Key Franchising Considerations for Brazil: Overview
Article published by Thomson Reuters.
A Practice Note providing an overview of the key legal and commercial considerations for foreign counsel to consider when advising clients on establishing a franchising arrangement in Brazil, including applicable laws and regulations, key provisions in the franchise agreement, and termination considerations.
Franchising is an arrangement in which franchisors, in exchange for an upfront payment or a series of payments, grant franchisees the right to operate a business and sell or distribute goods and services identified with the franchisors’ trademarks, trade names, and other intellectual property. Unlike in agency and distribution arrangements, franchisors typically exercise significant control over or provide significant assistance in, the franchisee’s business by requiring them to operate according to franchisor requirements.
Franchising can have many benefits for a foreign supplier, including the ability to expand and capture new markets quickly with limited capital expenditure. However, foreign counsel advising suppliers planning to establish a franchising arrangement in Brazil should consider the risks and requirements that may arise.
This Note considers the following aspects of franchising:
- Common types of franchising arrangements in Brazil.
- Key legal and regulatory requirements governing franchising arrangements in Brazil, including:
- industry codes;
- competition law;
- tax and currency regulations;
- product regulatory requirements and product liability laws; and
- legal formalities.
- Important considerations when appointing a franchisee in Brazil, including laws governing:
- intellectual property; and
- real property.
- The typical structure of a franchise agreement in Brazil.
- Issues related to termination of the franchising relationship in Brazil.
Legal Definition of Franchising
Brazil’s new Law No. 13.996/19 (known as the Franchise Law) entered into force on 27 March 2020, revoking the previous Franchise Law.
Law No. 13.996/19 governs the business franchise system in which a franchisor authorizes a franchisee to use trademarks and other intellectual property (IP) assets by contract:
- Always associated with the right of exclusive or non-exclusive production or distribution of products or services.
- Also associated with the right of use of methods and systems for the implementation and administration of a business or operating system developed or owned by the franchisor.
- Through direct or indirect remuneration.
- Without characterizing the relationship between the franchisor and the franchisee as a consumer relationship (as regulated by Law No. 8.078/90) (the Consumer Defence Code) or an employment relationship in relation to the franchisee or its employees, even during the training period.
When a distribution, joint venture (JV), or licensing agreement has the characteristics of a franchise agreement as defined by Law No. 13.996/19, there is a risk that local courts may consider that agreement a franchise agreement. The main consequence is that “the franchisor” will not have complied with the obligation to disclose the main legal and commercial information about the franchise offered to the potential future franchisee. This obligation must be performed before the parties execute the franchise contract. Failure to comply with this obligation can lead to the annulment of the contract and reimbursement or compensation for the values paid.
Overview of Franchising
All tradable goods and services can be franchised in Brazil, and franchising is very common. There are many Brazilian-owned franchises and many foreign franchises in the country. Brazil is the leading country in South America with respect to the number of franchises, followed by Argentina and Colombia (International Trade Administration, U.S. Department of Commerce). The franchising market has shown strong signs of recovery after the losses suffered due to the novel coronavirus disease (COVID-19) pandemic. Franchise revenues increased from BRL167 billion in 2020 to BRL185 billion in 2021, almost matching the 2019 result of BRL186 billion (the Brazilian Franchising Association (BFA)).
For the second year in a row, the home and construction sector led the growth of the Brazilian franchising sector with an increase of 19.3%. The health sector was the second largest, with an increase of 10.5%. The expansion of both the construction and health sectors was not affected during the pandemic years. On analysis of 2021 alone, the entertainment sector recorded the highest increase compared with the numbers from 2020, with an increase of 21.2%. This sector has not yet reached the results of 2019.
Methods of Franchising
Common local and international franchising methods are:
- Direct franchising.
- Master franchise agreements.
- Area development agreements.
- Unit or multi-unit franchises.
- Multi-brand and combination franchising.
A JV agreement is not part of a typical contractual structure to establish a franchise. If the parties to a JV agreement wish to enter into a franchising relationship within the scope of the partnership, they must do so by means of an additional franchise agreement.
Governing Legislation and Regulation
Brazil’s new Law No. 13.996/19 (known as the Franchise Law) entered into force on 27 March 2020, revoking the previous Franchise Law. Law No. 13.996/19 is intended to enhance business opportunities and provide more security for the players in the market.
Law No. 13.996/19:
- Makes explicit that the relationship between franchisor and franchisee does not constitute:
- a consumer relationship; or
- a labor relationship between the franchisee’s employees and the franchisor, even during the franchisee’s training period.
- Specifies that state-owned companies and non-profit organizations can also adopt the franchise model, not only private companies (paragraph 2, Article 1).
- Expressly mentions the possibility of an international franchise relationship in which the parties can opt to deal with potential disputes arising from the contract in a foreign jurisdiction. For example, a Brazilian franchisee that contracts with a foreign franchisor can choose a foreign jurisdiction for any disputes that arise (Article 7).
- Expressly refers to the possibility of including an arbitration clause in the franchise agreement (paragraph 1, Article 7).
Other Related Laws and Regulations
Even though Law No. 13.996/19 aims to regulate franchise agreements, it does not provide all the obligations and remedies to govern this complex type of contract. Provisions of the Civil Code (Código Civil) (Law No. 10406/2002) related to contracts, in general, may apply. Case law must also be taken into consideration.
The National Institute of Industrial Property (INPI) is the regulatory authority with jurisdiction in connection with its franchising regulations. The INPI is the official governmental entity responsible for IP rights in Brazil. It is a federal autonomous agency of the Ministry of Industry, Foreign Trade, and Services. The INPI’s regulations are mandatory for the following:
- Remittance of royalties abroad.
- Tax deductibility of payments by a Brazilian company.
- Making the agreement effective before third parties (erga omnis effect), so that third parties cannot claim to be unaware of the existence of the franchise agreement.
Therefore, certain requirements imposed by the INPI regulations have an impact on the terms of franchise disclosure documents and franchise agreements when the parties need or opt to register the franchise agreement with the INPI.
Parties can decide on the law and jurisdiction that will govern the franchise agreement and disputes arising from it. Dispute resolution through arbitration is also possible if the requirements imposed by the applicable laws for the validity of the arbitration are observed.
Voluntary Franchising Codes
The BFA has a Franchise Auto-Regulation Code (BFA Code) which mainly provides guidelines that govern the conduct and behavior of franchisees, franchisors, and third parties related to the franchise. Although the BFA Code is soft law, meaning it is not mandatory according to Brazilian law but that compliance with its provisions is mandatory if parties want to maintain BFA membership status. Either way, dealers need to adopt good rules of corporate governance to make their business more profitable.
In general, exclusive dealing, territorial restrictions, or any other obligation agreed between the franchisee and franchisor are allowed. Every limitation imposed on the franchisee must be disclosed in the franchise offering circular (Law No. 13.996/19). This obligation is necessary to protect the franchisee from the franchisor unexpectedly imposing mandatory approved suppliers or from new and unexpected franchisees competing in the same territory. However, resale price maintenance and any other anti-competitive practices are prohibited (Article 36, Law No. 12.529/11 (known as the Brazilian Antitrust Law)).
Limitation of consumers’ rights cannot be imposed. Law No. 8.078/90, which protects consumers, is mandatory law and prohibits any practice or clause that might in any way affect customers’ rights.
The imposition of minimum or maximum prices between franchisor and franchisee is generally allowed and valid. However, according to Brazilian antitrust law, price imposition is prohibited (the franchisor can suggest specific prices, but it is prohibited from imposing them), since the practice can affect the competition system. If the franchising contract provides for penalties to be applied if the franchisee does not adopt the suggested prices, the sanctions are considered mechanisms to enforce the suggested prices and are therefore invalid.
Restrictive covenants concerning geography and competition are allowed and enforceable under Brazilian law if previously provided for in the franchise offering circular (Article 3, Law No. 8.955/94).
Restrictions after the contractual term are also enforced if provided for in the franchise offering circular (Article 3, XIV, Law No. 8.955/94). However, case law is not harmonized and never allows restrictions longer than five years after termination, in analogy to Article 1.147 of the Civil Code, which restricts non-compete clauses between buyer and seller for five years. In practice, it is common to provide for non-compete clauses that extend for two or three years after the termination of the franchising contract.
There are no specific competition implications in licensing IP rights under Brazilian law. However, if the licensing agreement has the purpose of reaching, or results in, a dominant and anti-competitive market position, that agreement may be considered illegal under Law No. 12.529/11.
For more information on competition issues, see Practice Note, Competition Considerations for International Distribution and Supply Agreements.
The parties cannot waive the rights and obligations of Law No. 13.996/19 if they chose Brazilian laws and regulations to govern the franchise agreement.
Tax and Currency Regulations
The revenues from a franchising agreement earned by a Brazilian franchisor are subjected to corporate taxation (IRPJ, CSLL, PIS, and COFINS) according to the regime adopted by the franchisor.
In addition, the Federal Supreme Court (STF) has recently decided that tax on services (ISS) should be levied on the total revenues arising from a franchising agreement, in the future and for the past five years.
A foreign franchisor can be considered a business carrying on activities in Brazil but is rarely identified and verified as such by the Brazilian tax authorities. It is also possible for the franchisor to incorporate a company in Brazil, and that Brazilian company will be the franchisor.
Since 1996, dividend payments to partners and shareholders have been exempt from income tax, even when they are located in tax haven countries (Article 10, Law No. 9.249/05).
Withholding income tax (IRRF) is levied at 15%, or at 25% if the franchisor is located in a tax haven. Depending on how the remittance is characterized it may be taxed:
- CIDE (Contribution for Intervention in the Economic Domain) at 10%.
- PIS (Social Integration Program) and COFINS Contribution to Social Security Financing) at 9.25%.
- ISS (Tax on Services) varying between 2% and 5% depending on the municipality.
To pay royalties to a foreign franchisor, the franchising contract must be registered at the INPI. There is no express limit in Brazilian Law on the amount of royalties that can be paid. However, income tax deductions for royalty payments may be limited to 5% of the franchisee’s revenue, depending on the product or the activity (Law No. 4.131/62).
In addition, the registration certificate of technology contracts must indicate the following: “The INPI did not examine the contract in light of tax legislation, taxation, and remittance of capital abroad.” (Article 13, item XI, Normative Ruling No.
70/2017.) Normative Ruling No. 70/2017, therefore, terminated the INPI’s prerogative to analyze the provisions of technology contracts in terms of compliance with local tax legislation, taxation, and the remittance of capital abroad, so guaranteeing the application of the freedom of contract principle on these matters.
Product Regulatory Requirements and Product Liability Laws
With regard to obligations between the franchisee and franchisor, it is advisable, but not mandatory, that the franchise agreement indicates the party responsible for ensuring that products comply with regulatory requirements. In relation to consumers, the franchisor and franchisee are jointly liable for product defects and damage caused to consumers, but the franchise agreement can stipulate that one of the parties indemnifies the other for amounts paid to consumers arising from defects and damages. This language is usually found in franchise agreements but the party responsible for paying indemnities to the other, the franchisor or franchisee, will depend on who is responsible for providing the product.
Registration, Licensing, and Consents
No registration or special requirements are necessary, other than the filing of the franchise agreement with the INPI and registration with the Central Bank of Brazil for the following purposes:
- Remittance of royalties abroad.
- Tax deductibility of payments by the Brazilian company.
- Making the agreement valid before third parties, so that third parties must recognize the legal authority of the franchising agreement.
Certain requirements imposed by the regulations issued by the INPI also have an impact on the terms of franchise disclosure documents and franchise agreements. For example, if franchise fees and royalties under the franchise agreement will be remitted to a franchisor abroad, registration with the INPI is mandatory and therefore those amounts will only be payable after INPI has granted registration. The franchise agreement and the franchise disclosure documents must also indicate the INPI application or registration numbers, or both for the applicable trademarks under the franchise agreement, among several other requirements.
When setting up a franchise system, Article 2 of Law No. 13.996/19 requires the franchisor to provide to the franchisee candidate, in writing and at least ten days in advance of the date of signature of the franchising agreement, a franchise offering circular disclosing all of the following:
- A brief corporate history of the franchisor organization and the full name or corporate name of the franchisor and of all the companies with which it is directly connected, and their respective trading names and addresses. Law No. 13.996/19 does not provide a definition of directly connected, but usually, franchisors report companies that they control or with which they are under common control. When applicable, the Brazilian Taxpayers Registry (CNPJ) number must be provided.
- The franchisor company’s balance sheets and financial statements for the last two years.
- An accurate report regarding all ongoing court proceedings involving the franchisor, its parent companies, sub- franchisors, and owners of trademarks, patents, and copyrights relating to the franchise. This report must indicate which court proceedings, if any, specifically concern the franchising system or may directly prevent the franchise operation.
- A detailed description of the franchise and a general description of the business and the activities to be performed by the franchisee.
- The ideal franchisee profile, describing the previous experience, education level, and other characteristics that are mandatory or preferable.
- The requirements concerning the direct involvement of the franchisee in the operation and administration of the business.
- The specifications as to:
- the estimated initial investment required for the acquisition, installation, and start-up of the franchise;
- the initial membership fee or franchise fee; and
- the estimated value of facilities, equipment, initial stock, and payment terms.
- Clear information about periodic taxes and other amounts payable by the franchisee to the franchisor or third parties referred, detailing the underlying bases and their remuneration or the purpose for which they are intended, indicating, specifically, the following:
- periodic remuneration for the use of the system, brand, or other IP rights;
- periodic remuneration to be given in exchange for services actually rendered by the franchisor to the franchisee (royalties);
- equipment rental or real estate rental;
- advertising fees or similar; and
- minimum insurance.
- A complete list of all franchisees, sub-franchisees, the sub-franchisors’ network, and details of who left within the last 24 months, with names, addresses, and telephone numbers.
- Regarding the territory, specification of the following:
- whether the franchisee is guaranteed exclusivity or preference over a certain territory of operation and, if so, under what conditions;
- whether the franchisee is allowed to sell goods or provide services outside its territory or to export; and
- whether there are rules of territorial competition between self-owned units (operated by the franchisor) and franchised units (operated by the franchisee).
- Clear and detailed information on the franchisee’s obligation to purchase goods, services, or inputs needed for implementation, operation, or management of the franchise only from specific approved suppliers, including a complete list of these suppliers.
- An indication of what is effectively provided by the franchisor to the franchisee, in respect of:
- network supervision;
- incorporation of technology innovations into the franchise;
- training of the franchisee and franchisee’s employees, specifying duration, content, and costs;
- franchise manuals;
- guidance in the analysis and selection of the venues where the franchise will be installed; and
- layout and architectural patterns for the franchisee’s premises.
- The status at the INPI of trademarks and other IP rights whose use is to be authorized by the franchisor, including:
- their application and registration numbers;
- the classes and subclasses in which they were filed or granted; and
- if they involve plant varieties, their current status with the National Protection of Plant Variety Service.
- The status of the franchisee after the expiration of the franchise agreement, in relation to:
- know-how regarding the product, process, or management technologies; and
- confidential information and industrial, commercial, financial, or business secrets to which the franchisee may have access in view of the franchise.
- The standard contract model and, if appropriate, also the pre-standard franchise agreement adopted by the franchisor, with full text, including its annexes and expiration date.
- An indication of the existence or non-existence of assignment or succession conditions, and a description of those conditions, if any.
- An indication of situations that would result in penalties, payment of fines, or indemnifications, and the respective amounts, as determined in the franchise agreement.
- Information on whether there are requirements for minimum quotas for purchases by the franchisee directly from the franchisor or from third parties specified by the franchisor, and information on the possibility of (and conditions for) the franchisee to refuse products or services required by the franchisor.
- An indication of the existence or non-existence of a board or association of franchisees of the chain, with information on its attributes, powers, and mechanisms of representation to the franchisor, and details of the management skills and monitoring of the application of existing funds.
- An indication of conditions for limitation of competition between the franchisor and franchisees, and among franchisees themselves during the term of the franchise agreement, and details of the territorial scope and duration of the restrictions, and any penalties applicable in the event of breach.
- An indication of the contractual term and renewal conditions.
- Details of the time and place for the receipt of the franchisee’s application, and for the opening of the envelopes, in the case of public entities. Franchising by public entities generally requires a bidding process, although exceptions may apply. The opening of envelopes is a formal part of the bidding process, in which the proposals of potential franchisees are opened for analysis on a date and at a time previously specified.
- Failing to provide the offering circular ten days before the execution of the franchise agreement may result in the annulment of the franchise agreement and the reimbursement, by the franchisor to the franchisee, of all fees paid by the franchisee to the franchisor or third parties indicated by the franchisor.
- There is abundant case law on the lack of provision of the offering circular by the franchisor or missing information in the offering circular. However, local courts tend to reject a franchisee’s claims for annulment of the franchise agreement when they have operated the franchise for many years.
Other Legal Formalities
Brazilian law allows foreign franchisors to enter into a franchise agreement with Brazilian franchisees directly, without any subsidiary or a branch office in Brazil. However, it is necessary to take the issues and procedures involving the protection of IP into account, including trademarks, copyright, patents, and designs.
Foreign companies can set up branches and subsidiaries in Brazil. However, formal approval from the government is required in advance (Normative Ruling No. 7/2013, as updated by Normative Rulings No. 25/2014, No. 49/2018, and No. 59/2019, Business Registration and Integration Department (Departamento de Registro Empresarial e Integração)).
Several documents are needed to obtain approval to set up branches and subsidiaries in Brazil:
- A corporate resolution approving the setting up of a Brazilian branch or subsidiary.
- The articles of association or bylaws.
- A list of shareholders.
- A certificate of regularity, issued by the tax authorities and commercial registry of the country of origin.
- A corporate resolution appointing a Brazilian legal representative of the company and power of attorney giving it the power to act on behalf of the foreign company.
- An affidavit from the company legal representative promising to obey Brazilian laws and any conditions of the authorization set out by the federal government.
- The company’s most recent balance sheet.
- Evidence of payment of government fees.
Once the federal government grants the authorization, the foreign company’s branch or subsidiary must be fully in compliance with Brazilian laws, including registration with the relevant authorities, for example, the Board of Trade of the state in which it is established.
All documents must be presented in Portuguese. Any text in a foreign language will not be taken into consideration by Brazilian courts or government officials. All references to monetary values must be made in Brazilian reais.
Many franchisors opt to establish a wholly-owned subsidiary (most commonly a limited or joint-stock corporation) to avoid the need to register the franchise agreement with the INPI for the purpose of remitting royalties abroad. If the franchisee pays franchise fees and royalties into the franchisor’s bank account in Brazil, registration of the franchise agreement with the Brazilian Patent and Trademark Office (PTO) is not required. The franchisor can remit dividends from its subsidiary to its headquarters abroad.
JV agreements are not typically used to establish a franchise due to the risks arising from a lack of offering circular (see Legal Formalities). The parties can enter into a franchise agreement in addition to a JV agreement. Both will work in accordance with the particulars of the deal between the franchisee and franchisor.
A branch office does not consist of a new corporate entity formed in Brazil, and therefore it is not usually an option chosen by franchisors.
Appointing a Franchisee
Foreign franchisors planning to establish a franchising system in Brazil should bear in mind considerations relating to employment, IP, and real property.
The relationship between the franchisee and franchisor is commercial. Both parties are considered independent entrepreneurs. Law No. 13.996/19 specifically states that the franchise does not result in an employment relationship between the franchisor and franchisee, or between the franchisor and the franchisee’s employees.
Under Brazilian employment law, the situation is the same. The franchisee and their employees would not usually be considered the franchisor’s employees. In Brazil the general rule is that, for an employment relationship to exist, the relationship must meet the following requirements:
- Subordination. The employee works under the employer’s supervision, is subject to orders, and has no autonomy to make decisions on their own.
- Habit. The employee provides services to the employer on a regular and continuous basis.
- Remuneration. The employee is compensated for the services they provide through the payment of a salary.
- Personality. The services are carried out by a specific person.
(Article 3, Law-Decree No. 5.452/43 (known as the Consolidation of Brazilian Labor Laws).)
However, there is a risk that the labor courts may consider an employment relationship exists if a franchisee or (more likely) its employees bring a claim and can show that the relationship meets these requirements.
In addition, to properly guarantee their position, the franchisor must not interfere in the employment relationship between the franchisee and its employees.
Notwithstanding the foregoing, the Franchise Law enacted in 2019 includes express language stating that the franchise agreement does not result in an employment relationship, even between the franchisor and the franchisee’s employees.
Therefore, if the requirements for the characterization of an employment relationship are not met, the franchisor will not be considered an employer in relation to the franchisee or the franchisee’s employees.
Intellectual Property (IP) Considerations
IP Rights Granted
Trademarks are the most licensed IP right under franchise agreements, along with know-how, copyrighted materials, for example, the franchise manual, and access to the franchisor’s systems. Patents, designs, and software are also licensed, although less often. IP rights are licensed to franchisees within the scope of the franchise agreements.
The customs authorities do not require the importer to be registered as the owner or the user of the trademark to import the goods bearing the trademarks. However, goods bearing unauthorized trademarks are considered counterfeited goods, and their importation is a crime under Article 190 of Law No. 9.279/96 (known as the Brazilian Industrial Property Law).
Usually, the franchise agreement will state that franchisee will be held harmless from disputes on the validity of the IP rights granted to them within the scope of the franchise agreement. If a franchisor’s trademark is not registered in Brazil, franchisees should obtain legal assistance to check the possible risks of infringing third parties’ IP rights.
Protection of Franchisor’s IP
Trademarks are protected under Law No. 9.279/96. Trademarks are granted on a first-to-register basis for a ten-year term. Trademark rights are renewable indefinitely.
The most important provision in the franchise agreement is the payment of royalties to the franchisor in consideration for the licensing of the trademark to the franchisee. The franchisee does not acquire any trademark automatically by selling goods and services bearing the relevant trademark. Registration is required to acquire any trademark rights.
Termination provisions are also important. They usually provide for the franchisee to immediately cease the use of the trademark in any activity, establishment, or product on termination of the franchise.
The term of a franchise agreement must match the term of registration with INPI of any trademark used under the agreement.
In Brazil trademark notices are not commonly used, the trademark owner usually imposes all obligations to be observed by the licensee or franchisee within the scope of the relevant agreement between the parties.
At least two provisions are usually made concerning goodwill:
- The agreement provides for a formal waiver by the franchisee of the right to claim goodwill, so that goodwill resulting from use of the franchise belongs to the franchisor.
- The franchisor usually requires the franchisee to take responsibility for any behavior or act that could negatively affect the goodwill of the trademark.
It is very unusual for franchisors to compensate franchisees on termination of the franchise agreement for their development of goodwill during the franchise, but such an arrangement is possible.
Enforcement of IP Rights
The IP asset must be valid in Brazil for the franchisor or franchisee to enforce it.
Trademark rights are acquired when the INPI grants their registration, although certain exceptions under Law No. 9.279/96 (Law on Industrial Property) enable enforcement of well-known trademarks registered abroad.
Copyrights are regulated by Law No. 9.610/98 (known as the Copyrights Law) and can be exercised in Brazil regardless of registration. Law No. 9.610/98 states that ideas are not entitled to protection. Protection is provided in relation to how ideas are expressed, and originality is a main requirement. A franchisor can therefore enforce its copyrights without registration if they meet the requirements for validity.
A franchise agreement must be registered with the INPI to make it valid against third parties. The franchisee can use the certificate of registration issued by the INPI to enforce its IP rights against infringing third parties.
If an agreement is not registered with the INPI, the franchisee can alternatively obtain a specific authorization from the franchisor to enforce IP rights against third parties. This type of enforcement usually starts with a cease-and-desist letter against the infringer and, if it is not effective, a lawsuit can be filed requesting an interim injunction at the beginning of the litigation to interrupt the damages being caused.
Franchise agreements license, not assign, IP rights to the franchisee. The franchise agreement grants the franchisee a temporary right to use the franchisor’s IP. Therefore, franchise agreements usually require the franchisee to cease use of all of the franchisor’s IP granted under the agreement on termination.
Franchise agreements also typically state that during the term of the agreement the franchisee can use the franchisor’s IP strictly in accordance with the provisions of the agreement and all other types of use must be previously approved in writing by the franchisor.
During the franchise agreement, the franchisor may also prohibit the franchisee from disclosing any confidential information or know-how to third parties or from using the franchisor’s know-how in any activity outside the scope of the franchise agreement.
Brazilian law does not provide clear guidance for restrictions after the expiration of the franchise agreement. Franchisors must disclose in the franchise circular offering any after-expiration obligations of the franchisee regarding:
- The franchisor’s know-how accessed during the agreement.
- The deployment of competitive activities by the franchisee.
However, there is no clear provision regarding the enforceability of non-compete clauses (Article 2, item XV, Law No. 13.996/19). Brazilian case law provides that restrictions on the use of the franchisor’s know-how by the franchisee are valid, but may not, in general, be enforced for more than five years. It is common practice to include non-compete clauses that are valid for two or three years from the termination of the franchising contract (see Competition Laws).
Real Property Considerations
There are no legal restrictions regarding the form of real estate ownership or leasing used in a franchising situation by a franchisee in Brazil, irrespective of the franchisee’s or franchisor’s nationality. Only rural real estate has restrictions regarding deals with foreign buyers.
Law No. 13.996/19 regulates franchises in which the franchisor subleases a commercial plot to the franchisee for operation of the franchised business, providing that in these cases:
- Either party can file lease renewal court claims (a claim that aims to enforce the extension of the lease agreement provided that some requirements are met). Before Law No. 13.996/19 came into force, only the sub-lessee (in this case the franchisee) was entitled to file the renewal lawsuit when the real estate was subleased in its entirety.
- The lease and sublease agreements cannot provide for the exclusion, on their renewal, of the franchisee and franchisor’s prerogative to file a lease renewal claim, except in the event of breach for non-payment of the lease agreements or the franchise agreement.
- The rental price to be paid by the franchisee to the franchisor can be higher than the amount paid by the franchisor to the property owner of the commercial premises, provided that:
- this fact is clearly set out in the franchise offering circular; and
- the rental amount paid by the franchisee to the franchisor in excess of the rent paid by the franchisor to the property owner does not result in an excessive burden on the franchisee.
The Franchise Agreement
Franchise agreements will be fully enforceable under Brazilian law if both these formalities are met:
- The franchisor must have made the franchise offering circular available to the franchisee at least ten days before the formation of the franchise agreement or any payment by the franchisee to the franchisor, with all the required
information provided (see Disclosure Requirements). If the franchisor disregards this requirement, the franchisee can seek a judicial declaration that the contract is null and void, and also demand the reimbursement of all payments it has made to the franchisor, or a third party specified by the franchisor for affiliation to the franchise system or for royalties purposes. The amount to be reimbursed must be duly adjusted (Article 2, paragraph 2, Law No. 13.996/19).
- Franchise agreements that have effect exclusively in the Brazilian territory must be written in Portuguese and governed by Brazilian law. International franchise agreements must be written in the Portuguese language, or the franchisor must provide a sworn translation.
The parties can choose one of their countries of domicile as the jurisdiction of the agreement. If a specific jurisdiction is provided by an international franchise agreement, the parties must establish and maintain a legal representative or attorney:
- Duly qualified and domiciled in that jurisdiction.
- With powers to represent them administratively and judicially, including powers to receive a judicial summons.
In relation to offering circulars, there are cases where the courts have rejected franchisee claims that the franchise agreement must be declared null and void due to the lack of a franchise offering circular where:
- The franchisees failed to prove that the lack of the franchise offering circular resulted in actual damages.
- A considerable period had elapsed from the execution of the franchise contract and the claim to have it declared null and void. The delay, therefore, indicated acceptance of the contract despite the lack of an offering circular.
In April 2019, the São Paulo State Court of Appeals issued an official statement (Enunciado IV) that reflects the prevailing interpretation of the matter at that court (which is one of the most relevant in the country in terms of volume of potential claims), stating that:
“Non-compliance with the formality provided by Article 4 of Law 8.955/94 [the previous Franchise Law in force at the time the official statement was issued] may entail the nullity of the franchising contract, provided that it has been claimed by the plaintiff within a reasonable period of time and provided that the actual loss is duly proved.”
However, the Superior Court of Justice recently ruled on a franchise agreement in the laundry industry, holding that the franchisor breached its duty of good faith and its duty to inform by omitting relevant information which would have allowed the franchisee to make an informed decision on the franchise agreement. It held that the breach of important pre-contractual duties by the franchisor can give the franchisee a claim for contractual termination and recovery of damages. The Superior Court of Justice granted early termination of the franchise agreement and indemnities to the franchisee, based on:
- The fact the franchisor omitted to inform the franchisee of the failure of the previous franchisee in the same region.
- The court’s expert opinion that it was highly unlikely that the franchisee would be able to recover the investments imposed by the franchisor.
(RESP No. 1.862.508-SP, Official Gazette Dec 18, 2020.)
Rights and Obligations Generally
Franchisees are usually granted the following rights, which are not mandatory, but must be set out in the offering circular:
- To use the franchisor’s trademark or other IP.
- To be an exclusive distributor of the franchisor’s goods or services in a restricted area (according to the franchise circular offering).
- To use the franchisor’s technology, software, and know-how.
- To provide a uniform to its employees, and to use other types of distinctive property.
- To receive training sessions and submit its employees to training sessions related to the product or service to be provided.
- To receive technical manuals related to the implantation and operation of the franchise.
- To receive architectural standards and projects to be followed when setting up its business unit.
It is usual for the franchisor to grant exclusivity in matters relating to the territory and term of the franchise. Exclusivity does not have any prima facie competition implications regarding the relationship between the franchisor and franchisee. However, to comply with competition law, exclusivity must:
- Be limited in territory, object, and term.
- Not have the specific purpose of competition limitation.
- Not involve resale price maintenance, which is not permitted by Law No. 12.529/11 (see Competition Laws).
(Article 36, Law No. 12.529/11.)
The franchisor’s main obligation is to provide the franchisee with the franchise offering circular. Brazilian law also requires the franchisor to grant the franchisee a license to use its trademark or IP rights, technology, software, and know-how (Article 1, Law No. 13.996/19).
Fees payable vary significantly in accordance with the commercial sector of the franchise. Franchise agreements usually specify an initial fee and monthly royalties, although other fees, for example, customer care, training, and inspection fees, a loyalty program charge, and software license fees may apply.
When initial fees and royalties are payable to a local bank account owned by the franchisor, the parties can agree on their amount and when they are due without restrictions. When initial fees and royalties are payable to a franchisor abroad, the franchisor cannot impose payment before the franchise agreement is registered with the INPI (see Legal Formalities, Registration, Licensing, and Consents).
Term of the Agreement
The franchisor is free to suggest the term of the contract. Although both parties may negotiate it, the franchise contract will usually be the franchisor’s standard form contract and therefore the franchisor usually determines its duration.
The term must be sufficient for the amortization of the investments required from the franchisee. In addition, the term of franchise agreements must not run past the expiration date with INPI of any trademark used under the agreement (INPI’s Normative Ruling 199/2017).
It is common practice to provide for a five-year term, with the possibility of renewal if either of the parties so requests, with a reasonable notice period. It is also common that after an initial determined period of validity, the franchise contract can be extended for an undetermined period. In this situation, it is also necessary to stipulate a notice period for a party to terminate unilaterally (see Terminating the Franchise Agreement).
Considering the scale of investment required, a test period is not common. An alternative is to establish a shorter initial term (for example one year) and the possibility of further extension.
The term must be set out in the franchise circular offering, to avoid any allegations of nullity or invalidity from the franchisee.
Franchisees usually have the right of renewal, sometimes dependent on a performance requirement. Some franchises notoriously charge for renewal, but it is not common.
Operation and Compliance
Franchisors typically provide an operations manual to franchisees that details the standards, systems, and requirements that franchisees are expected to use and meet. The operations manual usually indicates requirements to be observed by the franchisee in relation to the franchise’s trademarks, branding, advertisements, software, technology, procedures, designs, policies, and interior and exterior signage. Operation manuals usually do not apply for a specific term. Franchisors commonly reserve their right to change them “from time to time” and state those modifications must be observed by the franchisee. There are no express legal restrictions preventing franchisors from imposing modifications on a mandatory basis. However, a franchisee can claim violation of the Civil Code good faith obligations if the franchisor imposes, for example, significant modifications shortly after the franchise agreement is executed without clear provision for these changes in the franchise agreement or the offering circular. Good faith provisions in the Civil Code aim to ensure security, loyalty, and reciprocal trust in contractual relationships.
Liability and Remedies
One of the franchisor’s main risks is granting the right to operate a franchise to a franchisee that does not have the necessary experience or means to operate the franchise in accordance with the franchisor’s expectations. Even when the franchisee appears to have the necessary expertise, it frequently, due to different factors, fails to meet the franchise’s standards. That failure damages the reputation of the brand and may expose the franchisor to joint liability to consumers for damages caused by the franchisee.
It is therefore very important that the franchise agreement includes a standalone guarantee agreement, by which the franchisee provides adequate assets, for example, real estate, to cover possible indemnities to be paid to the franchisor.
As franchise agreements or forms may be deemed adhesion contracts, according to Brazilian laws, the adhering party must have the opportunity to express its unwillingness to enter into the agreement or form, and the terms and conditions of the agreement or form must be written in a clear and easily understandable manner. In addition:
- Provisions representing limitations to the signatory’s rights must be written in an easily visible manner that can be immediately and easily comprehended.
- Provisions imposing a waiver of rights resulting from the nature of the agreement or form by the adhering party may be considered null and void.
However, the São Paulo Court of Appeals recently ruled that:
“In spite of the fact that the franchise agreement is an adhesion agreement, its clauses should not, for this reason alone, have their validity questioned. … Disparities in bargaining power and market power between the parties have little to do with the very concept of a contract of adhesion. The adhesion contract is formed in a unique way, between parties that cannot or do not want to waste time negotiating contractual clauses, under penalty of making it unfeasible.”
(Appeal No. 10039421720188260576 SP, Official Gazette Oct 4, 2021.)
Therefore, limitation of liabilities provisions should not be invalidated by local courts.
Indemnification and Insurance
Indemnification provisions under franchise agreements are common, including in relation to product liability claims (see The Franchise Agreement, Liability and Remedies and Product Regulatory Requirements and Product Liability Laws).
Franchise agreements typically require franchisees to maintain insurance, usually covering an amount per occurrence for commercial general liability and other coverage including:
- Liquor liability coverage.
- Automobile liability coverage.
- Business interruption.
- Employer’s liability insurance.
- Employment practices liability.
- Professional errors and omissions.
Disputes, Choice of Law, and Forum
Local law does not restrict resolution of franchising disputes by litigation, arbitration, or mediation. Franchising disputes are usually litigated or arbitrated (see Governing Legislation and Regulation) when the extrajudicial negotiations do not succeed.
The parties can choose one of their countries of domicile as the jurisdiction of the agreement. If a specific jurisdiction is provided by an international franchise agreement, the parties must establish and maintain a legal representative or attorney:
- Duly qualified and domiciled in that jurisdiction.
- With powers to represent them administratively and judicially, including powers to receive a judicial summons.
Law No. 13.996/19 expressly refers to the possibility of including an arbitration clause in the franchise agreement (paragraph 1, Article 7).
Article 105, I, i of the Federal Constitution and Article 35 of Law No. 9.307/96 (known as the Arbitration Law) state that decisions issued by foreign courts must be ratified by the Superior Court of Justice (STJ) to produce effects in Brazil.
Terminating the Franchise Agreement
The franchise agreement can be terminated with cause for any breach of contract (Article 475, Civil Code). Breach of the following statutory obligations may result in termination:
- For the franchisee, if the franchisor does not:
- guarantee the franchisee the use of the trademark, other IP rights, or know-how; or
- provide the franchisee with the franchise offering circular at least ten days in advance of the signature of the franchise agreement.
(Article 475, Civil Code and Articles 1-2, Law No. 13.996/19.)
- For the franchisor, if the franchisee:
- does not pay the franchise fee and the royalties (Article 475, Civil Code and Article 1, Law No. 13.996/19); or
- acts or adopts any conduct or practice that could damage the trademark or the product which is the subject matter of the contract.
In addition to statutory obligations, franchise contracts usually provide for termination on any breach of agreed quality or sales performances to protect the franchisor’s trademark and market value.
If the franchise contract is valid for an undetermined period, it typically provides for the possibility of unilateral termination by either party by prior notice. The applicable law does not provide for the term of the notice period, but rather gives a general guideline that unilateral termination is only effective after a term compatible with the nature of the business and of the investments made to run it has elapsed (Article 473, Civil Code).
Law No. 13.996/19 does not provide for termination of a franchising agreement, or for any compensation for termination. Therefore, there is no pre-liquidated (legal) compensation triggered by the termination of a franchising agreement.
For any of the parties to be entitled to compensation for termination, the other party must have failed to comply with its obligations and consequently must have caused damage to the aggrieved party. For example, if the franchising agreement is valid for a determined period, any unjustified early termination would constitute a breach and therefore the terminating party would be liable to pay compensation (except if both parties had mutually agreed to the termination). In this situation, the compensation would be equivalent to either:
- The damages and losses incurred by the franchisee (to be duly demonstrated through evidence).
- Any pre-liquidated damages provided by the contract.
However, if the contract is for an undetermined period, both parties are entitled to terminate unilaterally without cause, provided that reasonable prior notice is given. The contract usually determines the minimum prior notice. The franchise agreement must draw attention to the fact that a unilateral early termination by the franchisor will only be effective if the investments made by the franchisee have already been amortized. Otherwise, the franchisor will be prevented from unilaterally terminating the contract or the franchisee will be entitled to compensation due to an abusive and abrupt termination.
It is quite common for franchisees to seek damages related to the losses incurred due to failure to succeed commercially with a franchise. However, the courts are usually very restrictive and do not grant any type of compensation, stating that the parties are independent and that the franchisor is not liable for the franchisee’s failure. In these cases, the causal link between the conduct of the franchisor and the losses incurred by the franchisee must be proved.
The franchise agreement usually provides for the franchisee to immediately cease the use of the trademark in any activity, establishment, or product on termination of the franchise.
For non-compete covenants and their competition law implications see Competition Laws.
For the franchise premises after the franchise has been terminated see Real Property Considerations.
Whether a franchisor or a new franchisee can establish direct relationships with a former franchisee’s clients will depend on the terms of the franchise agreement. The franchisee must include provisions in the franchise agreement restricting the franchisor’s takeover of clients or proving compensation. However, franchisors rarely accept those provisions (see Intellectual Property (IP) Considerations, Goodwill).
To decide on the best arrangement for the remittance of franchise fees and royalties abroad the franchisor should assess:
- The costs of establishing a subsidiary in Brazil.
- The legal costs related to the registration of franchise agreements with the INPI.
There are purposes other than the remittance of local profits abroad for establishing a subsidiary but depending on the number of franchise agreements to be registered with the INPI, the establishment of a subsidiary may make sense for this reason alone. However, sometimes it is more advantageous, due to specific legal or corporate aspects that apply to franchisors’ entities, to register franchise agreements with the INPI and therefore receive payments as franchise fees and not as dividends of the local subsidiary.
The registration of agreements with INPI may be in the parties’ interest for other purposes, specifically, to make the agreement valid between third parties and for tax deductibility.