"The
franchise agreement is the fundamental document governing the relationship between franchisor and franchisee. It sets out the rights and obligations of both parties."
When you buy a franchise, you will no doubt have to sign a franchise agreement. Franchise agreements vary in size some as short as 10 pages, others exceeding 100 pages. Either way, it is critical that a prospective franchisee fully understands all of the terms of the franchise agreement and the workings of a franchise system.
The franchise agreement is the fundamental document governing the relationship between franchisor and franchisee. It sets out the rights and obligations of both parties. Often it will incorporate by reference other documents such as procedure manuals and it is important that the prospective franchisee understands those documents as well.
Review of franchise agreement It is prudent for all prospective franchisees to have the franchise agreement and any other related documents reviewed by a lawyer who has experience in advising prospective franchisees. The Franchising Code of Conduct requires franchisors to, at the very least, recommend this course of action to franchisees. Some franchisors will not approve franchisees unless they obtain such advice. The cost will vary from
franchise lawyer to franchise lawyer but a "ball park" cost for reviewing and advising on a franchise agreement is about $2,000.
What is a franchise? Many clients who I have seen do not initially understand what a franchise is.It is not a business - rather it is merely the right to conduct a business using someone else's trade marks, brands, systems and other intellectual property for a limited term (not indefinitely) and, in some cases, within a territory.
The franchisor does not own the franchised business and its tangible assets - the franchisee does.
What happens when the franchise ends? When the term of the agreement comes to an end, the right to conduct the business under the franchisor's trade marks, brands, systems and other intellectual property is lost without any right to compensation. Often, all that a franchisee is left with is a bundle of second hand plant and equipment.
Further, in most franchise systems, the franchisee cannot even continue to operate a "de-branded" business whether from the same premises or nearby premises. This is because most franchise agreements:
1. Are structured in a way whereby the franchisor "controls" the site, by either being the franchisee's landlord or by securing a commitment from a third party landlord the right to have any lease transferred to the franchisor, once the franchise agreement comes to an end; and
2. Contain restraints prohibiting an ex franchisee from conducting a similar business for a period of time within certain territory.
Worse still, some franchise agreements give the franchisor the right to buy the franchisee's plant and equipment at written down value on expiration of the term - this value may be less than the true value.
Therefore, the first thing I want my clients to understand is that their capital investment in the franchised business will, on the whole, evaporate at the end of the term and it is unrealistic to expect that any capital gains will be earned from operating a franchised business, unless it can be sold at a gain well before the end of term.
One sided agreement Prospective franchisees also need to understand and, ultimately accept, that the franchise agreement will substantially favour the franchisor. This is because the franchisor needs controls and flexibilities to protect its brands and systems. The need for this in theory, is to benefit the whole of the franchise system, including the franchisees in the network.
Hence there are often terms in franchise agreements which may ultimately allow the franchisor to alter the franchise system to something quite different to that initially represented. Franchisees must be aware of the risk associated with these types of flexibilities before they make their decision to proceed.
Franchisee obligations Most franchise agreements spell out the franchisee's obligations in great detail (often over many pages).
Financial obligations may include:
- the obligation to pay the initial franchise fee
- the obligation to pay a periodic royalty (which may be fixed or a percentage of sales or profit)
- the obligation to pay contributions into an advertising fund
- the obligation to pay a fee to the franchisor when the franchisee sells the franchised business
- the obligation to pay the franchisor's legal costs and any assessable stamp duty
- the obligation to pay for stock and other purchases
Operational obligations may include:
- the obligations to wear appropriate uniform
- the obligation to fit-out business premises or a motor vehicle in a particular way
- the obligation to have properly trained staff
- the obligation to properly maintain and keep clean business premises or a motor vehicle
- the obligation to provide excellent customer service
Franchisor obligations
Most franchise agreements, when spelling out the franchisor's obligations, leave a great deal of discretion to the franchisor. Clauses such as "the franchisor will, if it thinks it appropriate" do such and such, are not uncommon.
The primary obligation of the franchisor must be to provide the intellectual property and the components of the franchise system - the latter is often done via an Operations or Procedures Manual ("the Manual").
The Manual is a moving document, which franchisors will often amend from time to time to suite their operational needs. As franchisees promise to operate the business in accordance with the Manual, they too, need to recognise that they may need to be flexible to the franchisor's needs and desires as reflected in amendments to the Manual.
This article appears courtesy of
Mason Sier Turnbull.
20-Sep-2007