Failure to Disclose: Saudi Courts Enforce Compliance with Franchise Disclosure Requirements

Following the introduction of the Kingdom of Saudi Arabia’s Commercial Franchise Law M22/1441 (“Law”) in 2021, we have begun to see the emergence of case law and guidance from the Saudi judiciary helping to clarify how franchising disputes will be resolved in practice.

A recent dispute has put the spotlight on one key obligation under the Law: the franchisor’s duty to provide the prospective franchisee with a franchise disclosure document (“FDD”). Article 7(1) of the Law obliges the franchisor to provide the franchisee with a FDD at least 14 days before concluding the franchise agreement or from the date of any payment made by the franchisee in relation to the franchise, whichever comes first.

Background

In this case, the plaintiff franchisee entered into a restaurant franchise agreement with the defendant franchisor in exchange for payment of a Saudi Arabian Riyal (SAR) 100,000 non-refundable upfront franchise fee and ongoing 7% royalties. 

The franchisee alleged that the franchisor had not provided a FDD. As a result, the franchisee sought to terminate the franchise agreement early and claimed monetary relief including: (a) refund of the upfront franchise fee, (b) reimbursement of legal fees and (c) compensation. 

The franchisor did not refute the franchisee’s allegation that a FDD had not been provided. Instead, the franchisor argued it was exempted from providing a FDD because the transitionary provisions of the Law exempted franchisors from providing a FDD where the franchise agreement was entered into prior to the implementation of the Law. The franchisor also argued that the upfront franchise fee was non-refundable under the terms of the franchise agreement.

The Court's Decision

The Third Commercial Circuit of the Commercial Court in Riyadh (the “Court”) rejected the franchisor’s reliance on the transitionary provisions of the Law. The Court found that the exemption applies only to franchise agreements predating the implementation of the Law. In this case, the franchise agreement in dispute was entered into following the implementation of the Law. 

The Court ruled that the franchisee has validly terminated the franchise agreement. Under Article 17 of the Law, if there is a substantial breach by the franchisor of its disclosure or registry obligations, the franchisee may seek to terminate the franchise agreement by serving a written notice to the franchisor. 

The Court ruled that the franchisor refund the franchisee its upfront franchise fee and reimburse the franchisee a portion of the franchisee’s claimed legal fees. The court did not award further compensation to the franchisee.

The franchisor sought to appeal the Court’s ruling but was unsuccessful. The Court of Appeal upheld the earlier Court’s ruling and added a further ruling that the franchise agreement be terminated.

Key Takeaways & Conclusion

The 3 key takeaways from this case are:

1. Franchisors must provide franchisees with a FDD as required under Article 7(1) of the Law.
2. Where a franchisor fails to provide a FDD, the franchisee has the right to seek early termination of the franchise agreement under Article 17 of the Law.
3. Contractual clauses preventing refunds may be unenforceable. The courts have broad discretion to require the refund of any fees paid by the franchisee to the franchisor – even if such payments are expressly stated as non-refundable under the franchise agreement. 

This case serves as an important reminder for franchisors operating in Saudi Arabia to ensure strict compliance with the disclosure requirements under the Law. Franchisors should review their existing practices and ensure that a FDD is provided to franchisees within the prescribed timeframes. Failure to do so may expose franchisors to early termination of franchise agreements and the potential loss of fees - regardless of any contractual provisions to the contrary.