A prospective franchisee’s guide to understanding a franchise agreement

A prospective franchisee’s guide to understanding a franchise agreement

Many prospective Franchisees are aware of the much quoted mantra to “take independent legal advice” and many do take advice and embark on their franchise journey secure in the knowledge that they have a full understanding about the nature of the legal relationship with their chosen Franchisor.

Nevertheless, a significant number of Franchisees still decide not to instruct solicitors to review the agreement before they sign. Sadly, it is often the case that those same Franchisees end up spending far more on legal costs having failed to understand what the agreement meant.

The reason many cite for not taking advice is that the Franchisor had made it clear that the agreement was “standard” and could not, under any circumstances, be changed. This stance can mean the prospective Franchisee does not understand clearly the nature of the legal obligations he or she will be bound by. The review is not intended solely to suggest amendments and renegotiation of the agreement, although there may be times when this is appropriate.

By not taking advice, the Franchisee runs the risk of entering into what may prove to be one of the most expensive investments they will ever make, without having an accurate understanding of the “small print”.

Key terms to look out for include:

The length of the agreement

A common misapprehension often occurs around the length of the agreement. Although many agreements are for a fixed term, usually five years, many Franchisees assume they have the right to “resign” from the business, in much the same way as if they were an employee, if things don’t go to their liking. Nine times out of ten, this is not the case. A fixed term from a legal perspective is just that, fixed. Unless the contract provides the Franchisee with a right to give notice to end the franchise, which is most unusual, the only ways in which the agreement can come to an end are expiry, termination by the Franchisor for breach, or by the Franchisee selling the business. The grounds for termination are normally set out in detail in the agreement and the Franchisee needs to understand and ensure that s/he complies with the terms and does not fall into breach, otherwise they could lose their investment.

Selling up

Franchisees often fail to appreciate that their right to sell the business is conditional upon the Franchisor approving the proposed purchaser. It is common practice for the Franchisor to require payment if they have introduced a prospective purchaser which leads to sale. Commissions of up to 10% of the sale price are not unusual. This can come as a shock to the unwitting Franchisee who has already agreed the price with a purchaser and now faces 10% going to the Franchisor. The proposed purchaser must also agree to sign a new franchise agreement with the franchisor.

Hidden extras

All other fees charged by the Franchisor should be expressly set out in the agreement. The most common are the initial franchise fee, a monthly fixed or percentage management services fee, and a marketing levy which the Franchisor uses to fund national advertising and promotion. Increasingly the Franchisor may also charge IT support and website hosting fees.

Territory wars

Franchisees should also carefully check the Grant of Rights section in the agreement, particularly if they think they are getting an exclusive territory. That may not prevent the Franchisor selling into the territory, or the Franchisor operating a website which prompts sales to customers in the territory. It also cannot operate to prevent other neighbouring franchisees coming into the territory to provide goods or services to a customer who had sought them out, what is often referred to as a “passive” sale. A usual provision restricts neighbouring franchisees directly promoting the franchise outside of their own territories by mailshots or leaflets drops etc, but care must be taken to understand whether or not exclusivity has been granted.

Renewal

Another feature of most franchise agreements, which many Franchisees fail to appreciate, concerns the Franchisee’s option to renew. It is often overlooked that their option to renew is conditional, meaning that the right to renew is not automatic. Common conditions on renewal are that the Franchisee attends further training, updates equipment, premises and vehicles and replaces signage. It is not always the case that the new franchise agreement will be in an identical form to the original agreement. Franchise systems evolve and there are often legitimate reasons for a Franchisor wishing to change the agreement. Many Franchisees make the mistake of assuming that if they renew the agreement it will be identical to their old agreement. Often they have a right to the then current agreement which could be substantially different to the version they signed at the outset.

Understand ALL the terms

With franchise agreements often running to 40-50 pages, they contain numerous terms, all of which require attention and understanding. There are no superfluous terms; all have a purpose and some have legal meanings that are not always obvious to the untrained eye.

Caveat Emptor!

The lesson to be learnt is that the franchise agreement is not simply part of the Franchisor’s marketing literature. It is a legal document creating rights and imposing obligations. The most important reason why a prospective Franchisee should ask a solicitor knowledgeable about franchising to review the agreement is to ensure that the Franchisee knows, in plain English, exactly what s/he is taking on in terms of obligations before signing on the dotted line. Ignorance can prove to be expensive!

Jane Masih, Owen White Solicitors

jane.masih@owenwhite.com