The Franchise Agreement

What should you expect from a franchise agreement? The short answer is a complex and detailed commercial contract.

The great majority of franchise agreements are 40 (or thereabouts) pages long and some are well over 100 pages! If you are presented with a short and simple agreement that may not necessarily be a good thing because the agreement does need to deal with a significant number of issues which cannot be addressed in only a few pages. The most important provisions in a legal franchise agreement are:

• Duration

Most franchise agreements last for five years and give franchisees at least two “automatic” renewal options so, provided a franchisee has complied with the terms of the agreement, the franchise will carry on for fifteen years.

The franchisor usually has the ability to change the franchise agreement every five years and require a franchisee to enter into the revised agreement provided it is the franchisor’s “current form of agreement”.

• Exclusivity

By no means all franchise agreements give franchisees an exclusive territory and indeed in a retail based franchise you would generally not expect any exclusivity to be given.

• Fees

In franchising fees are payable by franchisees. The initial fee is the lump sum capital sum that franchisees have to pay for taking the franchise. This fee should not contain a significant profit element for the franchisor. Its purpose should be to reimburse the franchisor the very substantial costs incurred in recruiting and training franchisees.

There is also a continuing fee (very often referred to as a management service fee) which is usually calculated as a percentage of a franchisee’s turnover (8-9% is average) and a marketing/advertising fee to enable the franchisor to promote the brand nationally, of around 2.5%.

If franchisees have to purchase products or services from the franchisor or its nominated supplier, the franchisor may earn a profit or retain discounts (if so, that would need to be specified in the franchise agreement) and that should reduce the other fees that a franchisee pays.

Further, franchisees need “comfort” that they will be able to buy those products or services on reasonably competitive terms.

• Continuing Obligations

Franchisees must comply with the “manual”. The manual is a “living” document which the franchisor updates regularly and sets out the operational obligations with which a franchisee must comply.

Ideally franchisees would be shown a copy of the manual before they commit to the franchise agreement.

• Resales

Franchisees have the right to resell, but only to those persons who are approved by the franchisor because, obviously, the franchisor does not want to be obliged to grant franchises to people who it would not wish to have as a franchisee.

• Termination

There will “tough” termination clauses because it is essential that the franchisor is able to bring the franchise to an end if the franchisee is acting in a way that brings the brand into disrepute.

• Post-termination

There will be provisions to prevent a franchisee from operating a similar or competing business following termination or expiry of the franchise agreement and unlike similar restrictions in employment contracts, these are generally enforceable.

• Minimum Performance

Many franchise agreements contain a minimum performance clause which either requires a franchisee to pay a minimum amount of continuing fees, or to perform to minimum levels, failing which the franchisor can take action which may include termination.

Sometimes these minimum performance provisions are “disguised” in the form of an obligation on a franchisee to prepare a business plan which the franchisor must approve. Either way, the British Franchise Association has made it clear that minimum performance requirements must be set at a relatively low level – no more than 70% of the average performance of franchisees.

• Misrepresentation

In franchising, franchisors are concerned to reduce the risk of being sued for misrepresentation – the making of false statements with a view to inducing a prospective franchisee to enter into the franchise agreement.

Very few franchisors deliberately set out to provide incorrect information but, inevitably, franchisors may be “over enthusiastic” about the attractions of their franchise! As a result, all franchise agreements contain clauses which seek to protect the franchisor from such claims so franchisees should check out a franchisor very carefully before they enter into the franchise agreement.

• Personal Guarantee

If the franchisee is going to operate a franchise through a limited company, then the franchisor will require a personal guarantee from the one or more individuals who have established the franchise company.

Conclusion

You will also need the advice of an expert franchise lawyer on the franchise agreement – use one of the affiliated lawyers that is on the British Franchise Association list because many lawyers (whatever they may claim) do not know enough about franchising to advise properly.

What you should look for from your franchise lawyer is advice as to which provisions are unusual, unfair or unworkable and only those lawyers who are actively involved in the legal aspects of franchising will be able to give you that guidance.

It has often been said that franchise agreements are the most one sided commercial agreements and that, to some extent is true. After all a franchisor is allowing you to use its brand, benefit from its reputation and also make use of all of its know how. In the circumstances it is perfectly reasonable to ensure that a franchisee does not do anything that can harm the franchisor’s brand and thereby damage the investment made by other franchise owners.

Author: John Pratt, Hamilton Pratt Solicitors