From the outset, binding franchise documents generally comprise of a disclosure document, a
franchise agreement (also sometimes called a licence agreement) and, for franchises that operate from business premises, an occupancy licence agreement. It is important to note that there is no such thing as a 'standard' franchise agreement - each franchisor will have their own franchise agreement.
These documents are not bought off-the-shelf, and while there will be common provisions in every franchisor's franchise agreement, don't let anyone tell you that their franchise agreement is standard.
Franchise agreements are also weighted very much in favour of the franchisor and, although many of the provisions in the franchise agreement will be onerous for the franchisee, this is not unusual.
Given that the essence of any
franchise system is uniformity, franchisors are unlikely to agree to make changes to their franchise agreement - unless, of course, they have negotiated special conditions with a franchisee or the agreement contains a manifest error.
Financial and legal advice A franchisee embarking on buying a franchise should seek professional financial and legal advice. An accountant can provide advice about the financial commitments that the franchise agreement imposes, and can assist with formulating a business plan.
A lawyer can advise on the legal implications of signing the franchise agreement. This is a legally binding arrangement and is generally binding for a long period.
If the franchisor terminates the franchise agreement - say, because the franchisee has breached the agreement in some way - this does not necessarily relieve the franchisee of its legal obligations under the agreement. In such circumstances, the franchisee may still be liable to compensate the franchisor up until the time the agreement would have otherwise expired.
A lawyer will also be able to explain the terms of the franchise agreement, highlighting any terms that are unusual or excessively onerous.
Key terms in a franchise agreement include:
The territory
Some franchise systems are territory-based - that is, the franchisee is granted the right to conduct its franchised business within a specified territory. Important considerations are:
- Whether the territory is large enough to enable the franchisee to conduct the business profitably;
- Whether the territory is exclusive or not - that is, whether the franchisor can grant other franchises in the territory, or whether it is able to conduct business in the territory itself (for example, mobile franchises, internet sales, wholesales or retail sales from non-franchisor branded outlets such as supermarkets, and special events such as sporting events); and
- Whether exclusive rights can be lots - for example, because of the franchisee's failure to comply with the franchise agreement, or through a failure to meet any minimum performance obligations (such as minimum sales) set out in the franchise agreement.
The term
The term of the franchise agreement is important. Franchisors prefer longer terms and franchisees typically prefer shorter terms, with options to renew.
For a franchisee, the principal consideration is whether the term, plus options, is long enough for the franchisee to obtain an adequate return on their investment. Franchise agreements generally provide for an initial term, followed by an option to renew for a further term or series of terms. The option to renew for a further term is not a guaranteed right to renew - it is generally tied to the franchisee's 'good behaviour' and the payment of a renewal fee.
The premises
For franchises that are conducted from business premises, the franchise agreement will contain provisions that deal with those premises. The following considerations are important:
- Who determines where the premises will be located? Some franchisors prefer to have control of selecting the site from which a franchised business is to be conducted. In fact, some have teams of staff devoted to this function. Other franchisors are happy to allow their franchisees to choose the premises, but reserve the right to approve them.
- Who negotiates the terms of the lease? Franchisors generally prefer to negotiate the lease terms themselves - even if the franchisee is to hold the lease of the premises.
- The terms of the lease. The Franchising Code of Conduct requires that the franchisee be provided with a copy of the lease or, at the very least, a summary of it. Leases and ancillary documents (such as subleases and occupancy licence agreements) are usually complex, difficult documents that may require the assistance of a professional adviser to be understood.
- Whether the term of the franchise agreement and the term of the lease coincide. Generally speaking, many landlords, especially major shopping centre landlords, do not offer further terms. Accordingly, their franchise agreements may provide for an initial term that either exceeds the term of the lease or the franchise agreement may provide for options to renew, which go beyond the term of the lease. A well drafted franchise agreement will need to deal with what happens if it continues beyond the lease - does the agreement end if the lease ends or does the franchisee have the opportunity to relocate to new premises and, if so, at whose cost? Generally, the costs will be borne by the franchisee.
- Who holds the lease - the franchisor or the franchisee? The most common property holding options are:
- The franchisor holds the lease of the premises and grants the franchisee a licence to use or occupy the premises
- The franchisor holds the lease of the premises and enters into a sublease with the franchisee; or
- The franchisee holds the lease of the premises.
The decision about who holds the lease is one that the franchisor makes. If the franchisor holds the lease, the basis on which the franchisee will have the right to use or occupy the premises will need to be clarified. Some franchise agreements give the franchisee occupancy rights; others require the franchisee to enter into a separate agreement - either an occupancy licence or a sublease. In these cases, the landlord's consent to an occupancy licence or sublease will also need to be confirmed.
If the franchisee holds the lease, the franchise agreement should contain provisions about what is to happen in the event of the relationship being terminated. Franchise agreements generally provide that the franchisor will have the option of requiring the franchisee to transfer the lease to them. This means that a franchisee could find itself in a situation where the franchise agreement has been terminated, but the franchisee remains bound to the lease because the franchisor does not want to accept the transfer.
Systems, policies and procedures Although the franchisor's systems, policies and procedures will be set out in general terms in the franchise agreement, the detail will usually be found in the franchisor's manual. The manual is generally not made available to the franchisee until after the franchise agreement is executed. Until given the manual, it is difficult for a franchisee to make a truly informed decision about the franchise.
Inventory
Most franchise agreements contain provisions dealing with inventory. Some specify a minimum amount of inventory that the franchisee must hold. Franchisees should consider such requirements in the same light as the royalties and other payments they will be liable to make under the franchise agreement - and should seek professional financial advice. A franchisee does not want to find itself in a situation where it has slow moving inventory and does not have the flexibility to adjust its purchase requirements.
Other franchise agreements do not contain a minimum inventory requirement and simply deal with from whom the inventory is to be purchased. Some franchise systems operate on the basis that all inventory must be purchased from the franchisor; others require that it be purchased from authorised suppliers. Franchisors cannot, without authority from the Australian Competition and Consumer Commission, compel their franchisees to purchase from third party suppliers.
Fees
Franchise agreements generally provide for the payment of the following fees:
One off fees
- Initial Franchise Fee: for granting the franchise;
- Training Fee: for the initial training provided by the franchisor;
- Renewal Fee: payable on renewal of a franchise agreement that contains an option to renew; and
- Transfer Fee: payable by the franchisee to the franchisor on the sale of the franchised business to a new franchisee. This could be a flat fee or one based on a percentage of the sale price.
Recurring fees - Royalties (otherwise know as administration fees or management fees) are payable by franchisees to their franchisors for the ongoing right to use the franchisor's intellectual property or business system, or for the ongoing services that the franchisor provides. Such fees may be flat fees or ones based on a percentage of the franchisee's sales. They are generally payable on a weekly or monthly basis.
- Where the franchisor maintains a marketing fund, advertising or marketing contributions or levies are payable by franchisees. These sums are used to market and promote the franchise system as a whole. Again, these may be flat fees or ones based on a percentage of the franchisee's sales. They are generally payable weekly or monthly.
- Inventory/stock purchases: where franchisees are required to purchase all or some of their inventory or stock requirements from the franchisor, the franchisor's terms of trade will need to be examined. Those trading terms are also likely to vary during the term of the franchise agreement.
- Technology Licence Fees are imposed for using hardware/software/intranet/point of sale systems, which the franchisor has supplied or developed.
Other costs
- Initial fit out costs where the franchised business is conducted from premises. Franchisees may also be required to pay the franchisor a project management fee, where the franchisor manages the fit out on the franchisee's behalf.
- Site Evaluation Fees may be charted to a franchisee when the franchisor locates and evaluates premises, especially if the franchisor engages external consultants.
- The franchisor's legal costs associated with the franchise agreement, occupancy licence agreement or sublease (where the franchisor holds the lease) or where it negotiates the lease on behalf of the franchisee.
- The franchisee will also have its own legal costs associated with reviewing the franchise agreement, occupancy licence agreement or sublease or lease (as the case may be).
- Fees for any permits or licences required to operate the business.
Sale of franchise Another standard provision in a franchise agreement is a provision allowing the franchisee to sell the franchised business. Under both the Franchising Code of Conduct and a franchise agreement, franchisors cannot withhold their consent to a sale without good reason. However, the franchise agreement will contain certain conditions that will need to be satisfied to obtain such consent. Typical conditions include that:
- The franchisee must first offer the franchise back to the franchisor;
- The franchisee must remedy any breaches of the franchise agreement;
- The franchisee must pay any transfer fee;
- The franchisee must show that the purchaser is reputable, responsible and solvent; and
- The purchaser will no doubt need to complete the franchisor's training program.
Where the franchisee is an individual and dies or becomes disabled, family members will sometimes be given the opportunity to take over the franchise. However, many of the considerations that apply on a sale will apply to this situation - especially the training requirement.
Termination The circumstances under which a franchise agreement can be terminated will be covered in the franchise agreement and are also set out in the Franchising Code of Conduct. The usual grounds are:
Franchisee termination
A franchisee can generally only terminate a franchise agreement within seven days of entering into the franchise agreement or making a payment under the franchise agreement. This is the 'cooling off right'. It is rare to see provisions in a franchise agreement that allow a franchisee to otherwise terminate or withdraw from the franchise agreement during its term. Despite this, franchisees can terminate a franchise agreement if the franchisor has breached an essential or fundamental obligation under the agreement.
Franchise termination The usual grounds on which a franchise agreement may be terminated by the franchisor include:
- Where the franchisee is in breach of the franchise agreement and fails to remedy the breach within a reasonable time of receiving written notice from the franchisor to do so;
- Where the franchisee no longer holds any licence or authority required to carry on the franchised business;
-Where the franchisee enters into any form of insolvency administration, such as voluntary administration, receivership, liquidation or bankruptcy; Where the franchisee voluntarily abandons the franchised business or the franchise relationship;
- Where the franchisee is convicted of a serious offence;
- Where the franchisee operates the franchised business in a way that endangers public health or safety; or
- Where the franchisee is fraudulent in connection with the operation of the franchised business.
A franchisee and franchisor can always agree to the termination of a franchise agreement. Although all franchise agreements will contain common provisions, such as those discussed earlier, there is no standard franchise agreement.
This article appears courtesy of
Mason Sier Turnbull,
franchising lawyers.
24-Sep-2007