The most important document in franchising, alongside the operations manual, is the franchise agreement, since the terms within it underpin the whole relationship.

HOW, AND WHEN, TO CHOOSE YOUR LAWYER

It is important to remember that franchising is not a legal relationship with commercial aspects, it is a commercial relationship with legal aspects, and if you are going to franchise your business, domestically or internationally, the last thing you want is a lawyer!

You will most certainly need one, but not until you have worked out all the commercial arrangements, and completed the franchise development plan, so that you know you have a potentially successful network.

You will also need one who is experienced in preparing franchise agreements – not your normal commercial lawyer, not the one who did your house purchase or divorce, not your in-house lawyer if you are a large corporation, and not necessarily one who deals mostly with franchisees.

Many potential franchisors make the mistake of contacting one of the less experienced, saying ‘I’m going to franchise my business, I’ll need a franchise agreement, can you prepare one for me?’ Typically, the reply is, ‘Yes, of course. What would you like in it?’

The problem is that the client doesn’t know what he wants in it if he hasn’t had expert practical advice – and nor does the lawyer. He may know the matters to be considered, and most of them are outlined below, but he won’t know which option to choose.

Regrettably, some lawyers will simply copy a similar document from another franchisor, others will have a stab at recommending the detail. The good ones will ask if the client has prepared a franchise development plan, together with all the financial forecasts, and whether an experienced consultant was involved. If not, they should refer the client back to the consultant first. Beware of those who do not.

While the principles outlined in this book will apply to franchising anywhere in the world, it must be pointed out that we are writing from a UK perspective where we are fortunate in not having to deal with any franchise-specific legislation. Many other countries do have laws which regulate franchising and there may be a greater need for legal advice, although a good consultant in that country will know the legal matters to be considered and will take note of them when structuring the franchise and preparing the development plan.

ITEMS TO CONSIDER

The following are the matters most often covered in a franchise agreement, and some of the options to be considered when deciding the detail, but it cannot be too greatly stressed that the franchise agreement is a document that needs detailed professional advice.

Parties

Who is signing the agreement on behalf of whom. The franchisor may be a subsidiary of the business which originally developed and operated the system; it may be the original business itself; it may a master franchisee of an overseas franchisor.

The franchisee may be a sole trader; it may be a partnership; it may be a limited company set up solely for the purpose of operating the franchise; it may be a limited company already operating an existing business to which the franchise is to be added.

The franchisor will usually decide and control with which type of entity it wishes to be involved. If the franchisee is a limited company it will normally be required to name at least one individual who takes personal responsibility as ‘principal’ for the franchisee’s obligations-thereby removing the protection of limited liability for the franchisee.

The franchisee will be required to make it clear to the public, in a format prescribed by the franchisor, that it is an independent business operating under a franchise agreement with the franchisor, and that it is not an agent of the franchisor and cannot commit the latter’s funds or other resources.

Rights granted

Details the rights granted to the franchisee to use the name, system, trademarks, software and other relevant intellectual property owned by the franchisor, in what territory they can be used, and whether or not those rights are exclusive or non-exclusive. There are commercial pros and cons to all the options and they should be considered with an experienced franchise practitioner.

Term of agreement

Defines when the agreement starts and how long it lasts. The term could be anything from two to 20 years for a simple unit franchise – and there are many matters which influence the number of years. EU legislation affects the term for systems where franchisees are tied to products; banks’ attitudes to lending to franchisees dictate that any lending should be capable of being repaid by the end of the initial term; franchisors may want to limit the time that must elapse before they can enforce certain changes upon renewal; franchisees may not want to sign the agreement if they don’t think they have long enough to take full advantage of the opportunity.

Renewal

The franchisee will normally have the right to renew the agreement at the end of its first term, provided they are not in breach of its terms, and provided they bring their premises and equipment up to date. They will, however, renew on the ‘then current’ terms, which means they sign a new agreement which is the same as that being signed by franchisees now joining the system – they don’t just renew the agreement they already have. There may or may not be a further right to renew at the end of the second or subsequent terms, and the pros and cons again need to be considered as they will vary for every system. There may or may not be a fee payable on renewal but this would normally be much less than the fee payable by a new franchisee.

Fees

All the fees payable to the franchisor by the franchisee – upfront fee, training fee, management services fees, marketing fees, payment for products and services – will be defined, as will the processes for their payment, and the remedies available to the franchisor should they not be paid in full or on time.

Franchisor’s obligations

Usually fairly broadly defined, the franchisor’s obligations are laid out so that the franchisee can see what sort of support will be provided. The level of support will vary greatly from franchisor to franchisor but the items usually included cover training, marketing, business support, updating the operations manual, managing the corporate website and so on.

Franchisee’s obligations

These will be many more in number, and defined in much more detail. What has to be done, how often, who by and how well. They will include marketing, advertising, sales, operational, training, accounting, insurance, compliance, employment, record keeping, reporting matters and approval procedures. There will be a formal link to the procedures and standards laid down in the operations manual, with which the franchisee agrees to comply at all times, and which the franchisor can change at will during the term of the agreement (although common sense dictates that they will not do so in such a manner that will cause problems with, or for, the franchisees).

Premises and equipment

Some franchisors choose to take the head lease on business premises and sublet to the franchisee, but most do not. Those that do may or may not make a mark-up on the rent, or may or may not base the rent on the franchisee’s turnover. There is no right answer and the situation must be assessed for every franchisor, and possibly for every site. The franchise agreement and the lease agreement need to be linked, and once a decision has been taken, the technicalities are definitely a matter for the lawyers. Similar considerations come into play if the franchisee is using bespoke equipment – the franchisor may choose to lease, rather than sell, this to the franchisee, therefore maintaining control of it in the event of a dispute.

Selling the business

Franchisees typically have the right to sell their business as a going concern, but only to a buyer approved by the franchisor, using the same criteria as he would for a new franchisee. These criteria will not just consider whether the incoming franchisee has the right skills and attitudes, but also whether they can afford to buy at the price agreed, depending on how the deal is being financed. The franchisor will usually have the right to pre-empt the purchase by acquiring the business himself (either to operate as a company-owned unit or sell on) on the same terms as those agreed with a third party. The franchisor may or may not receive a percentage of the sale price, ostensibly to cover his approval and training costs, and may or may not additionally be entitled to a further percentage if he found the buyer through his normal franchise marketing efforts.

Death or incapacity of the franchisee

If the franchisee is a limited company it cannot die or become incapacitated but its principal can and there will be provisions in the agreement as to what should happen in such circumstances. The directors of the corporate franchisee, or the executors of a sole trader’s estate, will be given a period in which to appoint a successor as principal, who must be acceptable to the franchisor, and in the meantime to appoint a stand-in to operate the business after receiving appropriate training. Such a stand-in can be provided by the franchisor, at a cost. Should a replacement not be provided, or the business not be sold, within an acceptable period, say six months, the franchise would be terminated.

Termination of the agreement

Sooner or later all franchise agreements are terminated, either by mutual agreement or force of circumstances. The business fails, or is sold; the franchisee dies, or becomes incapacitated; the franchisor terminates because of non-performance or substantial breach by the franchisee; the franchisee just gives up; or the time simply runs out and there is no further renewal. The circumstances in which the agreement can be terminated by the franchisor will vary with each system and will be made clear in the agreement. The procedures will more likely be defined in the manual, and in all cases it is better to try to achieve an agreed solution rather than get the courts involved. Some agreements may insist that methods of alternative dispute resolution are tried first.

Post-termination provisions

Once the agreement has been terminated, for whatever reason, there will be a number of things that the franchisee must either do, or stop doing. These may include ceasing to use all the franchisor’s intellectual property, paying all money due to the franchisor, handing over premises or equipment as appropriate, providing a list of all past and current customers, not being involved in a similar business within so many miles for so many months, not contacting staff or customers, and giving back the operations manual.

The above are the main commercial considerations to be discussed in detail in order to develop a bespoke agreement for every franchisor. The output can then be presented to an appropriately experienced lawyer, either by the potential franchisor or his consultant (although the lawyer will be formally engaged by the client), who will then go on to formalise the wording and add all the necessary boilerplate clauses.

NEGOTIATION

To make life simple, there is no negotiation of the terms of the standard franchise agreement once it has been finally drafted. It is fundamental to practical franchise management, and to successful franchising, that all franchisees joining the system at the same time sign the same agreement and there should be no additions or amendments allowed.

That is not to say, as is often said, that all franchisees in a system are on the same agreement because they will not be. Changes to the standard agreement are made as legislation, good practice or practicalities dictate and the new standard version becomes the ‘then current’ agreement to which all subsequent new, or renewing, franchisees sign up. Until their next renewal, franchisees will be on the agreement they signed when they joined.

All potential franchisees should be advised by the franchisor to take their own independent legal advice before signing the agreement, but they too should choose a lawyer experienced in such matters. An experienced franchising lawyer will know that negotiation is not an option, but that their job is to explain the agreement and its implications to their client. The client then decides whether or not to sign it.

A contents list for an example franchise agreement is presented in Appendix D on page 260.

A list of specialist lawyers will normally be available from the national franchise association of any country, and a list of such associations and their websites is presented in Appendix H on page 273.