Whether or not to Lease premises is a question that will confront most Franchisors of "Static" and Retail based
franchise systems at one point or another.
There is no right or wrong answer to the question and no right or wrong way of structuring the franchise system.
It really comes down to two issues and a balancing exercise between two competing factors:
1. The degree of control the Franchisor wishes to have over the franchise site and hence the franchise system; and
2. The level of risk the Franchisor is prepared to assume.
Property holding options for Franchisors
1. The Franchisor holds the Head Lease and grants a Licence to Occupy to its Franchisees (whether by separate Licence Agreement or pursuant to licensing provisions contained in the Franchise Agreement itself).
2. The Franchisor holds the Head Lease and grants a Sub-Lease to its Franchisees.
3. The Franchisee holds the Head Lease and provisions are incorporated in the Head Lease providing for the transfer of the Head Lease to the Franchisor in certain circumstances (eg breach of the Head Lease).
4. The Franchisee holds the Head Lease and the parties enter into a separate Re-Entry Deed.
5. The Franchisor/Franchisee owns the freehold of the property.
Advantages where the Franchisor holds the Head Lease:
- The Franchisor maintains control over the lease, the franchise site and renewal of the lease.
- Subject to what the Head Lease provides, the Franchisor, as Tenant, will receive notices and if there is a breach of the Head Lease the Franchisor can take action to secure the site.
- If licensing provisions are incorporated into the Franchise Agreement itself, it avoids the need for a separate document, a Licence Agreement or Sublease, which will in turn reduce the Franchisor's costs.
- Retail Legislation may not apply to a licensing arrangement.
Disadvantages where the Franchisor holds the Head Lease:
- The Franchisor, as Tenant, is primarily liable under the Head Lease. Despite provisions in either the Franchise Agreement or the separate Licence Agreement or the Sublease requiring the Franchisee to comply with the terms of the Head Lease, if the Franchisee is in breach of the Head Lease, the breach may need to be remedied by the Franchisor if the Franchisor wishes to secure the site. The Franchisor's claim against the Franchisee will only be for breach of contract.
- If the Franchisee does not honour the lease obligations it is the Franchisor's reputation that is on the line.
- Stamp duty may be payable in some States on the Sublease, the licensing aspect of the Franchise Agreement or the Licence Agreement. This may mean that two lots of stamp duty are payable - one lot on the Head Lease and the other on the Sublease or Licence.
- If a separate Licence Agreement or Sub-Lease is used it will add to the Franchisor's costs.
- Retail Legislation may apply to the Sublease and the licence (whether contained in the Franchise Agreement itself or in a separate Licence Agreement).
Advantages where the Franchisee holds the Head Lease:
- There is less risk to the Franchisor as the Franchisee, as Tenant, is primarily liable under the terms of the Head Lease.
- Retail Legislation will only apply as between the Landlord and the Tenant Franchisee so it is up to the Landlord to comply with any applicable Retail Legislation.
- If a separate Re-Entry Deed is entered into between the Franchisor, Franchisee and the Landlord, the Landlord will be compelled to transfer the Head Lease to the Franchisor in certain circumstances which gives the Franchisor some control over the site.
Disadvantages where the Franchisee holds the Head Lease:
- Loss of control of the franchise site.
- If a separate Re-Entry Deed is used it adds to the Franchisor's costs.
- If provisions are incorporated in the Head Lease alone providing for the transfer of the Lease to the Franchisor it may be difficult for the Franchisor to require the Landlord to transfer the Head Lease to the Franchisor as the Franchisor is not a party to the Lease.
Applicability of Retail Legislation
The application of Retail Legislation is complex and varies greatly from State to State.
The Retail Legislation in Victoria contains a narrow definition of the term lease. It applies to leases, subleases or agreements to lease and former leases. Licences are not specifically mentioned. The question of whether the legislation will apply will, therefore, depend on the basic principle of whether an arrangement is a lease or a licence.
In other States the definition of "lease" in the Retail Legislation is broader and will cover licensing arrangements. The legislation in WA and Tasmania specifically mentions licences in the definition of lease. In other States (eg. NSW and SA), whilst a licence is not specifically referred to, the definitions of lease covers a “right of occupation” by one party to another “whether or not that right is a right of exclusive occupation”. This is wide enough to cover licences.
Accordingly, unless some other exception in the retail legislation applies, Subleases will definitely be caught by the Retail Legislation Australia wide and in some States licences will also be caught.
If the Franchisor adopts a property holding option that requires it to hold the Head Lease and grants a licence or sublease to the Franchisee, the Retail Legislation may apply and the Franchisor will need to comply with the Retail Legislation, including the onerous disclosure obligations and other obligations (e.g. the requirement to give a tenant a 5 year minimum term).
Tips for Franchisors: - Franchisors need to weigh up the advantages and disadvantages of each option before deciding how to hold property and choose the model that best suits their individual needs.
- Irrespective of the model chosen Franchisors should seek comprehensive legal advice as to:
A. Where the Head Lease is held by the Franchisor 1. The licensing provisions to be included in the Franchise Agreement or the provisions of any Licence Agreement or Sublease;
2. The provisions to be included in the Head Lease.
B. Where the Lease is held by the Franchisee
3. The provisions to be included in the Franchise Agreement to cover the transfer of the Head Lease to the Franchisor.
4. The provisions to be included in the Head Lease to cover the transfer of the Head Lease to the Franchisor and the provisions to be included in any Re-entry Deed.
C. State retail legislation 5. The applicability of the State Retail Legislation and possible ways of structuring licensing arrangements so that the Franchisor does not fall foul of the Retail Legislation.
This article was created by
Mason Sier Turnbull,
franchise lawyers.
28-Aug-2007