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Franchising - understanding a franchise agreement print Print

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A Franchise Agreement includes all of the key features, provisions and principles of the franchise, including the rights and obligations of both parties, the length of time the arrangement will last, the territory (if any) granted to the franchisee, and the costs involved and how they are to be calculated.

A Franchise Agreement is the foundation of your business. You must be certain that you understand it clearly before you start to build on it.

The following is an outline of some of the key features contained in Franchise Agreements. It is intended as a guide only and is not a substitute for professional legal advice.

Every Franchise Agreement needs to be read with care and you should therefore have your lawyer go through the Agreement clause by clause with you, to make certain that you understand all of its provisions.

Franchisees also need to be aware that, while it can be relatively simple to enter into a Franchise Agreement, it may be far more difficult to extract yourself from one. A standard Franchise Agreement is a long-term obligation to a third party (often of six to ten years in length). The Agreement will include strict obligations which have to be complied with for the full length of the term. Failure to comply with these obligations may (in many situations) allow the franchisor to terminate the Agreement.

While the strict provisions of Franchise Agreements are there to protect the interests of all parties and especially the franchise system itself, from time to time Franchise Agreements can include or exclude clauses which aim to protect the franchisor. Examples include:

  • A provision that any costs involved in defending the use of the trademark should be met by the franchisee
  • Immediate rights for the franchisor to cancel without notice if the franchisee misses or delays payment of royalties
  • Lack of clauses regarding ongoing support, training and development of the business by the franchisor
  • Limitation of the franchisor's liability to the franchisee even if the franchisor breaches their obligations to the franchisee
  • Widely drafted clauses undermining a franchisee's 'exclusive' territory in unwarranted circumstances.

The presence of these sorts of clause will vary between Franchise Agreements. An experienced franchise lawyer will be able to highlight them to you.
 

You should also be prepared for some franchisors being unwilling to make any changes to their Agreements. Often this is in order to retain consistency amongst their Franchise Agreements or because the franchisor is tied to an overseas form of Agreement and is unable to make changes easily. These situations call for tact, diplomacy and negotiating.

Regardless of what you may dislike about some provisions in a Franchise Agreement, it is nevertheless vital that you understand it fully and the obligations it places on you as a franchisee. Careful attention should also be paid to ancillary documents, as these may contain provisions that, if breached, constitute a breach of the Franchise Agreement itself.

You should also ensure that any pre-contractual representations regarding turnover etc that may have

attracted you to the franchise are carried over into the Franchise Agreement itself or in some other written form.

 

Summary of Agreements

Agreements generally identify the parties, provide a short background to the franchise and the Agreement itself and lay out the main provisions of the Agreement. There are also

usually one or more schedules or supplements containing specific details of dates, amounts, territory boundaries, renewal rights, sub-franchise agreements, disclosure statements and other details.

 

Grant of Rights

The Grant of Rights sets out the term of the franchise and its renewal provisions.

It is vital to ensure the term of the franchise is sufficient to allow you to achieve a reasonable return on your investment. Many Franchise Agreements include a number of shorter terms rather than one long term. This has advantages for the franchisor in that, upon renewal, the Franchise Agreement may be updated. In some cases, the franchisor can also request a renewal fee.

Renewal provisions therefore need to be looked at carefully. They may contain some or all of the following:

  • Notice of renewal - this is usually required within strict timeframes. If the renewal notice is not given in time, the right to do so may be lost
  • Payment of renewal fee
  • Changes to wording of the Agreement by the franchisor upon renewal
  • Changes to the franchise territory size by the franchisor where the particular Agreement provides exclusive rights to the franchisee
  • Changes, alterations and improvements to operating practices to meet competitive and other challenges
  • First options or first rights of refusal for additional franchises.

It is important that the franchisee appreciates that, more often than not, the 'right of renewal' may in fact be a right in favour of the franchisor. The franchisor often has the ability to veto the renewal if a franchisee has not been performing to set standards.

 

Ongoing costs and royalties

Many Franchise Agreements include ongoing payments to the franchisor such as:

  • Royalties
  • Advertising levies
  • Mark-ups or margins on products supplied by the franchisors
  • Training fees.

There may also be obligations to attend franchise conferences and other meeting and attendance requirements.

The Agreement should clearly set out the details of what has to be paid and when, including conditions relating to any deposits payable before securing the franchise.

For advertising and promotion costs, the Agreement should specify when the payment is to be made and to whom, including details of any special banking arrangements.

Back-up assistance and guidance are essential to the operation of a successful franchise. Details of the support and training to be provided by the franchisor need to be recorded in the Agreement, including both initial and ongoing assistance. As well as having your lawyer look over the Agreement for these provisions, talk to existing franchisees about the level of support they have received.

 

Initial costs

The Agreement, or often an ancillary document, should set out in full all ingoing costs. These may include the initial franchise fee, equipment costs, working capital requirements, fit-out costs, initial training costs and the cost of opening stock.

 

Premises, leases and mobiles

  • Lease provisions usually allow the franchisor to take over the lease at the end of the term, and also if the franchisee defaults during the term
  • Often the franchisor will lease the property itself and grant a sub-lease to the franchisee. You are responsible for paying the rent, so you should ensure the amount negotiated is a fair market rent
  • Mobile franchises usually contain terms that set out the signwriting and other décor required by the vehicles from which the business is operated, and possibly for any major items of equipment
  • One issue that is often overlooked is the need to ensure that the length of the franchise term coincides with the length of the lease term. Some franchisees have found themselves stuck with the responsibility of a ten-year lease only to find that the franchise term only runs for six years (or vice versa).

 

Obligations

  • Every Agreement should contain clauses setting out the initial and continuing obligations of both franchisor and franchisee
  • Examples of franchisee obligations include minimum opening hours, insurance, engagement of staff, and uniform requirements.
  • Examples of franchisor's obligations include maintaining the manuals, providing products, and training
  • Records of accounting must be up-to-date, with regular reporting and auditing
  • Intending franchisees should pay careful attention to the obligations since breach of any may entitle the franchisor to terminate the franchise.

 

Intellectual property

Intellectual property is a key element of most Franchise Agreements, covering various legal ownership rights by the franchisor relating to patents, copyright, trademarks, designs and even operating systems. Other relevant laws include the Fair Trading Act and common law rules prohibiting the copying of a business's identity. Intellectual property laws are often described as the 'glue' which holds franchises together.

 

Sale of the franchise

Most Agreements will allow the franchise to be sold during its term, but you should note that as a franchisee your rights to sell the business may be limited.

  • The franchisee may have to give the franchisor the first right to buy the business, which in itself can undermine the value of that business and the goodwill for a selling franchisee
  • If the franchisor chooses not to purchase, they may strictly control the sale process
  • The incoming franchisee must be approved by the franchisor
  • There may be a transfer approval fee, which the franchisee will need to pay to the franchisor when a sale takes place. This is intended to cover the franchisor's costs involved in training the incoming franchisee. It should not be an opportunity for the franchisor to make a quick profit!
  • Furthermore, in some Franchise Agreements, the term of an existing franchise for sales purposes covers only its unexpired residue, unless the Agreement provides for the franchisor to offer a new Agreement for a full new term.

 

Termination

Franchise Agreements list a number of circumstances in which the Agreement may be terminated prematurely. These include:

  • Bankruptcy, company liquidation or criminal conviction of the franchisee
  • Termination of leases to the franchise premises (where premises retention is important).

Termination provisions should be looked at very carefully as they are often points of contention. There are frequent misunderstandings by franchisees as to what happens at the end of a term and practices vary from one franchise system to another.

However, it should also be borne in mind that if the franchise is operating well and the franchise relationship is a good one, it is likely that both franchisee and franchisor will want to renew the Agreement.

 

Disputes

While many disagreements between franchisors and franchisees are solvable simply through discussion and negotiation, mediation and arbitration are also effective mechanisms for resolving disputes and less damaging to franchise relationships than full legal proceedings.

 

Cooling-off periods

The Franchise Association of New Zealand requires its members to provide in their Agreements an option for franchisees to withdraw from the Agreement within a period of seven days after having signed.

 

Other terms

  • The Entire Agreement clause is especially important as it usually states that what is contained in the Agreement overrides anything which may previously have been promised unless it is expressly referred to in the Agreement
  • As a franchisee, you should ensure that anything on which you have relied in selecting your franchise is carried into the Agreement in some way
  • The Definitions section, usually close to the beginning of the Franchise Agreement, contains key definitions. One of the most important is Gross Sales, the figure on which the franchisor's royalty is usually based. Usually this covers substantially every type of transaction carried out by the business and almost every payment received. Often it will include sales made, whether or not payment has actually been received.
  • If the franchise is operating well and the franchise relationship is a good one, it is likely that both franchisee and franchisor will want to renew the agreement.

 

Further information:

To talk to an ANZ Business Specialist:
Call 0800 269 249
Visit anz.co.nz/business
Visit your nearest ANZ branch

              

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