Do you need to read the franchise agreement?
Buying a franchise business is a significant undertaking – one that requires thorough research of the franchise system, speaking to existing and past franchisees and most importantly understanding the franchise agreement you will be asked to sign.
The franchise agreement is the document that will govern the relationship between you as a franchisee and the franchisor. It is critical that you understand the essential elements of the agreement and your obligations as a franchisee.
The agreement is governed by the Franchising Code of Conduct which dictates the documents that must be provided to a franchisee by the franchisor, the time lines that need to be observed and the processes that must be followed by both the franchisee and the franchisor throughout the life of the relationship between the parties.
Some of the key terms of the agreement that should be noted and understood are:
1. The territory
Some agreements will specify a territory in which the franchised business must operate. The territory can be defined in a number of ways including a geographical description outlining certain physical boundaries, a postcode or a particular shopping district.
It is important that the territory is defined accurately and that you consider any possible future changes, for example, changes to a postcode boundary or the location of a shopping district.
Other considerations to note in regards to the territory are:
- the franchisor’s territory selection policy or process;
- the scope of the territory and whether the franchised business can be operated successfully or profitably within its bounds;
- whether you have been granted exclusivity for the territory or whether the franchisor is able to grant other franchises to other franchisees or run similar businesses within your territory;
- whether the territory can be unilaterally changed by the franchisor; and
- whether the exclusivity granted to you for your territory can be lost as a result of a breach of the terms of the agreement or a failure to meet minimum performance obligations.
2. The fees
The agreement will provide for the payment of both one-off and recurring fees. It is important that you are aware of your financial obligations under the agreement and the payments you will be expected to make.
The one-off fees payable under the agreement can include the following:
- Franchise fee – for the grant of the franchise;
- Training fee – for the initial training provided by the franchisor;
- Renewal fee – payable upon the renewal of the agreement if there is a renewal option; and
- Transfer or assignment fee – payable by the franchisee upon the sale of the franchised business to a purchaser. The calculation of this fee will vary between systems, and may sometimes be a flat fee or a percentage of the sale price.
The possible ongoing fees payable under the agreement include:
- Royalties – payable by you to the franchisor for the right to utilise their intellectual property or business system for the term of the agreement. This can be a flat fee or alternatively a percentage of the sales generated by the franchised business. You should also note when the payment is due – monthly or weekly.
- Advertising/marketing fund contribution – where the franchisor has established and maintained a marketing fund, contributions are sought from franchisees. The funds obtained are used to advertise the franchise system as a whole. The contribution can be a flat fee or a percentage of the sales generated by the franchised business and may be payable monthly or weekly.
- Technology fees – are payable for the right to use the franchisor’s technology systems, software, hardware, intranet and/or point of sale system which has been developed for the franchise network.
- Ongoing training fees – where the franchisor provides ongoing training during the term of the agreement, these costs will usually be paid by you and could be significant, especially if the franchisor is interstate and travel and accommodation is required.
3. The franchise term
The agreement will usually outline the length of the term and any renewal conditions.
You should also be aware of any option to renew and the conditions of renewal. These conditions may include providing notice within a specified time frame, satisfying minimum performance standards, upgrading the fitout of the premises, signing a new franchise agreement and the payment of a renewal fee.
4. Breaches and termination
The circumstances in which the agreement can be terminated will be set out in the document. They are also governed by the Code. You must be aware of the situations that could lead to the breach and/or termination of your agreement so that you can avoid them or, if necessary, rectify any issues as soon as they are identified.
Under the Code, the franchisor can only immediately terminate the agreement on the following grounds:
- the franchisee no longer holds any licence or authority required to carry on the franchised business;
- the franchisee becomes bankrupt, insolvent under administration or an externally-administered body corporate;
- the franchisee is a company and it becomes deregistered by the Australian Securities and Investments Commission;
- the franchisee voluntarily abandons the franchised business or the franchise relationship;
- the franchisee is convicted of a serious offence as defined in the Code;
- the franchisee operates the franchise business in a way that endangers public health or safety; or
- the franchisee acts fraudulently in connection with the operation of the franchise business.
If the franchisee has breached the agreement on grounds other than those listed above, before the franchisor can terminate the agreement it must issue a breach notice. This outlines the breach or breaches, indicates what the franchisee must do to remedy them and sets out the timeframe for the franchisee to take remedial action (which must be reasonable). It also highlights that the agreement may be terminated if the franchisee fails to comply in the manner and within the time specified in the breach notice.
5. Special conditions
If you have negotiated special conditions with the franchisor, they will need to be specified in the agreement.
These terms of the agreement listed above are only some of the standard key clauses that you should be aware of.
Franchise agreements are usually complex lengthy documents and buying a franchised business is usually a long term proposition.
It is therefore essential that you obtain advice both professional financial and legal advice from experts in franchising.
However, such advice is not a substitute for you reading the agreement carefully. It is very important to fully read the agreement yourself and truly understand all your rights obligations and rights under it.