Under a typical franchise agreement, the franchisor grants the franchisee the right to use its trade marks. Under the Kingdom of Saudi Arabia’s Commercial Franchise Law M22/1441 (“Law”), this position is reflected in Article 1 of the Law, and the definition of “Franchise”:
Franchise: A right granted by a franchisor to a franchisee to run a franchise business on his own account under the trademark or under the brand name of the franchisor or the person licensed to use the same; this shall include transferring technical expertise and specifying the manner of operation. Such right may be granted for a financial or non-financial consideration, excluding the amounts the franchisee pays to the franchisor in return for goods or services.
A key element of the definition of a “franchise” under the Law is that the franchisee conducts a business under “the trademark or under the brand name of the franchisor”.
From a 2023 Court of First Instance decision handed down by the Eleventh Commercial Chamber of the Commercial Court in Dammam (“Court”), the Court provides further guidance on the requirements for a valid franchise agreement under the Law as it relates to the franchisor’s licensing of its trade marks.
Background
In this case, the plaintiff franchisee entered into a written franchise agreement on 16 January 2021 with the defendant franchisor, purportedly for the grant of a café franchise for a seven-year term. The franchisee also paid the franchisor fees of SAR 45,000 (approximately USD 12,000), which was described as inclusive of design work and fit-out of the premises.
Following execution of the franchise agreement by both parties and the franchisee’s payment of the fees, but before the franchisor had undertaken the work, the franchisee requested the franchisor produce evidence that it was the owner of the trademark, or alternatively authorisation from the trademark owner permitting the franchisor to grant franchise rights to the franchisee.
At the time the parties entered into the franchise agreement, the franchisor had not registered its trademark with the Saudi Authority for Intellectual Property (“SAIP”). The evidence produced by the franchisor to support its claim of ownership of the trade mark was a commercial registration bearing the café name. The franchisor subsequently sought to register the trade mark with SAIP after the franchise agreement had been concluded.
The franchisee filed a case seeking to nullify the franchise agreement, a refund of the fees it had previously paid the franchisor, along with reimbursement of the franchisee’s legal fees.
The case also raised additional issues, including the evidentiary weight of admissions made by a party’s representative during proceedings, whether or not the agreement constituted a franchise agreement, and whether the substance of the arrangement prevailed over its contractual form. Those matters are not addressed in this case note, which focuses on the Court’s treatment of the requirement for the franchisor to own the relevant trademark at the time of entering into the franchise agreement.
The Court’s Decision
The Court found in favour of the franchisee and declared the franchise agreement void on the basis that the franchisor had purported to grant rights it did not possess at the time of contracting.
The Court’s reasoning was based on the definition of a “franchise” under Article 1 of the Law, which provides that it is a right granted by the franchisor to a franchisee to run a franchised business linked to a trademark or trade name owned by the franchisor. From the Court’s interpretation of this definition, there was an express requirement that the franchisor own the relevant trademark at the time the franchise agreement was entered into. Under the facts of this case, the franchisor was the owner of the trademark only after the franchise agreement had been executed. The Court’s reasoning also referenced Islamic / Sharia legal principles and the Prophetic Hadith, “do not sell what you do not possess”.
The Court’s ruling did not address the franchisee’s request for reimbursement of the franchisee’s legal fees.
This decision was handed down by a Court of First Instance. It is not known whether an appeal was filed by the franchisor as no published appellate decision has been identified. As such, readers should keep this in mind when considering the precedential weight of the Court’s findings.
Key takeaways
The key takeaways from this case are:
- A Court may adopt a strict interpretation that the franchisor shall be the owner of the trade mark at the time the parties enter into a franchise agreement. Consequently, if the franchisor does not own the trade mark, then a Court may find the franchise agreement entered into between the franchisor and its franchisee to be void.
- Franchisors looking to enter the Saudi market via franchising should ensure that they have registered their trade marks before executing the franchise agreement. Given the timeframe required for a trade mark to be registered after it has been filed with SAIP, franchisors looking to recruit prospective franchisees in Saudi should ensure that they allow sufficient time to finalize their ownership of the trademark before the franchise agreement is entered into.
- Franchisors will also be required to produce a franchise disclosure document (“FDD”) and provide this to its prospective franchisees. The information that must be disclosed to prospective franchisees includes the trademarks used to identify the franchise business model. As such, this reinforces the importance under the Law that the franchisor be the owner of the relevant trademarks and that such information be disclosed to the prospective franchisee via the FDD.
Conclusion
This decision, read alongside the earlier Riyadh case concerning the failure to provide an FDD, shows that Saudi courts adopt a robust approach to the substantive requirements of the Law. Where a franchisor grants a franchise without owning the trade mark, the franchise agreement may be declared void and payments made under it will be recoverable by the franchisee.
For further information, please contact:
Melissa Murray, Partner, Bird & Bird
