When leasing or licensing a property, the most important thing is to ensure that both the franchisee and franchisor are part of the conversation
Franchise networks come in all shapes and sizes and their requirements in relation to business premises are equally diverse. For some, all that’s needed is a space at home big enough to sit a laptop. For others, location is crucial and may mean the difference between success and failure. In light of this, it’s important to consider the legal ins and outs of leasing or licensing property.
Most franchisors will offer at least some guidance on the selection of suitable premises. However, the extent of their involvement will largely depend on how important the premises are to the success of the business. The franchisor will have far more relaxed requirements in a network where the premises are little more than an office and some storage space for stock than in say a retail business where the location, fit out and decor of the premises are crucial.
Where premises are less important, the franchisor may offer guidance on the size and nature of the premises that will be appropriate and will specify the signage that must be displayed at the site but is unlikely to be concerned with the terms of the lease itself.
Franchises in the retail sector or where the premises are central to the operation of the business will take a more robust approach. In that case, the franchisor is likely to want the option to take over the premises itself in certain circumstances so that it doesn’t lose a prime location if the franchise agreement ends. There are two main ways that the franchisor can secure this.
Head lease and sublease
The first is that the franchisor takes a lease of the premises and then grants a sublease to the franchisee. This way, if things don’t work out with the franchisee or if the franchise agreement expires for any reason, the franchisor is able to terminate the sublease but retain the premises via the head lease. Typically, the franchisor will mirror its obligations to the landlord under the head lease in the sublease. This ensures that any obligations imposed on the franchisor by the ultimate landlord are passed down to the franchisee.
This approach has been popular in the past but can be risky for franchisors. If the franchisee’s business fails, then the franchisor is left with the ongoing obligations to the ultimate landlord. This means that the franchisor could be left not only with the obligation to pay rent but also obligations in respect to the repair and maintenance of the property for the remainder of the term. In view of the risk to franchisors, this approach has become less common in recent years and tends to be reserved only for networks where the premises are especially critical or where significant sums are invested in the acquisition and fit out of the site.
If the franchisor doesn’t want to risk being left with ongoing obligations to the ultimate landlord, an alternative is to include an option to acquire the premises from the franchisee if the franchise agreement is terminated. This gives the franchisor the flexibility to choose to take over the property if it’s in a particularly good location but without the obligation to do so if it doesn’t want to.
Whilst this approach is less risky, it also offers less robust protection for the franchisor. This is because whilst the franchisor and franchisee can agree to transfer the premises to the franchisor, the transfer will be subject to the ultimate landlord granting his consent to the transfer. There is always a risk that the landlord may withhold consent or may only agree on terms that are unacceptable to the franchisor.
Another consideration with this approach is that the lease will have been negotiated between the franchisee and landlord. This means that the franchisor stands to inherit a lease that was negotiated without their involvement. In view of this, the franchise agreement will usually include an obligation for the franchisee to obtain the franchisor’s approval of the terms of the lease before it’s completed. Although the franchisor won’t be directly involved in the negotiations, they will be able to ensure that the lease doesn’t contain anything too onerous, just in case the franchisor takes it over.
An increasingly popular trend is for premises to be occupied on the basis of rolling licences rather than a formal lease. The obligations on the franchisee under a licence will be far less onerous than under a lease. Typically there are no repair or maintenance obligations and the franchisee usually has the right to terminate at any time with a very short notice period. This gives the franchisee significant flexibility but this can also be the biggest drawback, since the franchisee has no guaranteed right to remain at the site beyond the current one to three-month period.
Term and obligations
No matter how the premises are occupied, a key consideration for franchisees is to ensure that they can vacate the property when the franchise agreement ends. Where the franchisee owns the freehold, they will have their choice of how to deal with the property moving forwards. Options could include granting a lease to an incoming franchisee – if their business is sold – selling the freehold or letting the premises to an independent third party.
Equally, if the premises are occupied on the basis of a rolling licence, termination of the franchise is unlikely to be a concern. The biggest challenge is with leasehold premises. The franchisee should ensure that the lease contains a break clause or termination date that coincides with the expiry of the franchise agreement. This is to avoid a situation where the franchisee must continue to pay rent on a property that they can no longer use following termination of the franchise.
Evidently there is plenty for a franchisee and franchisor to consider before they sign on the dotted line and take on a new lease. However, with a little thought and planning, there is plenty that can be done to secure the best deal for all involved.