Franchising and Liability Under the FCPA

This article was republished with permission from Tom Fox’s FCPA Compliance and Ethics Blog.

I am often asked about franchisor liability under the Foreign Corrupt Practices Act (FCPA). Franchising has been a successful model in the U.S. and now many corporations are looking at overseas expansion opportunities. Franchise law has become well developed across the U.S., with many states developing laws to protect the rights and obligations of both parties in a franchise agreement. According to an International Franchise Association survey of nearly 1,600 franchise systems in 2008, “nearly two-thirds (61 percent) of respondents currently franchise or operate in non-U.S. markets and three-fourths (74 percent) plan to begin international expansion efforts or accelerate their current ventures immediately.”

There are no reported FCPA enforcement actions regarding franchisors. However, the factors in a franchise relationship would appear to lead to clear FCPA responsibility of the franchisor for its overseas franchisee’s actions. Additionally, court interpretation of the FCPA has held that it is applicable where conduct, violative of the Act, is used “to obtain or retain business or secure an improper business advantage,” which can cover almost any kind of advantage, including indirect monetary advantage even as nebulous as reputational advantage. As everyone knows, the FCPA prohibits payments to foreign officials to obtain or retain business or secure an improper business advantage. Nevertheless, many U.S. companies view franchisees as different from other types of more direct sales representatives, such as company sales representatives, agents, resellers or even joint venture (JV) partners, for the purposes of FCPA liability.

I believe that such an analysis is misguided, as the Department of Justice (DOJ) takes the position that a U.S. company’s FCPA responsibilities extend to the conduct of a wide range of third parties, including the aforementioned company sales representatives, agents, resellers, JV partners and distributors. It does not take too great a leap of imagination to see that a franchise relationship could be contained within this interpretation. It does not take too many legal steps to see that a franchisee’s actions can impute FCPA liability to a U.S. franchisor.

There are other factors unique to the franchise relationship that would point toward FCPA liability of the U.S. franchisor. A U.S. franchisor’s intent and the degree of control it exercises over its overseas franchisees’ operations are factors the DOJ and Securities and Exchange Commission (SEC) might consider in determining whether to pursue an FCPA case against a franchisor for bribes made by one of its foreign franchisees. It is always in the financial interest of a U.S. franchisor for its franchisees to be successful businesses. Additionally, most U.S. franchisors require overseas franchisees to use the same company name for branding. Of course, not only the initial franchise fee but the franchisee’s monthly royalty payment roll up into the books and records of a franchisor, so that might well catch the attention of the SEC if there is an FCPA books and records violation.

Victor Vital and Jessica Parker-Battle, writing in the Franchise Law Journal, Winter 2012 Issue, in an article entitled “Implications of the Foreign Corrupt Practices Act for International Franchising,” believe that a franchisor may not have direct involvement in conduct prohibited by the FCPA — there may not be the requisite corrupt intent required under the statute. However, I believe unless a franchisor has an adequate compliance program in place, a franchisor may well find itself in the shoes of Frederick Bourke and sustain a finding of conscious indifference.

Most franchisors have thorough financial vetting requirements before allowing any person or business to become a franchisee. However, how many of these same businesses perform FCPA compliance due diligence on their prospective overseas franchises? How many U.S. franchisors have FCPA compliance training programs? How many evaluate, on an ongoing basis, the FCPA compliance and program of their overseas franchisees? How many U.S. franchisors have a compliance hotline or other reporting mechanism for any compliance violations made against their franchisees?

Vital and Parker-Battle suggest that franchisors conduct thorough research in both the foreign market they hope to enter and on their potential franchisees. The franchise agreement itself should have strong FCPA anti-corruption/anti-bribery language and any franchisee, and its key employees, should receive FCPA training. The franchisor also needs to have a compliance subject matter expert (SME) available for franchisees, and the authors suggest that the franchisor provide an anonymous reporting hotline for FCPA violations, as well. They conclude their suggestions for franchisor practices, saying “it would be prudent to pay particular attention and monitor those countries in areas where bribery or gifts are encouraged in business relations. In sum, franchisors must be diligent when entering a foreign market and make sure to use best practices routinely and consistently.”

Another way to look at this issue comes from Foley and Lardner attorney Aaron Murphy from his book, entitled “Foreign Corrupt Practices Act – A Practical Resource for Managers and Executives.” In a chapter entitled “You Do More With the Government Than You Think,” Murphy has several examples of how any U.S. company doing business overseas will come into contact with a foreign governmental official and, thereby, create a possible FCPA liability. Many of these are areas that a U.S.-based franchisor would have to utilize to do business in a foreign country, including some or all of the following:

• Interactions with Customs Officials. Every time your company sends raw materials into — or brings them out of — a country, there is an interaction with a foreign governmental in the form of a customs official. Every customs transaction involves a payment to a foreign government and every transaction involves some form of a foreign governmental regulatory process. While the individual payment per transaction can be small, the amount of total transactions can be quite high if a large volume of goods are being imported into a foreign country.
• Interaction with Tax Officials. While noting that interacting with international tax authorities can present problems similar to those with customs officials, Murphy observes that the stakes can often be much higher since tax transactions may be less in frequency but higher in financial risk. These types of risks include the valuation of raw materials for VAT purposes before such materials are incorporated into a final product or the lack of segregation between goods to be sold on the foreign country’s domestic market, as opposed to those which may be shipped through a free trade zone for sale outside that country’s domestic market.
• Licensing and Permits. Your company is a retail seller of clothes and cosmetics and you do not understand how the FCPA applies to your foreign sales operations? Every physical location that you sell your goods in will require some type of license to operate your business. It could require multiple licenses such as a national license, state license and local municipal license.  Additionally, you will need a building permit if you intend to build out or modify your retail stores.
• Work Permits and Visas. If your company franchises overseas, it will have to send someone from the home office to operate in-country at some point. In the post-9/11 world, this probably means that, at a minimum, your company will have to obtain a visa for each employee who enters the foreign country and perhaps a work permit as well. The visa process can start in the United States with a trip to foreign government consulate or even the embassy, and at that point, you are dealing with a foreign governmental official. The work permit process can also begin in the United States, but often may continue in the foreign country.
• Inspections and Certifications. Consider the Tex-Mex restaurant chain that desires to take its cuisine across the world. In any city in the world, there will be some type of certification process to enable to the business to set up and start operating, and then there will be the need for ongoing inspections for sanitary conditions. Such inspections may be rare, but if there is “slime in the ice machine,” it may be grounds to close the restaurant.

How would all of this play out for a franchisor? As a franchisor moves into foreign markets, there could well be the temptation to “grease the skids” and make payments or offer gifts to government officials, or their family members, to get the permits or permissions necessary to open and operate. In many countries, bribery is a common way of getting business done, and there can be tremendous pressure from local agents or franchisee candidates to follow regional customs and use bribes to become or remain competitive. Even if it is not the U.S. franchisor’s own employees that engage in the FCPA violations, the U.S. franchisor will still face the risk of an enforcement action if the franchisee’s employees engage in such conduct.

This publication contains general information only and is based on the experiences and research of the author. The author is not, by means of this publication, rendering business advice, legal advice or other professional advice or services. This publication is not a substitute for such legal advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified legal advisor. The author, his affiliates and related entities shall not be responsible for any loss sustained by any person or entity that relies on this publication. The author gives his permission to link, post, distribute or reference this article for any lawful purpose, provided attribution is made to the author. The author can be reached at tfox@tfoxlaw.com.