Philippines: Franchise & Licensing

There is no statutory definition of a franchise in the Philippines as there is currently no specific local law on business franchising. However, the Philippine Department of Trade and Industry (“DTI”) issued on 17 November 2010 Bureau Order No. 10-24, a non-binding advisory on franchising, which defines the term “franchising agreement” as “a written contract or agreement between two or more parties by which a Franchisor grants the Franchisee a right to engage in the business of offering, selling, or distributing goods or services under a marketing plan/system/concept, for a certain consideration. Unless otherwise provided, said right includes the use of a trademark, service mark, trade name/business name, know-how, logo-type advertising, or other commercial symbols associated with a particular business.”

Under the Intellectual Property Code of the Philippines (“IP Code”), “franchise agreements” may also be considered as “technology transfer arrangements” which are “contracts or agreements involving the transfer of systematic knowledge for the manufacture of a product, the application of a process, or rendering of a service including management contracts; and the transfer, assignment or licensing of all forms of intellectual property rights, including licensing of computer software except computer software developed for mass market.”

There are no prerequisites to the offer and/or sale of a franchise in the Philippines.

There are no registration requirements for franchisors and/or franchisees in the Philippines other than the ordinary business registration with the DTI for sole proprietorships or with the Securities and Exchange Commission (“SEC”) for partnerships and corporations.

There are no disclosure requirements for franchisors and/or franchisees in the Philippines. However, Bureau Order No. 10-24 advises franchisees to secure from the franchisor the following information:

a. The franchisor’s business address, email address, internet home page/website, fax numbers and other contact details;
b. A copy of the franchisor’s DTI or SEC registration;
c. Information as regards the franchisor’s parent companies and affiliates, if any, and their respective roles in the franchise; and the franchisor’s declaration if any affiliate is a supplier and a statement as regards the goods or services these suppliers provide;
d. The names of the directors and officers, with a brief description of their qualifications, background, ownership of interests and references;
e. The contact details and business locations of existing franchisees;
f. Copies of executed promotional/marketing materials;
g. A description of the business concept, which includes the brand image, brand personality, unique selling proposition, target market, mission and vision, among others;
h. Basic information on training, commercial, and/or technical assistance provided by the franchisor;
i. A certificate that the franchisor is a member in good standing of any franchisor association and that the franchisor has no pending administrative, civil, or criminal case;
j. A declaration with respect to the initial franchising fee, other amounts that will be collected, and the services covering these fees;
k. Information with respect to training, e.g., the number of persons entitled to training, the duration of said activities, and the respective modules;
l. The number of years the company has been operating and the number of years it has franchised with corresponding numbers of company-owned branches and franchised outlets;
m. A draft Franchise Agreement;
n. Full disclosure of the financial requirements of the business franchise;
o. A provision that requires the franchise applicant to seek adequate legal and financial counsel before signing the Franchise Agreement; and
p. A mechanism for dispute resolution.

As there are no disclosure requirements for franchisors in the Philippines, disclosure to the SPV’s parent company would suffice.

Franchise agreements are governed by the provisions on obligations and contracts under the Civil Code of the Philippines (“Civil Code”). Under the Civil Code, mis-selling by the franchisor, when made deliberately, amounts to fraud. In such cases, the franchisee’s remedy would be to file a complaint for damages when the mis-selling is merely incidental to the execution of the franchising agreement, or for annulment of the franchise agreement when the mis-selling is direct and causal.

Any disclaimer made by the franchisee is, generally, inconsequential. Under Philippine jurisprudence, responsibility arising from a fraudulent act cannot be waived because such waiver is contrary to public policy [Philippine Commercial International Bank v. Court of Appeals, G.R. No. 97785,29 March 1996].

A non-negotiable franchise agreement may be characterized as a contract of adhesion, which is a contract whereby the participation of the other party is limited to affixing his signature or his “adhesion” to the contract. Under Philippine jurisprudence, a contract of adhesion is not invalid per se because the party adhering to the contract is, in reality, free to reject it entirely. Nevertheless, Philippine courts are not precluded from declaring a contract of adhesion void if the attendant facts and circumstances show that the contract is “obviously too one-sided” [Polotan v. Court of Appeals, G.R. No. 119379, 25 September 1998].

Trademarks, patents, and copyright are protected under the IP Code, which prohibits and penalizes infringement.

The IP Code includes “protection of undisclosed information” in its definition of “intellectual property rights”. Trade secrets and know-how may fall under this definition. The IP Code, however, does not have specific provisions protecting undisclosed information. Nevertheless, the Revised Penal Code punishes an employee of any manufacturing or industrial establishment who, to the prejudice of the owner thereof, shall reveal its secrets.

There are no franchise-specific laws governing the ongoing relationship between franchisor and franchisee in the Philippines. Their relationship is governed by the franchise agreement which is subject to the Civil Code provisions on obligations and contracts.

However, a “franchise agreement” that is in the nature of a “technology transfer arrangement” under the IP Code must include the mandatory provisions and exclude the prohibited provisions enumerated in Section 88 and 87, respectively, thereof. Non-compliance with either provision renders the technology transfer arrangement unenforceable, unless a request for exemption is made and granted by the Documentation, Information and Technology Transfer Bureau (“DITTB”) of the Intellectual Property Office (“IPO”).

The Philippine Competition Act (“PCA”) prohibits an entity enjoying a dominant position in the market from imposing restrictions on a franchise transaction when the object or effect of these restrictions is to prevent, restrict or lessen competition substantially.

The IP Code additionally deems unenforceable technology transfer arrangements which contain provisions presumed to have an adverse effect on competition and trade. Examples are: provisions which impose upon the franchisee the obligation to acquire materials necessary for production from a specific source; provisions which require the franchisee to permanently employ persons indicated by the franchisor; provisions where the franchisor reserves the right to fix the sale or resale prices; and provisions where there are restrictions as regards the volume and structure of production.

Section 87.9 of the IP Code considers as prima facie having an adverse effect on competition and trade a provision restricting the use of the technology supplied after the expiration of the technology transfer arrangement, except in cases of early termination of the technology transfer arrangement due to reason(s) attributable to the licensee. The inclusion of such a provision, unless approved by and registered with the DITTB, shall automatically render the technology transfer arrangement unenforceable.

In the Request for Pre-Clearance of a Shop Franchise Agreement, the Office of the Director General (“ODG”) of the IPO issued a Decision dated 21 October 2003, holding that the provision barring the franchisee for two (2) years after the expiration of the Agreement to engage directly or indirectly in any food service business, which is in competition with the activities and services performed by the Franchisor as well as to use the technology supplied by the Franchisor to the Franchisee, are non-compete clauses that violate Section 87.9 of the IP Code. Note, however, that the ODG in the same Decision held that said provision may be retained provided that the period is limited to one (1) year from the termination of the Agreement.

The primary local law on consumer protection is the Consumer Act of the Philippines (“Consumer Act”). Under the Consumer Act, “consumer products and services” are defined as goods, services and credits, debts or obligations which are primarily for personal, family, household or agricultural purposes, which shall include but not limited to food, drugs, cosmetics, and devices. Arguably, the sale of a franchise is not covered by the Consumer Act because a franchise is not “primarily for personal, family, household or agricultural purposes.”

The Civil Code provisions on obligations and contracts require the contracting parties to comply with their obligations in good faith. Bad faith in the performance of the contract will render the party acting in bad faith liable for damages.

Under Philippine law, the following factors are considered in determining whether there is an employer-employee relationship:

a. The power to select the employee;
b. The payment of wages;
c. The power of dismissal; and
d. The power to control the employee and the means and methods used to accomplish the work.

The power to control the work of the employee as to the results to be achieved and the means by which such results are reached is considered as the most significant determinant of the existence of an employer-employee relationship. To minimize this risk, the franchisor must ensure that it does not exercise control over the work of the employee, both as to the result of the work and the means and methods in achieving the same.

Under the Civil Code provisions on agency, an agency relationship is one whereby a person binds himself to render some service or to do something in representation or on behalf of another, with the consent or authority of the latter. Philippine jurisprudence clarifies that the basis of agency is representation. This implies that the mere rendering of services does not create an agency relationship. Thus, as long as the franchisee, in its dealings with others, does not act in representation of the franchisor, there is minimal risk that the franchisee will be considered as the agent of the franchisor.

It is also a common practice to include a provision in the franchise agreement whereby the parties deny the creation of an agency relationship between them. This reduces the risk that the franchisee will be considered as the agent of the franchisor.

As regards the settlement of disputes on the payment of royalties for a franchise agreement that is in the nature of a technology transfer arrangement, the IP Code provides that any dispute between the parties arising from technology transfer payments, including the fixing of appropriate amount or rate of royalty, shall be under the quasi-judicial jurisdiction of the Director of the DITTB of the IPO.

As regards the remittance of the royalties to a foreign franchisor involving the cross-border transfer of currencies, the Bangko Sentral ng Pilipinas (Central Bank of the Philippines) Manual of Regulations on Foreign Exchange Transactions provides that the prior written approval of/declaration to the Philippine central monetary board is required when specified thresholds are met.

As regards the payment of interest, there is no limit as to how much interest can be charged. However, Philippine jurisprudence holds that interest rates may be nullified when it is unconscionable for being contrary to morals. In a few cases, the Philippine Supreme Court has held that interest rates of three per centum (3%) per month are excessive, iniquitous, unconscionable and exorbitant and are, thus, void for being contrary to morals.

The Civil Code provisions on obligations and contracts allow the imposition of penal clauses. The penalty would be in the form of liquidated damages and is generally demandable upon breach of the contract. The Civil Code provides that the penalty may be reduced when it is unconscionable for being contrary to morals. Whether the penalty is unconscionable depends on factors such as the type, extent, and purpose of the penalty, the nature of the obligation, the mode of breach and its consequences, the supervening realities and the standing and relationship of the parties.

Section 88.4 of the IP Code requires that Philippine taxes on all payments relating to the technology transfer arrangement shall be borne by the licensor.

The National Internal Revenue Code imposes a final income tax of twenty per centum (20%) upon the amount of royalties paid to the franchisor. This tax must be withheld by the payor-franchisee.

Further, under the National Internal Revenue Code, any person who, in the course of trade or business, sells goods or properties or renders services shall be subject to value-added tax (“VAT”). Thus, the franchisor will be liable for VAT upon selling the franchise because the sale of the same is made by the franchisor in the course of trade or business. On the other hand, the franchisee will be liable for VAT upon its sale of the goods or its rendering of the services to the consumers pursuant to the franchise agreement because the sale of the goods or the rendering of the services is made in the course of trade or business.

The relationship between franchisor and franchisee is contractual in nature. Parties are free to stipulate terms on extension or renewal, post-contract compensation, and the circumstances which prompt the same provided these are not contrary to law, public order, public policy, morals, or good customs. Hence, the original franchise agreement may provide for the renewal of the franchise without the execution of a new contract.

Normally, a renewal clause is included in a standard franchise agreement and may be exercised by the parties prior to the expiration of the original term subject to conditions as regards payment of renewal fees and/or fulfilling continuing qualifications set by the franchisor on the franchisee. When these conditions are not met, the franchisor may lawfully decline a renewal of the agreement.

There are no mandatory provisions governing the rights of either party after their franchise agreement has expired or has otherwise been terminated. Likewise, there is no mandatory minimum notice period which the parties must observe prior to such termination.

However, if the franchise agreement is such as would make it a technology transfer arrangement under the IP Code, a provision therein which restricts the use of the technology supplied post-termination shall be unenforceable if it would have an adverse effect on competition and trade.

The possible acquisition of intangible assets by a franchisee upon the franchise’s expiry or termination shall be primarily governed by the pertinent terms of the franchise agreement.

Should the business in which the franchise is engaged be characterized as would make either franchise party a “personal information controller” or “personal information processor” under Republic Act 10173 (“Data Privacy Act”), customer information shall only be retained for as long as necessary for the fulfillment of the purposes for which the data was obtained or for the establishment, exercise or defense of legal claims, or for legitimate business purposes, or as provided by law.

Currently, there are three national franchising associations in the Philippines, namely, the Philippine Franchise Association (“PFA”), the Filipino International Franchise Association (“FIFA”), and the Association of the Filipino Franchisers, Inc. (“AFFI”). These organizations are self-regulating and membership is wholly voluntary.

Except for AFFI which also admits non-franchising entrepreneurs, the PFA and FIFA have internal regulations akin to a code of ethics or fair franchising standards that compel their respective franchisor-members to fully and timely disclose material investment information to prospective franchisees.

Membership may be advisable due to benefits resulting from the organizations’ reputation, gaining access to a network of prospective clients, suppliers, and business enablers, securing preferential intra-association terms, and sharing of best practices. This is especially true in view of Bureau Order No. 10-24 which advises a franchisee to secure from a franchisor a certification that the latter is a member in good standing of a franchisor association.

Apart from the general requirements which all foreign businesses in the Philippines must comply with (e.g. prohibition on foreign nationals and corporations from owning land in the Philippines, or from engaging in certain industries wholly or partly reserved to Philippine nationals/corporations), there are no local laws specifically applicable to foreign franchisors. It is only to the said extent that foreign and domestic franchisors are treated differently.

There are no specific requirements for payments arising from a franchise agreement to be made in local currency.

The parties are generally free to stipulate the law governing their franchise agreement. However, should the same be considered a “technology transfer arrangement” as defined in the IP Code, Section 88.1 thereof requires the inclusion of a provision that Philippine law governs the interpretation of the contract and that in the event of litigation, the venue shall be the proper court in the place where the franchisee has its principal office. Non-compliance shall render the agreement unenforceable unless it is approved and registered as an “exceptional case” with the DITTB. For an exemption to be granted, the technology transfer arrangement must result in substantial benefits to the economy, such as high technology content, increase in foreign exchange earnings, employment generation, regional dispersal of industries and/or substitution with or use of local raw materials. Nevertheless, the DITTB is not known to grant exemptions to this mandatory provision.

Parties to a franchise agreement are free to stipulate the alternative dispute resolution procedure between them. These include arbitration, mediation, conciliation, early neutral evaluation, mini-trial, or any combination thereof.

The IP Code, however, provides that in the event the technology transfer arrangement shall provide for arbitration, the Procedure of Arbitration of the Arbitration Law of the Philippines or the Arbitration Rules of the United Nations Commission on International Trade Law (UNCITRAL) or the Rules of Conciliation and Arbitration of the International Chamber of Commerce (ICC) shall apply and the venue of arbitration shall be the Philippines or any neutral country. For disputes particularly involving technology transfer payments, such as royalties, mediation is mandatory under IPO Rules. If it however involves the fixing of the appropriate amount or rate of royalty, the law vests the DITTB with quasi-judicial jurisdiction.

Three requisites must concur for a class action filed by franchisees to prosper. First, the subject matter of the controversy must be one of common or general interest to all franchisees. The rights asserted must be shared and not be distinct for each franchisee. Second, the franchisees must be so numerous that it is impracticable to join all as parties. Third, a number of them which the court finds to be sufficiently numerous and representative as to fully protect the interests of all concerned must sue for the benefit of all.

There are no provisions specifically requiring franchise agreements and disclosure documents to be in any language. Business contracts are generally written in English as it is one of the Philippines’ official languages.

Philippine law requires that any written contract be in a language understood by the parties. Should a party allege not understanding the language indicated, and such party was likewise mistaken as to the contract’s terms or was defrauded into entering the same, the person enforcing the contract must show that the terms have been fully explained to the former. Otherwise, the agreement may be susceptible to annulment.

There is no prescribed type of signature for the perfection of a standard franchise. Consensual contracts are perfected the moment parties reach an agreement, whether they do so verbally, in writing, or via electronic means. When the agreement, however, involves real property, local law requires that the contract appear in a paper-based public document.
The Philippine Electronic Commerce Act (“E-Commerce Act”) further provides that no contract shall be denied validity or enforceability on the sole ground that it is in the form of an electronic document. Hence, agreements perfected electronically shall produce the same legal effect had the parties written the same on paper.

Owing to the consensual nature of franchise agreements, the contract remains legally binding irrespective of the form in which it exists, i.e., paper-based or electronic. Additionally, in the event of litigation, the Philippine Rules of Court provides that the digital version may be admissible when the original document has been destroyed without bad faith on the part of the party offering the agreement into evidence.

There is no franchise-specific bill pending in Congress. Attempts at regulating this industry have failed three times in the Philippine Senate, i.e., in 2007, 2010, and 2014. The bills primarily sought to protect potential franchisees from deceptive business franchising practices. Among the proposals were mandating pre-investment disclosures and compulsory provisions as regards standards of conduct, conditions on franchise transfer, franchise termination, and post-term restrictions on competition.

On a related matter, a bill that was recently filed in Congress proposes to reduce current restrictions on foreign retailers by lowering their minimum paid-up capital requirements to just US$200,000. At present, foreign investors may only participate in the local retail sector if their paid-up capital is at least US$2,500,000. If the bill is passed, the lower barriers to entry of foreign retail franchises may lead to increased competition among incumbent and new franchising stakeholders, and would substantially affect the current market structure.