12 Jul What clauses might you expect to see in a Franchise Agreement?
There is no such thing as a standard Franchise Agreement. However there are certain things that all Franchisors will try to control using their agreement. This need for the Franchisor to maintain control gives all Franchise Agreements a common flavour.
There is sometimes a misconception that the Franchise Agreement is designed to protect both Franchisor and Franchisee. There is however little contained in a Franchise Agreement which is designed to protect a Franchisee and this is often a source of disappointment to the Franchisee once the documents are reviewed. Franchisees do however enjoy significant protection given at common law, from legislation such as the Franchising Code.
The purpose of the Franchise Agreement is to set up a relationship and ensure that the Franchisee conforms to the Franchisor’s requirements. If the Franchise system is poorly run it is unlikely that the Franchisee will find any solution in the Franchise Agreement.
The purpose of this article is to list some of the more common clauses that a Franchisee will encountered when reviewing a Franchise Agreement. It is essential to understand the Franchise Agreement before buying in.
Term – The Franchisee should aim to get the longest term possible. The term needs to be at least long enough to recover the capital expended and then make a profit in each year of operation. There is no standard term, and in many systems, less than 10 years is in our opinion not sufficient.
Right of Renewal – The agreement should provide the Franchisee with the option to renew for a further term. If there is no right of renewal then this is likely to impact upon the sale price that the Franchisee can achieve when the Franchisee wants to sell. When the time comes to sell a buyer is unlikely to pay for a Franchised business which could end within five years.
Lump sum “one off” Fees – Some Franchise Agreements impose lump sum fees upon Franchisees. If the fees are too high then it is not possible for the Franchisee to obtain a return on capital. Some of the lump sum fees to look out for are:
- initial franchise fees upon entering into the Franchise Agreement
- further fees when extending the franchise for a further period
- a sale fee when selling the franchise
- Franchisors legal fees
Some of these fees such as the sale fee can require a payment to the Franchisee, which is a percentage of the value of the business. This fee can run into tens of thousands of dollars. Franchisees unfortunately sometimes ignore delayed fees when entering into a Franchise Agreement however all fees need to be taken into account in the business plan.
In addition to these lump sum fees there are almost always ongoing fees that must be paid.
Ongoing fees are usualy made up of:
- a Franchise fee which is the royalty which the franchisee receives for the use of the Franchisor’s intellectual property.
- advertising or promotion fees relating to the promotion of the Franchise Agreement which should be paid into an audited trust account.
- administration fees relating to the administration of the system.
- the income the Franchisee is likely to make from joining the Franchise system.
- the level of support which one might expect to receive from the Franchisor.
- the detail of the advertising, marketing and promotion that will be undertaken by the Franchisor.
The proof will be in the pudding. The Franchise Agreement may not document the kind of support that the intending Franchisee will receive. The best way to identify what is on offer is to make contact with other Franchisees. The contact details of all Franchisees must be made available to the intending Franchisee in the Disclosure Document.
Increases in Fees
The Franchisor may have the right to increase fees without any agreement from the Franchisee.
The Franchisee will almost always be asked to pay the Franchisor’s costs of preparing the Franchise Agreement as well as their own costs.
The Franchisee may be allocated a territory, however, that territory may not be exclusive. The Franchisor may be entitled to compete with the Franchisee. Often the territory allocated is very small and it may even be as small as the shop itself. Whether these things are reasonable will depend upon the kind of business involved and the way in which the Franchise system is operated.
The Franchise Agreement may provide that the franchisor retains ownership of all goodwill in the business. Whether this is reasonable again is dependent upon your circumstances and the background of the transaction.
Power of Attorney
Franchisors will often require a power of attorney in favour of the Franchisor. The terms of the power of attorney must be carefully examined to ensure that the power is not too broad.
The Franchisee may be required to keep financial and other records, in a particular way. The Franchisee must allow the Franchisor a right to examine all of these private financial records. These types of clauses can be very onerous and should be carefully examined. They may include the obligation to pay auditors costs if records are inaccurate, even in a minor way.
The Franchise Agreement may provide that the Franchisee agrees to anything that, the Franchisor decides to include in the operations manual. This can create a complicated state of affairs where it is not possible to know what the Franchisee may have to agreed. The operations manual is often not provided to the intending Franchisee until after the Franchise Agreement is signed. Any intending Franchisee must carefully review the operations manual as soon as possible and obtain legal advice if the requirements are unreasonable.
Clauses relating to training should oblige the Franchisor to provide training and will compel the Franchisee to attend. There may be other costs associated with training.
The Franchisee may be required to attend
- Annual conferences;
- Area workshops;
- Annual special training.
Usually the Franchisee can be asked to undertake further training at any time.
A Franchisee may even be required to make their shop available to the Franchisor at no charge so that the Franchisor can use it to train other Franchisees.
Restraint Against Trade
Almost every Franchise Agreement contains a restraint against trade. Whether a Franchisee should agree to a restraint of trade depends upon their particular circumstances. If, for example, an intending franchisee is a mechanic, the franchisee may not be in a position to agree to a restraint. Any restraint could prevent the Franchisee from earning a living when the Franchise Agreement ends. People who bring particular skills to the Franchise system may argue that they should not be restrained.
The restraint may also prevent the franchisee from operating any other business while the Franchise continues.
The end of the Franchise Agreement
Pay particular attention to what a franchisee is required to do when the Franchise Agreement ends.
If the Franchised business is operated from commercial premises then there will be a commercial lease associated with the Franchise Agreement. What happens if the lease ends while the Franchise Agreement is still continuing? Who controls the lease of the premises? Who holds the obligations in relation to the leased premises? This is a particularly touchy issue in Franchising and care must be taken to ensure that the lease and Franchise Agreement work together to produce a fair result.
Some Franchise Agreements will force the sale of the Franchise Agreement in the event that an owner or manager dies or is incapacitated.
A franchisee will only be entitled to sell a Franchised business to a third party with consent from the Franchisor.
Certain criteria will have to be met for consent to be granted. The Franchising Code provides that Consent must not be unreasonably withheld. The Franchisor may try to control the conditions which are included in the third party sale agreement.
The Franchise Agreement often gives the Franchisor a first right of refusal to purchase the Franchise. The drafting of these conditions should be checked by the intending Franchisee to ensure that the required sale conditions and the conditions of the first right of refusal will not hamper the Franchisees ability to sell the business.
Operation of the business
The Franchisor wants to control the way the Franchisees business is operated. This is of course to be expected. This may mean that the Franchisee is encouraged to purchase from approved suppliers.
There is no limit to the different kinds of clauses that can be included in a Franchise Agreement. Above is a sample of some common clauses.
Franchise Agreements also generally include guarantees and indemnities. It would be wise for Franchisees to structure their affairs correctly and make their initial contact with the Franchisee only after speaking with a lawyer about asset protection
If we can assist you with your Franchising needs please contact us.