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What an exclusive purchase agreement means for a franchise

on Thursday, 06 August 2015. Posted in Legal

Exclusive purchase agreements are commonplace in franchising but the onus is on franchisors and franchisees to ensure they work in their favour, says Claire Robertson, associate at Stevens & Bolton

What an exclusive purchase agreement means for a franchise

What is the difference between a McDonald’s burger from Exeter and one from Essex? If McDonald’s has its way, the answer should be “nothing”. For McDonald’s and any other product-based franchise, ensuring consistency and quality across the franchise network is essential. 

It is for this reason that franchisors often stipulate that franchisees must purchase products and materials from the franchisor itself or from suppliers approved by the franchisor. Such an obligation is known as an exclusive purchase obligation. 

Exclusive purchase obligations are common in franchising and have different implications depending on what side of the fence one sits. Whilst franchisors undoubtedly benefit from imposing exclusive purchase obligations across their franchised networks, there are risks and due care should be taken. In particular, franchisors should consider the following: 

What is the term of the franchise agreement? 

If the franchise agreement is to contain an exclusive purchase obligation, it is standard for the length of the term to be five years. Imposing a longer term may result in a breach of competition law. If a longer term is to be agreed, the franchisor must ensure that this can be justified. 

What items will be covered by the obligation?

Is it only brand-defining products that will be covered – for example, the burgers in a burger franchise or the shoes in a shoe franchise? Or will the exclusive purchase obligation go wider, for example, to apply to purchases of display units, telephones, stationery and other items used in the franchisee’s business?

Whilst the temptation may be to seek to control all such purchases, with such control also comes a level of responsibility and franchisors should balance the two against each other. Excessive limits on a franchisee’s ability to select its suppliers may be off-putting to prospective franchisees, as well as being hard for the franchisor to justify. 

Who is it that will be supplying the products?

Will the franchisor be supplying the products itself or is it going to nominate approved suppliers? If the latter, the onus will be on the franchisor to select suitable suppliers and negotiate competitive rates with such suppliers on behalf of the franchise network.

The franchisor should also reserve the right to review and amend the list of approved suppliers on a regular basis. This will help avoid the franchisor being tied in to using suppliers that no longer suit the franchise network. 

Will profit be made or a rebate received when the franchisee buys products?

According to the British Franchise Association (bfa) Code of Ethics, if a franchisor is making a profit from products supplied under an exclusive purchase obligation or is receiving kickbacks from approved suppliers, it should be transparent about this. Such rebates should not be a source of secondary income to the franchisor and instead should be used for the benefit of the entirety of the franchise network.

What if the franchisee asks to use a different supplier?

It may be that the franchisee has a relationship with an existing supplier that it would like to continue using. The franchisor should consider whether its model can allow flexibility in such circumstances, albeit subject to a vetting procedure. If flexibility is to be allowed, it should be applied consistently across the network.  

When purchasing a product-based franchise, an informed prospective franchisee should not be surprised to see exclusive purchase obligations in the franchise agreement. It is important to remember that such obligations are not necessarily a bad thing for franchisees. Franchisees are choosing to buy in to an established brand; therefore, the ability to access the necessary products and materials of that brand will be essential in the success of the franchisee’s business and may be worth the sacrifice in autonomy to select suppliers. 

When faced with exclusive purchase obligations, prospective franchisees should consider the following:

What items are covered by the obligations?

Do the restrictions apply only to brand-defining products or do they go wider? If the latter, is it reasonable for the franchisor to insist that the item in question is purchased from it or an approved supplier? 

How much do the products cost?

Are the prices charged for those products that must be bought from the franchisor or its supplier competitive or at least reasonable? Can the franchisor increase these prices at will and are such increases subject to any control? According to the bfa Code of Ethics, the franchise agreement should provide protection against such unilateral increases. If such protection is not in the franchise agreement, a wise franchisee should seek assurances before signing. 

Has the franchisor negotiated a good deal?

The franchisor should provide evidence that it has negotiated a competitive deal with any approved suppliers and is committed to regularly reviewing the terms agreed with suppliers to ensure that it is getting the best deal for the entire franchise network.

What is the franchisor getting out of it?

Of course, the franchisor will have the benefit of ensuring consistency across the network but what profit is in it for the franchisor? What margin is the franchisor making? Is it receiving a kickback or other rebate? Has this been disclosed and, if so, will any profit be used for the benefit of the franchised network? 

Can a franchisee use its own suppliers?

If there are particular suppliers that the franchisee would like to use for certain products, this should be discussed and if possible agreed with the franchisor at the outset and before the agreement is signed. 

Exclusive purchase obligations are a fact of franchising and should benefit all because maintaining product integrity and quality across the franchised network will only serve to enhance profits. By taking the steps listed above, parties to a franchise agreement can help ensure that exclusive purchase obligations work for both of them. 

Claire Robertson is an associate at Stevens & Bolton, the law firm.

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