Legal view: Your rights as a franchisee
The Franchise Agreement defines the relationship between the franchisor and franchisee, which could make it the most valuable piece of paper you own. Jonathan Chadd offers his view on the issues you may need to look into when reviewing the contract
Investing in any new business involves risks. One of the advantages of franchising is the prospect of establishing a new business based on the franchisor's tried and tested model. Of course, this will not guarantee success and it is important for the franchisee to thoroughly investigate the franchise opportunity before committing to it.
The nature and extent of pre-contractual enquiries to be made will depend on a number of factors such as the complexity of the franchise system, the type of products or services to be supplied and the nature of the market. An important source of information is clearly the franchisor and its network. While the matters referred to below are not intended to represent a comprehensive list of enquiries to be made by a prospective franchisee, they do reflect what are likely to be key concerns for most franchisees. The decision to invest in a franchise should not be taken lightly and should involve thorough research into the local market conditions and professional advice on the financial and legal aspects of the venture.
• Pilot Operation
Where the franchisor has operated a pilot franchise to test the business system the franchisor should be able to provide details of the performance of the pilot. It is important to assist the buyer in determining whether the results achieved reflect the current system.
The franchisor may have introduced changes, for good reasons, but the potential effect of these will need to be understood. The financial implications of any additional support that may have been made available to the pilot operation will also need to be factored into the franchisee's business plan.
• Financial Projections
Profit and cashflow forecasts are often provided by franchisors (usually with a 'health warning'). The franchisee should ensure that the source of any figures is identified - ie is the data drawn from the pilot operation or from the performance of franchisees or does it simply reflect the franchisor's aspirations?
Most franchises require the payment of an initial fee and ongoing management service fees. There are also likely to be hidden costs perhaps relating to the acquisition and refurbishment of premises, marketing and promotion, training etc. Again, these costs will need to be reflected in the franchisee's business plan and it is sensible to raise enquiries with the franchisor and existing franchisees to establish the likely extent of these.
• Products and Services
Where the successful operation of the business is dependent on sourcing products and/or services at competitive rates, the franchisor should be able to confirm that it will be able to either meet the franchisee's requirements or that it has appropriate arrangements in place with approved suppliers.
Support, whether by way of training, marketing and promotional activity or regular meetings is extremely important, particularly for a new franchisee at the outset. The franchisor should be able to provide details of programmes of support provided by it and enquiries of the existing network should reveal the effectiveness of such support.
• Intellectual Property
At the heart of franchising is the right for the franchisee to use the franchisor's brand identity. It is important therefore to obtain assurances that the franchisor's rights in trade marks and other proprietary rights relating to the operation of the business are not restricted or threatened by the rights of third parties. If the franchisor's rights are challenged this could have a serious, adverse affect on the value of the franchisee's business.
THE FRANCHISE AGREEMENT
The Franchise Agreement governs the relationship between the franchisor and franchisee. Whilst the franchisee may have obtained assurances to any enquiries made, it is important to ensure that any representations or promises made are confirmed in the Franchise Agreement. Evaluating the franchise opportunity will require an understanding of what rights are being granted and the franchisee will need to look carefully at the following key issues:
Usually an initial term is granted and the franchisee will need to ensure that this is sufficient so as to obtain a return on his investment. Whilst there may be a right to sell the business, the value of the business will reduce towards the end of the initial term where there is no right to renew.
A right to renew the Franchise Agreement is important as it will enable the franchisee to secure the ongoing benefit from a successful business. That said, there may be direct costs on renewal by way of payment of renewal fees or indirect costs through modifications to the business system or introduced by the franchisor's current version of the Franchise Agreement.
• Territory Rights
If an exclusive territory (right to an area) is to be granted are there circumstances in which the territory can be reduced or exclusivity withdrawn? Where no exclusivity is granted how can the franchisee ensure that he derives the benefits from having developed the business in the territory?
• Training and Support
What initial training and launch support will be provided by the franchisor (and at whose cost)? Is ongoing support important and, if so, what contractual right does the franchisee have to ask for support?
• Products and Services
Is the franchisor obliged to provide products and services on competitive terms?
• Right to Sell
Does the franchisee have the right to sell the franchise and, if so, what conditions apply on sale - ie does the franchisor have the right to reject an application for the sale of the business where the purchaser does not meet the franchisor's standards and can the franchisor exercise an option to purchase the business?
It is important to take advice on the Franchise Agreement because it is probable that the franchisor has advised that the terms of its Franchise Agreement are standardised and it is unwilling to change the Agreement. That may be the case although it is not unusual for franchisors to agree minor amendments (and sometimes substantial amendments) by way of a side letter or supplemental agreement.
Even if the franchisor is unwilling to change the Agreement any commercial assessment as to the prospects of the business and the viability of the franchisee's business plan will require an assessment of the Agreement. The franchisee will need to be satisfied that there are reasonable prospects for obtaining a return on the investment in the business over the term.
A report on the Agreement will allow the franchisee to identify which points require clarification, explain precisely what the agreement means and whether there are any serious deficiencies which might cause the franchisee to question any decision to proceed, such as:
• hidden or unreasonable costs;
• restrictions on the franchisee in sourcing products or services from third parties;
• requirements for the franchisee to invest in goods and equipment;
• unusually harsh termination provisions;
• unreasonable conditions on renewal.
WHY SPEAK TO A BFA AFFILIATED LAWYER?
The British Franchise Association (bfa) is the self-regulating governing body of franchising. They appreciate that Franchise Agreements are specialised commercial agreements and commonly contain a wide range of provisions which are peculiar to franchising. A well drafted agreement will be a comprehensive document and should comply with the bfa's code of ethics.
An experienced, specialist franchise lawyer will be familiar with the structure of such agreements, will be able to explain the nature of the Agreement in the context of the franchise industry and identify any unusual provisions or areas of concern.
Although it is the case that Franchise Agreements tend to be weighted in favour of the franchisor this does not mean that individual terms are not negotiable. An experienced franchise lawyer is likely to be better placed than a non-specialist lawyer to identify which issues may be capable of negotiation and to highlight any potential pitfalls.