The franchise agreement is often presented as a “non-negotiable” “take it or leave it” document which psychologically can leave the prospective franchisee wondering if they are somehow being disadvantaged. It also often leads to some franchisees opting not to get legal advice for that precise reason – that the franchise agreement is non-negotiable and they perceive that whatever the legal advice may uncover, the franchisor won’t make any changes and therefore doing so is a waste of time and money. But is it?
The point of seeking legal advice is to ensure that there is alignment of expectations when it comes to the rights and obligations of each party thus enabling the prospective franchisee to make an informed decision.
There are very good reasons why a franchise agreement is a standard document and why it is often described as “non negotiable”. The franchisor will have invested time, effort and money in establishing a successful and proven business, creating and protecting the brand and setting up the support system. Every franchisee who joins the network will get the immediate benefit of the established brand, the infrastructure, the support and guidance which the franchisor will provide but all of this is subject to conditions and restrictions which are set out in the franchise agreement and it is important to understand what these restrictions are.
Expiry date
Every franchise agreement is entered into for a fixed period of time – it has a start and a very definite end date. The point is that the franchisee cannot simply change their mind half way through the term and walk away though equally any renewal is not automatic or guaranteed and will be subject to criteria.
Right to sell
The most logical exit option for the franchisee who no longer wishes to be part of the network is to sell the business. What value the franchisee may be able to achieve will depend on a number of factors including but not limited to whether the business is making a profit and whether it is compliant or “on model”. Any sale will be subject to the franchisor’s process and/or approval because the franchisor would need to vet and approve the buyer since the buyer will be essentially replacing the outgoing franchisee. The point to remember here is that the business cannot be sold without the “franchise” – although it will have value in itself, most of the value will be intrinsically connected to the brand and the franchise system, and the two cannot be distinguished.
Post termination restrictions
Every franchisee, and where the franchisee is a corporate entity also the individual behind the corporate entity, will be subject to restrictions once the franchise agreement comes to an end (whether through termination, expiry or sale). This is typically a prohibition on being involved in a similar or a competing business for a period of time. This is very important to note because it is non-compliance with this obligation that most commonly leads to litigation.
In-term restrictions
Similarly, most franchise agreements will contain a clause preventing the franchisee, and where the franchisee is a corporate entity also the individual behind the corporate entity, from being involved in a similar or competing business during the term of the franchise agreement – this does not usually come as a surprise. It is important to check who else may be affected by this restriction as typically this will also apply to immediate family of the individual!
Changes to shareholders and directors
Where the franchisee is a corporate entity, then all changes to directors and shareholders will require franchisor’s prior approval. This is because shareholders own the corporate entity and because the corporate entity is a franchisee, it cannot have an owner who has not been approved by the franchisor. Therefore, even if the change is minor or for tax or other reasons, it must first be discussed with and approved by the franchisor. The same principle applies to directors since although a director does not “own” any part of the corporate entity, a director has certain powers and authority and can bind the corporate entity.
The above are just some key examples and are not an exhaustive list. In fact, there are many more provisions to be aware of including the fact that where a franchisee is a corporate entity, the individual will be expected to provide a personal guarantee to the franchisor just as they would to a bank, or that if something is not in the franchise agreement then it cannot be relied upon afterwards. It is therefore essential that each prospective franchisee is fully aware of what they can and cannot do both throughout the term of the franchise agreement and beyond.
As can be seen from the examples outlined above, the restrictions are there to protect not only the franchisor and the franchisor’s investment but by extension, the franchise agreement protects each franchisee within the network and their investments. As such, although the franchise agreement may be presented as a non-negotiable document, the purpose of seeking legal advice prior to entering into the franchise agreement is to protect your own investment.
This article comes courtesy of Beyond Law Group built around people and human perspective. We create and operate specialist law firms that can independently focus on specific client needs and specific services, all under one corporate Group.
