Executive Order (“EO”) No. 169 defines “franchise” as “a contract or agreement between a franchisor and a franchisee where: (i) the franchisor grants to the franchisee the right to operate a business according to the franchise system and during a term as determined by the franchisor; (ii) the franchisor grants the franchisee the right to use a mark, or a trade secret, or any confidential information or intellectual property owned by the franchisor or relating to the franchisor; (iii) the franchisor possesses the right to control the administration over the franchisee’s business operation during the franchise in accordance with the franchise system; and (iv) in return for the grant of the above rights, the franchisee is required to pay a fee or other form of consideration.”

Notably, EO No. 169 specifically applies to franchises involving micro, small and medium enterprises (“MSME”). Nevertheless, this definition is conceptually broad enough to encompass any type of franchise.

Currently, there are no laws or rules that specifically regulate the requirements for the offer and/or sale of a franchise.

Franchisors and franchisees which are juridical entities must be duly registered in their origin country to have the legal capacity to enter into franchise agreements. In the Philippines, domestic corporations must be registered with the Philippine Securities and Exchange Commission (“SEC”) and comply with post-registration requirements. Other than the foregoing, there are no specific registration requirements for franchisors and franchisees.

With respect to franchise agreements, there are registration requirements which differ depending on whether it involves MSMEs as franchisees.

As a general rule, under the Intellectual Property Code of the Philippines (“IPC”), franchise agreements need not be registered with the Documentation, Information and Technology Transfer Bureau (“DITTB”) of the Philippine Intellectual Property Office (“IPO”) if they comply with the provisions on voluntary licensing, particularly the prohibited and mandatory clauses under Sections 87 and 88 of the IPC.

Relevantly, the provisions under Sections 87 and 88 of the IPC apply only when the agreement involves a Technology Transfer Arrangement (“TTA”) which are broadly defined as “contracts or agreements involving the transfer of systematic knowledge for the manufacture of a product, the application of a process, or rendering of a service including management contracts; and the transfer, assignment or licensing of all forms of intellectual property rights, including licensing of computer software except computer software developed for mass market” (IPC, Section 4.2).

Rule 1 (n) of IPO Memorandum Circular 2020-002 further qualifies the definition of a TTA to those that involves the transfer of “systematic knowledge.” The term “systematic knowledge” is not specifically defined under local regulation or jurisprudence and remains subject to interpretation.

Assuming the agreement is a TTA, under Section 91 of the IPC, an exemption from the application of Sections 87 and 88 of the IPC may be allowed upon application with the DITTB and only in exceptional and meritorious cases where substantial benefits will accrue to the economy.

If the franchisee is an MSME, the franchise agreement must meet the minimum terms and conditions as provided under Section 2 of EO No. 192 and be registered with the Philippine Department of Trade and Industry (“DTI”). Further, the said EO provides that it is the obligation of the franchisor to register the franchise agreement with the DTI, as well as execute an undertaking that all future franchise agreements with MSME franchisees shall incorporate the minimum terms and conditions prescribed under the said EO.

DTI issued Bureau Order No. 10-24 which advises the prospective franchisee to secure from the franchisor Disclosure Information, consisting of information regarding its corporate existence and franchise operations, among others, as part of its due diligence measures before deciding to engage in or acquire a franchise business.

Notably, the issuance is merely an advisory and does not impose an obligation on the part of the franchisor to provide Disclosure Information. Neither does it indicate a prescribed manner or format by which the information should be disclosed to the requesting franchisee.

Disclosure by the franchisor to the franchisee is currently not required under Philippine law [cf. item 3].

In the absence of a standalone franchise law in the Philippines, the general law on contracts shall apply. Thus, if the consent of the franchisee is vitiated by mistake, violence, intimidation, undue influence or fraud, the franchisee may have the contract annulled (Philippine Civil Code, Article 1390), despite a disclaimer in the franchise agreement, disclosure document or sales material. However, if the franchisee has been made aware of facts and circumstances which requires the conduct further due diligence, it may be construed as implied acquiescence or consent.

It is legal to issue a franchise agreement on a non-negotiable, “take it or leave it” basis. A contract of adhesion, wherein one party imposes a ready-made form of contract on the other, is as binding as ordinary contracts because the party who adheres to the contract is free to reject it entirely. Nevertheless, its validity or enforceability is dependent on the peculiar circumstances and the situation of the parties concerned (Dio v. St. Ferdinand Memorial Park, Inc., G.R. No. 169578, 2006).

Trademark rights and protection shall be acquired through registration made validly in accordance with the provisions of the IPC (IPC, Section 122). However, trade names are protected, even prior to or without registration, against any unlawful act committed by third parties (IPC, Section 165). Meanwhile, literary and artistic works are protected by copyright from the moment of their creation even without registration (IPC, Section 172). Similarly, undisclosed information, which may include trade secrets and know how, are likewise granted protection even without registration (IPC, Section 4).

There are currently no franchise-specific laws or government agencies exclusively regulating the ongoing relationship between the franchisor and the franchisee. The relationship between franchisor and franchisee is governed by the Philippine Civil Code provisions on contracts, the IPC for TTAs, and EO No. 192 for MSME franchisees.

The franchise industry in the Philippines self-polices its own ranks through franchise associations, such as the Philippine Franchise Association (“PFA”). The PFA is a self-regulating governing body for franchising in the Philippines and a private association which is not connected with the government. Membership therein, or in any franchise association, is purely voluntary.

Section 15 of the Philippine Competition Act (“PCA”) generally prohibits entities from abusing their dominant position by engaging in conduct that would substantially prevent, restrict or lessen competition. Particularly, the PCA prohibits the imposition of restrictions on the contract for sale of goods or services but also identifies franchising, licensing, exclusive merchandising and distributorship agreements, which give each party the right to unilaterally terminate the agreement, as permissible.

Notably, the PCA must be read in conjunction with the IPC which prohibits clauses expressly enumerated under Section 87 and other clauses which similarly have anti-competitive effects. These clauses are considered prima facie to have an adverse effect on competition and trade.

In-term and post-term non-compete and non-solicitation clauses are generally enforceable in the Philippines and are not necessarily void for being a restraint of trade as long as there are reasonable limitations as to time, trade, and place, which may be assessed on a case-to-case basis.

The IPO has previously allowed non-compete clauses for a period limited to one (1) year from the termination of the agreement. However, in Blue Sky Holdings Limited v. DITTB, IPO Appeal No. 05-2012-0001 (30 April 2013), the IPO ruled that a non-compete clause for a period of 2 years following the termination of the franchise agreement is a prohibited anti-competitive clause. Notably, however, the IPO stated that, while a request for exemption may be granted by the DITTB on a case-to-case basis, the franchisor failed to provide evidence of substantial benefits that will accrue to the economy as a result of the agreement.

Article 1159 of the Philippine Civil Code expressly states that “obligations arising from contracts have the force of law between the contracting parties and should be complied with in good faith.” If one of the parties acts in bad faith, such party is liable for damages (Philippine Civil Code, Article 1170).

Philippine jurisprudence uses the four-fold test in determining if there is an employer-employee relationship between parties, which considers the: (1) selection and engagement of the employee; (2) payment of wages; (3) power of dismissal; and (4) power of control.

The power to control the employee is the most important factor and pertains not only to the result of the work to be done but also the means and methods by which the same is to be accomplished.

The existence of employer-employee relationship is determined by law and not by contract. Thus, if the four-fold test is satisfied, there is a risk that the staff of the franchisee could be deemed as the employees of the franchisor. To mitigate this risk, it must be clear from the franchise agreement that the means or methods to be employed in attaining the mutually desired results by the parties must not be dictated by the franchisor.

Article 1868 of the Philippine Civil Code defines the contract of agency as one whereby a person binds himself to render some service or to do something in representation for or on behalf of another with the consent or authority of the latter. Thus, as agency is principally a matter of contract, it must be clear from the franchise agreement that the franchisee is not an agent of the principal.

There are currently no specific laws and regulations that affect the nature and payment of royalties to a foreign franchisor. As to the interest, Article 2209 of the Philippine Civil Code states that if the obligation consists in the payment of a sum of money, and the debtor incurs in the delay, the interest shall be what is agreed upon by the parties, and in the absence of stipulation, the legal interest, which is 6% per annum. Based on the foregoing, the interest will be what is stipulated in the franchise agreement.

Article 1226 of the Philippine Civil Code permits parties to impose contractual penalties for breach of contract. In such case, the penalty shall substitute the indemnity for damages and the payment of interests in case of noncompliance, if there is no stipulation to the contrary.

Generally, the parties may freely establish such stipulations, clauses, terms and conditions as they may deem convenient, provided they are not contrary to law, morals, good customs, public order, or public policy. In case of the imposition of interest as part of the contractual penalty, the same must be in accordance with usury laws. Since the effectivity of the Usury Law is suspended, the lender and borrower may agree on the interest, provided that the same is not unconscionable.

Value-Added Tax (“VAT”)

The Philippine National Internal Revenue Code, as amended (“NIRC”) imposes a VAT equivalent to 12% of gross receipts derived from the sale, barter, exchange or lease of goods or properties. The licensor is liable to pay the VAT if such licensor transfers or leases the right to use intellectual property in the course of trade or business. The transaction is subject to VAT irrespective of the place where the license agreement is executed provided that the property is leased or used in the Philippines.

Final Tax on Royalties

The NIRC also imposes a final tax on royalties, the rate of which depends on the taxpayer involved, i.e., an individual, a non-resident alien not engaged in trade or business in the Philippines, a domestic corporation, and a non-resident foreign corporation.

If the agreement is a TTA, it is mandatory that the Philippine taxes relating to the same be borne by the licensor pursuant to Section 88.4 of the IPC.

With respect to the specific terms in franchise/license agreements in relation to e-commerce, the same is subject to the agreement of the parties, provided that such terms are not contrary to law, morals, good customs, public order, or public policy.

With regard to data protection relevant to the franchisor-franchisee relationship, Section 4(g) of the IPC, provides that “intellectual property rights” includes the protection of undisclosed information such as client databases. In terms of non-disclosure and confidentiality obligations, the parties are generally free to stipulate on the specific terms and periods in the contract. It is also possible to impose a non-disclosure obligation on the licensee following termination of the licensing agreement, as there is no legislative prohibition on the matter.

Apart from the foregoing, there are no existing laws restricting the transfer of the franchisee’s rights and obligations under the franchise agreement and the franchisee’s ownership interest. The same is subject to the agreement of the parties provided that they are not contrary to law, morals, good customs, public order, or public policy.

Grounds for termination and procedural requirements, including matters such as survival of terms, extension or renewal of the agreement, filing requirements or other termination formalities, are subject to the agreement of the parties.

An agreement can be terminated on the ground of default, and the parties are free to stipulate on what are deemed events of default. The parties may also agree on the effects of such events of default, for instance, by adopting an automatic termination clause. The PCA provides that franchising, licensing, exclusive merchandising and distributorship agreements which give each party the right to unilaterally terminate the agreement are permissible.

In case of insolvency, applying Section 57 of the Financial Rehabilitation and Insolvency Act of 2010, a license cannot be unilaterally terminated on the ground of mere insolvency of the licensee or licensor and will remain valid and effective despite a subsequent declaration of the insolvency of either or both parties.

As discussed in item 19 above, the grounds for termination and procedural requirements are subject to the agreement of the parties.

Post-termination or post-expiry terms are subject to the agreement of the parties, provided that such terms must not be contrary to law, morals, good customs, public order, or public policy.

Generally, however, pursuant to the standard confidentiality clauses in franchise/license agreements, trade secrets and other confidential information, which may include customer data, are not retained by the franchisee upon expiration or termination of the franchise/license agreement.

As stated in item 9 above, the PFA is a franchise association in the Philippines where membership is purely voluntary. Nevertheless, membership in the PFA is commercially advisable since it adds credibility to the franchise business and guarantees the franchise’s clientele that it adheres to the Fair Franchising Standards implemented by the PFA and adhered to by its members. Further, it gives the business a platform for expansion opportunities and can provide support to the business in case of issues relevant to the business’ sector.

Foreign equity ownership is restricted or limited as enumerated in the Foreign Investment Negative List (“Negative List”) issued pursuant to the Foreign Investment Act, as amended, which periodically cover investments areas/activities which are open to foreign investors and/or reserved to Filipino nationals. The maximum amount of equity that can be held by a foreign national in a corporation will therefore depend on the nature of business activity that it will engage in.

If the franchisor is a branch office or a domestic corporation which will have foreign ownership that exceeds 40% of its outstanding capital stock, the minimum inward remittance or paid-up capital in said entity should be at least US$200,000.00 or its equivalent, provided that the line of business of the entity does not fall under any of the nationalized activities under the Negative List. Under the  most recently issued list, the business of operating a franchise is not among the nationalized or partly-nationalized activities in the Philippines.

Parties are generally free to stipulate on the governing law for the contract. However, if the agreement falls under the definition of a TTA, it is mandatory for the agreement to provide that the laws of the Philippines shall govern the interpretation of the same and in the event of litigation, the venue shall be the proper court in the place where the licensee has its principal office. Otherwise, the TTA unenforceable in the Philippines.

In case of franchise agreements governed by a foreign law, resort to dispute resolution such as arbitration would be more advantageous as this allows parties to freely stipulate on the governing law for the enforcement of the agreement, a forum convenient for the parties or a neutral forum, the language to be used, and the members of the deciding tribunal, which they deem mutually beneficial for their respective interests.

Under Philippine law, parties may generally freely agree on the place of arbitration pursuant to Section 30 of the Alternative Dispute Resolution Act of 2004 (“ADR Act”). If the agreement involves a TTA, and the parties provide for arbitration, the IPC requires the agreement to include a specific provision on arbitration (see Section 88).

There is no legal requirement in the Philippines for an agreement to be drafted in a certain language, but in practice, most commercial documents are in English. Moreover, if an agreement which is not in English is to be submitted for recordal with the IPO, it must be accompanied by a verified English translation.

Contracts shall be obligatory in whatever form they may have been entered into, provided all the essential requisites for their validity are present. Moreover, the use of electronic signatures is valid and recognized under the E-Commerce Act. However, there is still no jurisprudence where the due execution or authenticity of a digitally-signed contract is in issue.

Apart from the IPO, another agency involved in the regulation of franchise and license agreements in the Philippines is the PCC. At present, the review of franchise and license agreements are done by the IPO, particularly the DITTB, including the determination of whether the agreement has anti-competitive effects.  There are discussions on the transfer of their review from the IPO to the PCC, but it has yet to be formalized into a bill. If codified into law, it would have an impact on franchise relationships since the transfer would entail compliance with a new set of stricter regulations that the PCC would enforce.