligors are subject to are (and must be) the same as those contemplated by the franchise agreement, which are recommended to be the laws of the country where the franchise agreement will be effective.
ALTERNATIVE DISPUTE RESOLUTION MECHANISMS
According to Mexican law, it is valid to agree on arbitration as an alternative mechanism to resolve disputes, which may be subject to Mexican or foreign law. Arbitration awards which do not contravene public order laws are enforced in Mexico through a recognition and enforcement procedure before a Mexican judge, by means of a homologation process, given that Mexico is a party to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards.
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.
In addition to the above, please note that under Mexican law the parties may also include mediation provisions prior to the commencement of an arbitration or jurisdictional procedure; however, the parties should analyse the benefits of including these kinds of provisions, which are normally not enforceable.