Franchising headaches in Indonesia

Franchising is popular in Indonesia. Historically many sectors had market entry restrictions, so many companies preferred not to invest in the pre 1998 Soeharto era, as Indonesia was a rather unknown market. All that changed in recent years, even though investment in Indonesia is still a difficult process compared to more modern economies.

The franchise regulations are an example of how messy investment in Indonesia can be. The 1997 Franchise Regulation is the start of the problem.

Government Regulations 1997

The main thrust of the 1997 Government Regulations (No. 16 of 1997) is that franchise agreements and pre-contract prospectus disclosure needs to be registered by the franchisee with the Ministry of Industry and Trade.  Other noteworthy features are that Article 4 mandates the parties to make it a priority to use Indonesian produced material for the franchise operation.  (Later this requirement morphs into a new creature through a series of Ministerial Regulations.)

Government Regulations 2007

In 2007, the 1997 Government Regulations were replaced by Government Regulation No. 42 of 2007.  The 2007 Regulations put the onus on the franchisor to register the disclosure prospectus while it is for the franchisee to register the Franchise Agreement.  The transitional provisions in the 2007 regulations required pre-existing franchise agreements to be re-registered under the 2007 regulations and they have one year to do so from enactment of the 2007 Regulations.  Failure to comply with registration invites sanctions from the Ministry of Industry and Trade but the regulation is silent on legality of the agreements in the event of breach. On the requirement to use local products, the 2007 Government Regulations use the same broad language as the 1997 regulations: to "prioritize" use of local produce. Not surprisingly, there was no sanction to enforce compliance.

Ministerial Regulations 2008

In 2008, a set of Ministerial Regulations were passed by the Ministry of Trade pursuant to the 2007 Government Regulations.  The Ministerial Regulations were meant to provide the mechanism to implement the Government Regulations.  A problematic feature in the 2008 Ministerial Regulations is this. The franchisor is required to settle all disputes with an existing franchisee before a new franchise operation certificate can be issued to a new franchisee for the same geographical region.  If there is no resolution reached with the franchisee, the franchisor has to wait for six (6) months to pass before a new franchisee can be appointed for that same region. 

Ministerial Regulations 2012

In August 2012, the Minister of Trade signed off a new set of Ministerial Regulations (No. 43/M-DAG/PER/8/2012) to replace the 2008 regulations.  The 2012 Ministerial Regulations still draws its legitimacy from the 2007 Government Regulations although it also mentions a host of regulations on the preamble page apparently related.  The impetus for this set of Ministerial Regulations is apparently to support the local economy by putting in a clear minimum on goods that the franchisee must source locally. This is a move away from the earlier broad language the franchises need only to "prioritize" use of local products.  Article 19 of the Regulations requires 80% of the materials or services to be sourced locally. There is no mention of the measure – e.g. weight or dollar value.  Sanctions against non-compliance are by way of reprimand/fine. Exemption from compliance can be sought for but the criteria for exemption is unknown. 

There are a whole series of important requirements such as

Article 20 requires the Franchiser to "cooperate" with small and medium enterprises "as franchisees and/or suppliers". 
The franchiser and franchisee will need to file reports annually including as to its sourcing.
There are restrictions on terminations.
It is unclear if arbitration is an option.
Display of a new 'Certified Franchise' logo from the Trade Services Offices. 

Decree 7/2013
Another rule hit the newspapers this week. This specifies that master franchisees are limited to 250 outlets. The government's new Decree 7/2013 includes an aim to diversify ownership by putting a cap on owned outlets. KFC's business of 440 outlets and growing will be challenged by this if they are required to divest a large number of them. The government is hoping that this will ensure more owners will have equity in these operations, that it will boost small business ownership. But the industry points out that forcing divestment is pointless since few SMEs will be able to acquire substantial equity ownership of many quite valuable franchise operations.

It is going to be quite difficult for franchisers to comply with much of the rules; indeed existing franchisers need to review their agreements quickly to make sure they can match the new rules with their existing agreements.

Indonesia's government points out that the massive economic growth (40 million people in the middle class and growing fast) driven by the consumer boom will create opportunities for everyone, so is seeking to restrict dominance and ensure local sourcing.