The legal issues of buying a franchise
When looking to acquire a franchise it is crucial that you do your homework and carry out all the relevant checks on the franchisor and the concept itself, counsels Nicola Broadhurst
The franchise agreement is probably the most important document in the transaction process as it is the legal commitment, which is binding on both you and the franchisor. If after signing the contract you discover it is more onerous than you thought you cannot simply give up and walk away. Invariably you will have to negotiate an exit with your franchisor, usually involving payment or ultimately seek redress through the courts.
Therefore, before you sign any franchise agreement you must ensure that you have checked it yourself and had the agreement reviewed by a specialist franchise lawyer, preferably one who is affiliated to the British Franchise Association (bfa), as they will have proven franchise experience and be aware of the bfa's code of ethics.
A franchise agreement is not a standard commercial agreement, it is usually non negotiable and one-sided being weighted heavily in favour of the franchisor in order to protect the franchisor's intellectual property. A specialist franchise lawyer recognises this fact, which avoids issues being raised that a franchisor would not be prepared to negotiate on and are irrelevant in the context of franchising. This should also prove more cost effective. A specialist would, therefore, be able to advise on those areas that are standard to all franchise agreements and those areas that may well be in breach of the bfa's Code of Ethics and should validly be challenged with the franchisor.
Most franchise agreements are issued to prospective franchisees as non-negotiable agreements. This is justified on the basis that the franchisor is preserving uniformity in the network and not treating one franchisee more favourably than another. This should not be accepted at face value. If the agreement contains unethical provisions or does not reflect everything that has been promised to the franchisee then this needs to be addressed, usually by way of a side letter to the agreement. The side letter will vary the franchise agreement where applicable and have contractual force.
What to expect from a franchise contract
The franchise contract should briefly describe the concept, who owns the knowhow, trade mark and system. If the franchisor is a licensee of the concept or trade mark owner this should be stated to avoid any ambiguity.
2.The rights granted
A franchise is always granted, never sold - ie. the rights to use the trade mark, expertise, trade connections and all the other things that comprise the franchise package are given only for a specific period of time and subject to certain terms and conditions. On expiry of the agreement all rights revert back to the franchisor. It must be clear whether the rights being given are exclusive, sole or non-exclusive.
The grant of the franchise is usually for a specific term of years. As a general rule the length of the initial term must be long enough to allow the franchisee to recover its capital investment and enjoy at least two years profit. In practice this is usually five or 10 years.
Most franchise agreements allow the franchisee the option to renew for at least one further term, but this right tends to be conditional. Any renewal fees must be looked at carefully.
The franchisor's initial obligations should include an obligation to provide the operations manual, one of the most essential parts of the franchise concept as it contains the day to day detail of the business. The franchisor's continuing obligations should state what advice, support and consultation will be given and at what price. The franchisee's obligations are usually far more detailed and extend to almost every area of the franchised business.
The payment provisions should be unambiguous. Ability for the franchisor to increase fees during the term of the agreement should be resisted unless they are clearly justifiable. The fees usually consist of a royalty or continuing franchise fee, which tends to be calculated as a monthly percentage. Occasionally fixed fees are charged rather than a percentage, but these can penalise a franchisee when he is not succeeding.
The agreement usually restricts the way in which the business can be advertised. This helps protect the brand of the franchisor, which is one of its most valuable assets. In some contracts there is an obligation on the franchisee to commit to a minimum spend on advertising or to contribute regularly to a central advertising fund, which is maintained by the franchisor to promote the network. There must be sufficient accountability on the franchisor, who should be obliged to use these funds for advertising purposes only.
- Minimum performance clauses
It is becoming increasingly common for franchise agreements to contain minimum performance targets. Care needs to be taken in their use, there must be minimum targets not maximums and it is preferable for a staggered approach to be taken so that failure does not automatically lead to termination. The figures must be justifiable.
8.Sale of the Business
The franchise agreement should provide an exit route for the franchisee. Usually this is subject to the franchisor's consent, which should not be unreasonably withheld. The conditions that are applicable to the consent being given tend to relate to the eligibility of the prospective purchaser and reimbursement of the franchisor's costs on the sale.
9.Terminating the Relationship
It is rare for a franchisee to have a contractual right to terminate, however, at common law a franchisee may terminate if the franchisor is in fundamental breach of the agreement. The termination clauses tend to be onerous and extensive, allowing a franchisor to terminate on notice on a number of events such as failure to pay fees on time, to provide the accounting information required, insolvency and breach of the confidentiality provisions.
The agreement may also terminate where the franchisee becomes incapacitated or dies. It is important that the agreement provides a period of time within which the franchisee's personal representatives can nominate a beneficiary to take over or arrange a sale of the business.
It is not sufficient for a franchisee to rely solely on the franchisor's reputation without ensuring that the franchisor is tied down to specific contractual obligations. The franchisee should speak to as many existing franchisees as possible to establish whether there have been any problems. Many of the bfa affiliated lawyers offer fixed fee reviews of franchise agreements. These fees, when compared to the total investment costs required for many of the franchises concerned, are minimal and it is wise to take advantage of this service to ensure there are no nasty surprises waiting further down the line.