Franchising a Business-Legal Aspects

Franchises are widely used business methods as they adapt to a variety of products and services. As a business model, they serve as a system to drive a company’s growth. They are unique systems in which separate units connect to drive the growth of a highly integrated business.

From a legal standpoint, franchise contracts “are characterized by the granting to independent entrepreneurs of the privilege to distribute products of certain brands or to provide names.” Tastee Freez v. Negdo. Seg. Empleo, 108 D.P.R. 495, (1979). Apart from Law 75, which regulates distribution contracts, and Law 22, which regulates sales representative contracts, Puerto Rico does not have a specific law to address the relationship between the franchisor and the franchisee, as is the case in many U.S. states.

Differences Between a Franchise Contract and a Distribution Contract

There are significant distinctions between a franchise contract and a distribution contract. The latter focuses on the distributor’s obligation to market and sell the products of the principal or manufacturer under certain conditions imposed by the principal. In franchising, the franchisor also imposes conditions for marketing the products or services, but these conditions tend to be more comprehensive and restrictive. Importantly, the franchisee operates under the brand of the franchisor, following procedures that have been developed and tested.

Whereas, in a distribution contract, the emphasis is on product sales and the distributor has wide discretion in how to market it. In franchising, it is expected—besides generating a certain volume of sales—that the franchisee will operate the business in a particular way and under the franchisor’s tutelage according to their operational manuals. These manuals tend to be very specific and cover everything from the use of the business brand to operational and accounting matters. This supervisory/support relationship from the franchisor is based on the need to maintain the integrity of the entire franchise and because it is assumed that the franchisor is the person who best knows the business and how to market it for long-term sustainable profits.

Validity of the Franchise Contract

Franchising a business in Puerto Rico is valid as long as it is governed by the will of the contracting parties, as long as this is not contrary to laws, morality, or public order, and rests on the good faith relations of both parties. When we talk about a franchise contract, we are not referring to a single document. Typically, other interrelated contracts focusing on different aspects of the franchisor-franchisee contractual relationship are included in the ‘package,’ including documentation related to any financing provided. In the case of Franquicias Martín’s BBQ, Inc. v. Luis García, 2010 TSPR 71, the Supreme Court of Puerto Rico elaborates on the concept of a franchise.

Frequently, franchisors do not deal directly with franchisees. Instead, they contract with a sub-franchisor, so that within a given territory, they have the authority to operate or grant individual franchises. In the U.S., a sub-franchisor is known as a Master Licensee.