Vietnamese law does not define distribution nor does it define a distributor. This can create confusion between distributorships and franchises. As different elements are added or varied, a simple distributorship may seem more and more like a franchise. It has become apparent that at least in Vietnam, certain characteristics of a franchise appear in a distributorship. Externally, the two forms of selling begin to appear indistinguishable. In practice, more and more retail outlets have willingly come to look like franchises with a more uniform appearance, rather than the traditional stand-alone retail model. So what, you may ask. What differences does it make? The indistinction, when it occurs, blurs the lines between the two forms of selling and raises questions when navigating the legal framework.
We discuss the two concepts, and then look at the overlaps and distinctions.
What is distribution?
We start with the fact that there is no legal definition of distribution. The Commercial Code considers ‘distribution’ as merely a sale and purchase[1]. That is, title to the goods passes from one counterparty (manufacturer/wholesaler) to another party (retail distributor) at the time of delivery unless otherwise agreed. That is, the distributor resells the goods it owns to a buyer and does so on its own terms. Practically, distributorships can be more nuanced. The distributor will resell it, sometimes under terms and conditions imposed by the seller, but the fundamental transaction is unchanged.
What is franchising?
The Commercial Code also regulates franchises. The rules and regulations are robust. A franchise is defined as a commercial activity whereby a franchisor authorizes and requires a franchisee to be part of the purchase and sale of goods or to provide services, subject to the following conditions:
- The purchase and sale of goods or the provision of services must be conducted according to the method of business organization specified by the franchisor and be associated with the trademark, trade name, business know-how, business mission statements, business logo and advertising of the franchisor; and
- The franchisor has the right to control and offer assistance to the franchisee in the conduct of the business.[2]
What are the distinctions?
- Appearance:
The two models in Vietnam are not pure. There are overlaps and there are elements of one in the other. By its definition, control of operations is one of the key features of a franchise. Control helps to ensure uniformity, consistency, efficiency, and quality across all franchise locations. To the franchisor, this is vital to maintain the brand’s consistency, reputation, customer trust and identity. It, however, does not mean that every degree of control creates a franchisor-franchisee relationship. Control can be found in similar authorized retailing arrangements. For example, in the case of Apple’s authorized resellers/service providers and in other similar cases, there are business standards designed by the seller that a distributor must follow, including among others, location, store layouts, general conformity in appearance, staff training, etc. But the fact that a franchise also has these requirements–often more intense–does not convert the wholesaler-retailer or manufacturer-distributor relationship into a franchise. There may be arguments about the degree of control that differentiates franchises from distributorships. But the degree of control is not relevant because control does not differentiate a distributorship from a franchise. Control is an unregulated variable, dependent totally on the parties’ agreement. There is no legal criteria set out in the Commercial Code by which a distributorship is converted into a franchise. The lack of specificity may add to the matter’s complexity and confusion.
- Operational control:
There are distinctive differences in the way the two models exercise control. Firstly, the franchisor’s right to exercise control is inherent in the relationship. Operational control in distributorship agreements typically focuses on preserving brand image integrity. There may be requirements on product display, control of product models that may be sold, age of inventory, etc. The control under a franchise relationship also does this, and goes further to protect, among others, the franchisor’s know-how in that the franchisee must apply and execute the know-how appropriately–probably the most important aspect of a franchise arrangement. Distributorship agreements, on the other hand, generally do not involve granting access to or applying proprietary know-how, but even when they do, access is not pivotal to the relationship.
- Liability:
The liability under the two models is also contrasting. In a distribution arrangement, the manufacturer is primarily liable for the quality and safety of its products. It means that, if a defective product reaches consumers, the manufacturer may be held legally accountable for damages. In contrast, a franchisor does not bear responsibility for the franchisee’s products or services. Rather, the franchisee, as an independent business entity, is solely liable for the quality, safety, and legal compliance of the products or services they sell.
- Payment structure:
Another key difference between the two models is the payment structure. In a distributorship, a distributor pays a purchase price to a seller/manufacturer in an outright sale of goods. This is the primary source of revenue for the seller/manufacturer. Generally, no payment or commission for use of brand name, trademark, etc. applies. This is true even in case the number of distributees in a designated area is limited by the manufacturer. Meanwhile, a franchising payment structure is an intrinsic element of franchising activities with the main focus being the sale of “a package of rights” (which includes trademark, tradename, know-how, business logo and advertising of the franchisor), rather than the goods themselves. Indeed, often, no goods are even provided by the franchisor. The objects of sale are created by the franchisee. This is further supported by multiple provisions in the Commercial Code and its guiding documents. Specifically, the Commercial Code provides that a franchisor is entitled to earn franchising fees from the franchisee and a franchisee is obliged to pay franchising fees to the franchisor[3]. Additionally, “price, periodic franchise fee and mode of payment” are terms suggested in a franchise agreement[4]. Furthermore, a franchisor is required to disclose (in its Franchise Disclosure Document (“FDD”) filed with the authorities) the information on (i) initial franchising fees that the franchisee has to pay (including type and amount of initial fees, the time of payment, cases in which fees will be returned), and (ii) other financial duties of the franchisee. These other financial duties include payment of recurrent fees, marketing fees, training fees, service fees, payment for lease, etc.[5]
- Registration/Licensing:
As a result of the above differences, the two models have distinct legal requirements. A distributorship is subject to less stringent regulatory requirements than a franchise. A distribution agreement can be executed between a seller/manufacturer and a distributor without strict regulatory oversight. However, for a franchise, Vietnamese law imposes a considerable administrative burden on a franchisor when setting up its franchise in Vietnam. A franchisor is required to file an application dossier (including among other things: a Franchise Disclosure Document which details financial risks, fees, and operational terms to prospective franchisees) with the Ministry of Industry and Trade (“MOIT”) for the registration of the franchising activities in Vietnam[6] which registration is subject to approval.
A franchisor must have operated the business for at least one year before franchising in Vietnam.
- Duty to Disclose:
By law a franchisor is subject to certain disclosures and reporting requirements. It must make key commercial disclosures via the FDD. It must provide a copy of the franchise agreement at least 15 working days prior to its execution unless the parties agree otherwise[7]). Besides the initial disclosure requirement mandated in the FDD, a franchisor is required to keep its franchisees updated concerning all significant changes related to its franchise system. A “significant change” is defined as any change that may have an impact on the business activities of a franchisee. All of this to say that the law provides a franchisee with many protections that are ignored in a distributor-distributee relationship.
Additionally, the franchisor is required to report to the MOIT in case of certain changes (eg, information on the franchisor, scope/type of business to be franchised, etc.), within 30 days from the date of the change. A distributor, on the other hand, is not subject to such an obligation.
Takeaway
To conclude, in order not to cause confusion or misperception of the relationship, it is possible to structure a distributorship with an appropriate level of control but steering away from the intense control of know-how that is normally reserved for a franchise. More importantly, a payment structure that suggests a franchise relationship (eg, ongoing fees, royalties, etc.) should be avoided in order not to trigger any requirements on franchise registration.
For further information, please contact:
Chu Bao Khanh, Russin & Vecchi
CBKhanh@russinvecchi.com.vn
[1] Regulations on the sale and purchase of goods and services are provided under Articles 24–87 of the Commercial Code.
[2] Article 284 of the Commercial Code.
[3] Articles 286 and 289 of the Commercial Code.
[4] Article 11 of the Government’s Decree No. 35/2006/ND-CP dated March 31, 2006 guiding the Commercial Law on Commercial Franchising (as amended by Decree No. 120/2011/ND-CP dated December 16, 2011) (“Decree 35”).
[5] Annex III of Circular No. 09/2006/TT-BTM dated May 25, 2006 of the Ministry of Trade on registration of commercial franchising (“Circular 09”).
[6] Section II of Circular 09
[7] Article 8 of Decree 35