Franchise and Distribution: Similarities and Differences

Authors: Mykolas Jakutis, an Assistant to Attorney-at-Law in METIDA, Erikas Saukalas, an Associate Partner, Head of International Relations Division in METIDA 

The terms ‘franchise’ and ‘distribution’ are often confused. Franchise is defined as a contract under which the holder of certain rights undertakes to grant the rights to the user: the right to the company name, trade or service marks, protected commercial/manufacturing information, etc., whereas a distribution contract refers to an undertaking of one party (the distributor) to purchase, in its own name and for its own account, goods or services offered by another party (the manufacturer/vendor) and sell them on to the end user.

In order to fully understand the two terms, it is important to bear in mind that only firms rather than natural persons striving to do business as private entrepreneurs can act as parties to a franchise contract. Franchise contracts are used in different industries, a number of world-famous companies, e.g. McDonald’s fast food restaurants, Raddison and Hilton hotels, etc. operate as franchises. In Lithuania franchise-based businesses include McDonald’s restaurants network, Statoil petrol stations, Zara clothing stores, The Body Shop body care stores and many others.

Distribution relationship between parties is created when a manufacturer or re-seller of goods does not own an established and developed distribution network that would allow him/her to deliver the goods to the end-user or strive to set up an additional goods’ network. The main similarities and differences of the contracts are outlined below.

Similarities:

  • Both franchise and distribution contracts can be close-ended or open-ended;
  • When limitations are imposed on the rights of the parties to a franchise or a distribution arrangement, the tailored limitations of each specific contract can’t be contrary to competition provisions.

Differences:

  • The Civil Code of the Republic of Lithuania (CC RL) provides for the franchisee’s right of sub-franchise which entails an authorization under which the franchisee can permit other persons to use all or a part of the exclusive rights granted to him. The possibility of ‘sub-distribution’ is not provided in the CC RL.
  • Franchise is a contract for pecuniary interest and entails the payment of a periodic or one-off fixed fee from the franchisee’s revenue, or a fee calculated using another method stipulated in the contract. In a distribution arrangement pecuniary interest is included merely as an additional compensation collected by the distributor for proper fulfilment of the contract, additional services or works.
  • Contract of franchise grants certain rights and duties to its parties. The CC RL does not regulate the rights gained by the franchisee and the rights holder therefore the parties are free to make all the arrangements; their agreement, however, can’t conflict with imperative legal provisions, public order and good morals. Nonetheless, the Civil Code provides for certain rights of the parties. Unlike in the case of contracts of franchise, rights and duties of parties to a distribution contract are set forth in the CC RL.
  • CC RL sets forth termination grounds of a contract of franchise (upon the end of the period when the franchisee’s exclusive rights expire; in the event of bankruptcy proceedings being started; in the event of the death of the franchiser or the franchisee when their rights under the contract of franchise do not pass to a heir who must be an entrepreneur, etc.). CC RL does not speak of similar expiry grounds of distribution contracts.

The comparison of definitions, similarities and differences of contracts of franchise and contracts of distribution reveals that the contracts’ concepts are substantially different in terms of the subject matter of contract. Contracts of distribution provide for an obligation to buy and sell goods/services and perform other works in connection with the purchase and sale, whereas under contracts of franchise the rights holder grants exclusive rights to use the name and mark of his/her firm, etc. Thus, one can conclude that contracts of franchise have a much wider scope than contracts of distribution: contracts of franchise involve the granting of the right to use the name and other exclusive rights of a firm that has already been established and whose market position has been consolidated.

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