Key provisions to highlight in a franchise agreement
Franchising in simple terms is a licence granted by a company (the 'franchisor') to an individual or company (the 'franchisee') to operate a business selling the franchisors' goods or services through use of the franchisors intellectual property rights and by following their stipulated guidelines when operating the franchise. Some of the best known and most successful companies in the world contained franchised businesses such as McDonalds and Subway.
The main benefits of entering into a franchise include having instant brand recognition from franchising an establish business as opposed to starting a business from new as well as tapping into the franchisors' already built-in customer base to maximise profits.
The arrangement is governed by a franchise agreement which sets out the various contractual obligations on both parties in the operation of a franchise. Unlike other commercial contracts where there is scope for amendments to be made, as the franchisor would want its network of franchisees to be on identical terms to avoid any disputes, the franchise agreement would not generally be open to negotiation.
Ketan Mistry, Commercial Solicitor at Chattertons has set out the key provisions a franchisee would need to be aware of when reviewing a franchise agreement:
Generally the franchisee will enter into a franchise agreement for an initial fixed period, for example five years, in which the franchisor grants the franchisee the right to operate the franchise. It is usually expected that this will permit the franchisee the time in which to grow the franchise business in the assigned territory and the fees required to be paid to the franchisor would also increase year on year to reflect this. Whilst the franchisee will be granted the right to renew the franchise agreement following the expiry of the initial period this would be on the basis that stipulated financial performance targets are met and also the franchisee is not in breach of any of its obligations under the franchise agreement.
In order to tie the franchisee into the operation of the franchisee for a sustained period of time, the franchise agreement would not give the franchisee the right to terminate within the initial fixed period. The franchisor would however have the right to terminate in the event that the franchisee commits a material breach of the franchise agreement such as failing to pay the franchise fees. The only option the franchisee would have to exit early would be to seek to sell the franchise to a third party. It may be that a financial settlement for the franchise fees payable for the remainder of the term left on the franchise agreement would be payable to the franchisor.
A franchise agreement will grant the franchisee the right to open and operate the franchise within a specific area or locality as described within a map or a set of postcodes. This is in order for the franchisor to control the number of franchisees in a specific locality. The network of franchisees would generally not be permitted to make active sales within another territory that has not been assigned to them.
Intellectual Property Rights
The most valuable aspect of a franchise is the licence granted to the franchisee to use the intellectual property of the franchisor such as the name, logo and banding. A renowned franchise such as Subway or McDonalds is known the world over through its branding so the franchisee is purchasing the right to operate such a well-known and established brand. The franchisor will however have very tight control over the rights granted to the franchisee over use of its intellectual property and this would be stipulated within the franchise agreement and any trading manuals provided by the franchisor.