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More questions than answers

New franchise regulation in Indonesia



Philip K. Zeidman is a senior partner in the Washington, DC office of DLA Piper US LLP.  He is general counsel to the International Franchise Association.

Phil can be reached at Philip.Zeidman@dlapiper.com

Indonesia is a country as hard hit as any in the region by the Asian financial crisis of a few years ago.

It’s also a land that seems to attract devastating natural disasters with unnerving frequency—volcanoes, earthquakes, tsunamis—and growing numbers of incidents of avian influenza.

It has a political system that often seems dangerously close to breakdown, and a judicial system that too often ranges from inept to corrupt.

At a time of rampant anti-Americanism in the world, it has the largest Muslim population of any nation.

Since 9/11, it’s a country that has seen bombings in Jakarta and Bali, and riots and attacks on Marriott, McDonald’s and KFC, incurring loss of life and property.

So why would any franchisor think about expanding to Indonesia?

For starters, it’s the world’s fourth most populous country, with vast natural resources; a large, educated, easily trainable workforce; a young population, 55 percent below age 30; and a rapidly growing middle class. In addition, there’s increasing urbanization, and Indonesia’s economy is steadily improving with an annual growth rate of approximately 5.6 percent. Per capita income rose in 2005 to the level that existed prior to Indonesia’s financial crisis in 1998.

With improvement in the economy, franchising in Indonesia is growing again. In 2005, Indonesia had approximately 250 foreign franchises and 130 local franchises. In addition to the well-known fast-food franchises that exist in Indonesia, a number of lesser-known companies sell franchises there as well.

All of which has caused multinational franchisors to focus their attention on this country, where foreign franchisors—and especially U.S. companies—have long dominated the franchising presence. And that renewed attention has made it necessary to focus once again on the legal climate for franchising.

That climate just changed again.

Indonesia has had franchise regulations since 1997. A government regulation promulgated that year, together with a more comprehensive so-called “implementing” decree issued by the Ministry of Industry and Trade formed the basis of Indonesia’s “franchise law.” Despite the franchise law being in force for almost a decade there have always been uncertainties with respect both to its meaning and its implementation.

At its heart, the franchise law is a moderately demanding set of disclosure requirements, coupled with specific clauses that must be included in a franchise agreement, obligations to register the franchise agreement (and related documents) and for the franchisee to obtain a franchise business registration certificate. This has been a relatively document-intensive process. While the disclosure document is not required to be in the Indonesian language, the franchise agreement is, and must be subject to Indonesian law.

There have always been some peculiarities of the regulatory scheme. While the required disclosures are manageable, the reference to “other matters needed to be known by the franchisee” introduces a troubling degree of subjectivity. At the time of registration of the franchise agreement with the contractual disclosure attached, the Ministry of Trade may “suggest” additional information. The consequence of false or inaccurate information can be more severe: private remedies; and, under general Indonesian law in the event of fraud, even the possibility of criminal penalties. And the statutes of limitation cast long shadows: 30 years, for example, for civil suits.

But it is in the area of the substantive franchisor-franchisee relationship where some provisions with which franchisors are typically unfamiliar have cropped up. A master franchisee must operate at least one unit of its own, in addition to sub-franchising. More serious is the “clean break” requirement, which essentially permits a terminated franchisee to maintain a stranglehold over the appointment of a new franchisee. Another concern is the vague requirement of a preference for domestic goods by the franchisor and the franchisee, and a required priority to “small-and-medium scale” enterprises as both franchisees and suppliers. Under Ministerial Decree 259 there could be governmental restrictions on cities in which franchises can be located, and limits on the appointment of franchisees in proximity to one another “if it…should be understood that the appointment of more than one franchisee may result in the franchised business not being feasible to run.” And a government official could “give his counsel about an improvement to a franchising agreement …in order to protect the interest of the franchisee.”

A new Regulation of the Minister of Trade was passed in March this year. Among the changes, under the current franchise regulations a franchise agreement between a franchisor and a master franchisee must be valid at least 10 years, while a franchise agreement between a master franchisee and franchisee must be valid at least five years. Under the previous franchise regulations the franchise agreement has to be only for a minimum period of five years.

Following the passing of Regulation 12, some of the new questions which arise:

• What additional obligations does the franchisor have by virtue of the requirement to “provide sustainable operational consultancy support”?

• What are we to make of the Indonesian language provision, removed from Ministerial Regulation 12 but still present in Government Regulation 16?

And would removal of the requirement be realistically meaningful in any event, in light of the requirement of registration?

Welcome to the confusing world of Indonesian franchise regulation.

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