THE “ZERO-FEE” FRANCHISE MODEL

Legal Risks of Disguised Material Markup Schemes: When “Free” Entry leads to Operational Insolvency

In the current economic climate, the “Zero-Fee Franchise” model (Nhượng quyền 0 đồng) has emerged as a popular strategy to attract small-scale investors. Under this scheme, the Franchisor waives the Initial Franchise Fee and ongoing Royalty Fees. However, the monetization model shifts entirely to the mandatory procurement of raw materials and equipment at significantly inflated prices.

While legally permissible under the principle of freedom of contract, this model harbors significant legal and financial risks for the Franchisee, often bordering on predatory practices. The following analysis examines these risks under Commercial and Competition Law.

1. The Legal Nature: Franchising or Disguised Distribution?

The core legal issue is determining whether the relationship is truly a “Commercial Franchise” or merely a “Distribution Agreement” disguised as a franchise.

• Franchise Definition: Under Vietnam Commercial Law 2005 (Article 284), franchising requires the transfer of a business system, trademark rights, and operational control.
• The Risk: If the Franchisor does not provide a comprehensive operations manual, training, or ongoing support, but simply enforces a contract to sell ingredients (e.g., coffee beans, tea powder, pre-mixed sauces) at a premium, the contract may be re-characterized by a court as a Sale of Goods contract.
• Consequence: If re-characterized, strict franchise clauses regarding non-compete or control over business premises may be deemed invalid, stripping the Franchisor of their protective legal framework.

2. “Tying Arrangements” and Supply Chain Exclusivity

To sustain revenue without royalties, these contracts contain rigid “Tying Clauses” (Source of Supply restrictions).

• The Mechanism: The agreement mandates that the Franchisee must purchase 100% of essential ingredients (and sometimes non-essential items like napkins or plastic cups) exclusively from the Franchisor or designated suppliers.
• Legal Validity: Generally, maintaining uniformity is a valid justification for sourcing restrictions in franchising. However, when the markup is exorbitant (e.g., 200-300% above market rate), it creates a conflict of interest.
• The Trap: The contract typically classifies sourcing from unauthorized third parties (even for identical generic goods) as a “Material Breach,” granting the Franchisor the right to immediate unilateral termination and imposition of heavy penalties.

3. Disclosure Obligations and the “Hidden” COGS

The most significant legal vulnerability lies in the pre-contractual disclosure phase.

• Decree 35/2006/ND-CP: Mandates that the Franchisor provide a Franchise Disclosure Document (FDD) describing the “estimated initial investment” and “financial obligations.”
• Information Asymmetry: In “Zero-Fee” models, Franchisors often fail to disclose the unit price of mandatory ingredients or the projected fluctuation of these costs. They market the “Zero Fee” aspect while obfuscating the high Cost of Goods Sold (COGS).
• Legal Recourse: If the Franchisee can prove that the Franchisor intentionally concealed the material price structure or provided misleading financial projections (e.g., promising high margins while knowing the ingredient costs would erode all profit), the Franchisee may sue to void the contract due to deception or demand damages for breach of the duty of good faith.

4. Profit Squeeze and Insolvency Risk

While not a direct violation of law, the economic structure of these contracts often leads to a legal dead-end for the Franchisee.

• Lack of Flexibility: In a standard business, if input costs rise, the owner can switch suppliers or raise prices. In this model, the Franchisee is contractually locked into a single supplier (the Franchisor) but is often restricted by the Franchisor’s “Maximum Resale Price Maintenance” policy to keep the brand competitive.
• The Outcome: The Franchisee bears all the market risk. The Franchisor profits from the wholesale of ingredients regardless of whether the Franchisee’s retail store is profitable. This creates a misalignment of interests that is structurally different from standard royalty-based franchising (where the Franchisor only makes money if the Franchisee makes money).

5. Strategic Recommendations for Investors (Due Diligence)

Before entering into a “Zero-Fee” Franchise Agreement, legal counsel must advise the client to:

1. Request a Detailed Material Price List: Demand an annex to the contract listing the current unit prices of all mandatory ingredients and a clear Price Adjustment Mechanism (e.g., prices can only increase in correlation with the CPI or market raw material index).
2. Analyze the “Break-Even Point” with High COGS: Recalculate the financial model assuming the ingredients are 20-30% more expensive than the market rate.
3. Review Termination Clauses: Ensure that “accidental” sourcing of minor items from outside does not trigger immediate contract termination.
4. Verify IP Ownership: Ensure the Franchisor actually owns the trademark. Many “Zero-Fee” schemes are “pump and dump” operations where the brand is not even registered.

CONCLUSION

There is no “free lunch” in the legal or business world. The “Zero-Fee” franchise model is often a sophisticated transfer pricing mechanism. While not inherently illegal, it shifts the financial burden entirely to the operational costs. Investors must scrutinize the Supply Agreement as closely as the Franchise Agreement itself.

📞 CONTACT LEGAL CONSULTANT:

TLA Law is a leading law firm with a team of highly experienced lawyers specializing in criminal, civil, corporate, marriage and family law, and more. We are committed to providing comprehensive legal support and answering all your legal questions. If you have any further questions, please do not hesitate to contact us.

1. Lawyer Vu Thi Phuong Thanh, Ha Noi Bar Association

Email: vtpthanh@tlalaw.vn

2. Lawyer Tran My Le, Ha Noi Bar Association

Email: tmle@tlalaw.vn

Nguyen Hien Mai