Franchise vs distribution – what you need to know

To the average person, franchise and distribution agreements sound merely like some pie-in-the-sky commercial arrangement between parties. The prevalence and importance of franchise and distribution agreements is significantly underestimated – a casual stroll through almost any busy street or shopping centre in the UAE will show the result of a variety of franchise and/or distribution agreements. Think of any recognizable restaurant or café brand – it is almost certainly involved in a franchising agreement. Almost any product, whether groceries or medicines, will often be channelled to the consumer through one or more distribution agreements. But, what is the difference between a franchise agreement and a distribution agreement? At a high level, they can often get a little muddled. This article aims to clarify the difference and provide an insight into how such arrangements work in the UAE.

Franchise agreements

In a franchise agreement (think Subway, or any other such restaurant or cafe brand), the franchisor is the party who owns the brand and is selling the rights to a local franchisee, who will run the business using that brand name and know how. The franchise agreement will provide for the royalties which are paid to the franchisor in return for franchising the rights to the specific brand.

It is important to note that there is no specific franchise law in the UAE as yet. The legal framework in this area is comprised of a combination of related legislation such as UAE’s federal laws on Civil Transactions, on Commercial Transactions, to name a few.

Distribution agreements

Distribution agreements, as the name suggests, are often used in order to import and distribute goods into and within the UAE. Distribution agreements are also covered by the UAE’s Civil Transactions Law and Commercial Transactions Law. However, the UAE Commercial Agencies Law may also apply to distribution agreements, which often adds a layer of complexity to supplier-distributor relationships.

A foreign supplier who wants to sell its goods within the UAE has a few options to choose from. It may wish to set up a company in the UAE to do so, or it may enter into an agreement with a third party who can distribute the product(s) on its behalf. Until recently, a distributor had to comply with local ownership rules, which required at least 51% of a trading company to be locally owned. Recently, the UAE’s landmark changes to its Commercial Companies Law made it such that trading companies (with exceptions in some sectors) were no longer subject to local ownership requirements. Nevertheless, in order to benefit from local knowledge of the market, some suppliers may still wish to use a local distributor, or enter into a joint venture with a local individual/company that has experience and connections in the market.

Key differences

One of the differences between the above arrangements is the know-how aspect. In franchise agreements, the franchisor’s know-how and branding is key, and must be executed appropriately by the franchisee. On the other hand, a supplier under a distribution agreement will not be sharing know-how; rather, only the right to sell its products onto third parties in the geographical region. Accordingly, franchisor’s often exert a much greater level of control over the practical execution of the franchise, whereas the supplier in a distribution agreement is far less involved.

Arguably the key difference between franchise and distribution agreements is the additional protections that come into play for distributors through the Commercial Agencies Law when a distribution agreement is registered with the UAE Ministry of Economy. This can only happen when the agreement meets certain specific criteria, i.e., (1) the distributor must be a UAE national/company or wholly owned by a UAE national/company, (2) the arrangement is exclusive in relation to the all or part of the UAE, and (3) the agreement is notarised.

In such cases where the distributor is recognised as a commercial agent under the Commercial Agencies Law, it becomes extremely difficult for the supplier to terminate the relationship. The distributor can enforce the exclusivity privilege, and the agreement may only be terminated by the with a justifiable cause – in practice, this is a high threshold and termination often requires the consent of the distributor.

Franchise agreements and, to a greater extent, distribution agreements can have a significant impact on businesses. Obtaining appropriate legal advice that is tailored to the industry and the specific parties is key to avoid additional problems and disputes down the line.

A potential change

The Commercial Agencies Law might soon be amended to allow for deregistration of a commercial agent and termination of a registered distribution agreement. As covered above, this is possible under the current law, but it is difficult to achieve in practice.

The removal of local ownership requirements through the Commercial Companies Law was initially thought to impact commercial agencies, however, the registration of such agreements/agents as described above still require local ownership.

Whether we will see further changes to bring greater balance between the franchisor-franchisee / supplier-distributor relationship is yet to be seen. Nevertheless, the UAE remains an attractive market for franchisors and suppliers in many industries.

About the author

Taronish Mistry joined BSA Ahmad Bin Hezeem & Associates in March 2020 and is part of the Corporate and Commercial practice in our DIFC office.

He is currently developing his experience in the UAE across numerous sectors including banking, restructuring, employment and real estate. He regularly contributes to client updates and legal articles for well-known publications.