Making the most of the franchise agreement

The Franchise Council of Australia is a not for profit membership organisation that is the peak body representing the franchising sector in Australia.

Are franchise agreements simply different in degree from traditional forms of contract? Or are they something entirely new? If they are different, what does it mean for franchisors and for franchisees? What are the implications for regulators making and enforcing laws that relate to franchise contracts? What are the principles that should be applied by courts seeking to interpret contracts in light of such regulation? The practical implications of the ongoing research into these questions, while they are slow to emerge, can be useful.

Think about the last time you bought a house, one that you really wanted to live in. Maybe when you first saw it you weren’t sure. Maybe it took a little time for you to commit. But once you did, once you knew in your heart that it was the house for you, you were probably putty in the seller’s hands. And if the seller knew it, he or she may well have taken advantage. Fortunately the sale of a house is a discrete transaction, a one-off deal; one of its saving graces is that most of the time you never see the other side again after settlement.

Franchise agreements are not the sort of one-off deal, like the sale of a house, upon which concepts of contract in the common law have traditionally been based. While a house sale is a discrete contract, a one-off, franchise contracts are relational contracts, that is, they concern long-term relationships. There are parallels to marriage and family law, joint ventures and employment contracts, even sharecropping arrangements. Franchise agreements can borrow from all these other arrangements, and other complex business arrangements can borrow from franchising. In fact, franchising is not only charting new territory in the business disciplines of management and marketing; it is revealing emerging paradigms in the law as well.

Relational contracts are different from discrete contracts in two fundamental ways. First, they must be flexible enough to accommodate change. Practitioners draft contracts to address issues as specifically as possible, but they cannot anticipate every contingency in a long-term business association. Many aspects of the franchise relationship change over time. Highly specific, rigid contractual terms are incompatible with the flexibility necessary to maintain the parties’ relationship over the duration of the agreement. Second, relational contracts must balance the needs of both sides in the relationship. If one side takes unfair advantage in the negotiation of the agreement, the resulting one-sided agreement can undermine the relationship permanently. While the side that takes advantage may believe it is making a better deal for itself, it’s not. If the relationship suffers in franchising, both sides suffer.

Flexibility or uniformity?

Creating contracts that accommodate change is not a new idea, but it is an art that requires knowledge and skill in the tools of contract, as well as a thorough understanding of the franchise relationship. Researchers in the US continue to debate the degree to which the franchise agreement is negotiable. It is true that franchisees should beware of the franchisor who is overly willing to make concessions. In the interests of economy, certainty and control, the franchisor will want to maintain as much consistency as possible in the basic agreement. Uniform agreements may also protect the franchisor from accusations of treating individual franchisees unfairly. This is not to say, however, that there is no room for negotiation in the franchise agreement.

The franchisor will certainly be less committed to some contract terms than others. According to a recent study in the US based on a sample of 170 franchise contracts, contract terms in franchising were often determined in a haphazard way. Franchisors identified a few key requirements, but commonly left much of the contract to be filled in with precedent. Imitating what other franchisors have done was often not the best solution for their situation. The provision in question may not have been appropriate in the first place. In one case a franchisor copied another major franchisor’s policy regarding exclusive territory, not realising that the provision had resulted in chronic litigation for the first franchisor.

Uniformity in franchising has long been considered a crucial ingredient to success, but as the sector matures and our understanding of franchising grows, we can afford to take a more nuanced view. We must determine which parts of the agreement are non-negotiable, and when and in what circumstances other aspects of the agreement can be adjusted for the benefit of the relationship. Ultimately, the contract is part of the product the franchisor is selling. As Jim Penman wrote in Surprised by Success, “It has to be an offer too good to refuse.”

Control or balance of power?

Power imbalance is present in every relationship. The more powerful party is usually the one who can walk away, the one with the least to lose. This is a matter of perception. Many people would say the franchisor has the power in franchise negotiations; it’s the franchisor’s business, the franchisor draws up the contract, the franchisor writes the operations manual, and so on. In many ways the franchisor does have power, but franchisees have power, too. Franchisors refer to franchisees as prospects; they want to make the sale. There are other franchisors out there. But good franchisee prospects are in short supply in Australia. A franchisor can’t make an offer ‘too good to refuse’ unless he or she knows what the other side wants. Accommodating needs requires maximising communication among parties. One study identified the four factors critical to the long-term stability of a franchise as follows:

› the franchisee’s perception of the quality of service delivery by the franchisor

› flexibility in system administration

› adequate financial returns from the relationship

› a perception that the franchisor resolves disputes in a quick, eager and fair manner.

The franchisor has both the opportunity and the responsibility to set the tone from the outset. If a pattern is established from the start that the franchisee can rely on the franchisor’s quality of service, fairness and flexibility, the franchise is more likely to succeed.

Franchisees, then, are justified in seeing themselves in a position of power. They can ask for more favourable terms in the contract. Hammering out a better deal can create a win for both sides. And it’s a valuable exercise for a franchisee to find out early whether they are dealing with a franchisor who is willing to listen or one who isn’t. For the franchisor, a position of power shouldn’t necessarily translate to control. A franchisor who is willing to ease up on the reins a bit may find a better rapport with a franchisee that can maximise returns. Just as a skilful rider must give a good horse the latitude to perform at its best, a franchisor can get a better result by sometimes giving an enterprising franchisee greater latitude to exercise his or her own judgment and expertise.

There are many techniques that can help the franchisor and franchisee communicate more effectively in negotiating a flexible agreement. The adversarial approach that is often taken by legal counsel can get in the way of better mutual understanding between the parties. This is particularly true where the solicitor lacks a thorough understanding of both sides of the franchise relationship. As many solicitors tend to specialise in representing either franchisors or franchisees, thorough understanding of both sides is probably the exception rather than the rule. Solicitors should therefore be willing to listen to clients’ needs, and to counsel them accordingly. They should not insist on provisions or precedent that serve no relevant purpose, or worse, are damaging to the franchisor-franchisee relationship.

Counsel for the franchisee should not be heard to say, “this is the way it’s always done – it’s non-negotiable”, refusing to negotiate as far as the client would like on a point in the client’s behalf. In negotiation circles, this is known as negotiating with yourself. Your lawyer should be negotiating with the other side, not with you.

The contract is one part of the product when you enter a franchise agreement. As a franchisee, you should kick its tyres, find out as much as possible about how it works, and try to get what you want. For the franchisor, particularly in business format franchising, the contract can be an important sales tool; it can signal to prospective franchisees that the franchisor’s entire package is an attractive one. It sets the tone for the relationship, even if you’re lucky enough never to have to refer to it again.

More research is needed to enhance our understanding of the franchise relationship and the function of franchise agreements and ancillary agreements. There is no universal formula for success; each relationship has to find its own formula. Until we decipher all the mystery in human relationships, be they business or personal, good communication is essential.

BIO (RETRIVE PIC FROM P.63 JAN/FEB 2004)

Elizabeth Spencer is a lecturer in the School of Law at Bond University, Queensland. She can be contacted on (07) 5595 2218, email liz_spencer@staff.bond.edu.au.