“In the UK, franchising is an unregulated industry, unlike in the US and Australia, for example, which have franchising laws and codes. This means that, provided franchise networks are operated lawfully, franchisors and franchisees are to a large extent at liberty to agree commercial terms between themselves. In a very British way, this provides a liberal and flexible platform for franchised and licensed operations to flourish without having to cut through too much red tape and incur eye-wateringly expensive legal fees.
Members of the British Franchise Association (bfa) are required to comply with the Code of Ethics. The code is more than just a set of rules and provides the very basis from which any ethical business format franchise should operate. Whilst the code has no formal legal standing, the courts have recognised that the code “provides a good indication of what is to be regarded as fair practice in the industry” (Drivertime case, 2004) and so both members and non-members of the bfa are likely to be judged by its standards.
Therefore, it might be useful to remind ourselves of some of the key provisions within the Code of Ethics that governs the terms of any franchise agreement.
Minimum performance obligations
Improving performance is all about the carrot and the stick.”On the one hand, a franchisor seeks to encourage a franchisee’s performance in order to increase the royalties – often referred to as management service fees – it receives. These royalties are often based on a percentage of the franchisee’s turnover. As the turnover grows, the franchisor receives more but the franchisee’s profit margin should increase with the net effect that the franchisee also becomes more profitable.
On the other hand, the franchisor likes to have the ability to deter a franchisee from performing poorly. Quite often this is in the form of minimum performance obligations which, if not achieved, give rise to a franchisor having the right to remove exclusivity from a territory, reduce the size of a territory and/or terminate the franchise agreement.
The Code requires that any performance obligations must be by reference to the performance of other franchisees operating within the network. Any minimum performance obligation must be reasonable. Whilst the bfa is reluctant to prescribe what is reasonable it is generally accepted that the benchmark is 70% of the average turnover of franchisees within the network who have been operating for at least 12 months.
Limitations of liability
In any commercial contract parties are always keen to limit their liability to the greatest extent possible. A franchisor provides a standard form agreement so it is very tempting for it to ensure that its liability is limited to the maximum level that can be achieved but that the franchisee is actually liable to the greatest extent possible.
There have been some recent examples of franchise agreements that really have, in my opinion, completely overstepped the mark. For example, a franchise agreement included a clause that stated that the franchisor’s maximum liability owed to the franchisee shall be limited to the total amount of management service fees it has received in the previous 12 months to the breach. It might seem that there is good commercial sense to being able to ascertain the franchisor’s maximum liability.
However, one of the most common bones of contention within any franchised business is in connection with misrepresentation where the franchisee alleges that the franchisor has misrepresented the business opportunity to the franchisee. If the franchisee is successful in bringing such a claim then one remedy available to the courts is to put the parties back in the position they were in prior to entering the franchise agreement. You only have to read the case of Papa John’s v Doyley to get an understanding of the potential liability facing a franchisor should it fundamentally mislead a prospective franchisee in providing projected turnover figures.
Any franchisor should take great care in its representations regarding turnover and profitability and not simply rely on disclaimer wording. For example, it would be entirely unreasonable for a franchisor to include a provision within its franchise agreement that states that no matter what information is disclosed to the prospective franchisee, its total liability is limited to a financial amount far less than the franchisee’s actual loss. And it would be especially unreasonable if, in the same agreement, the franchisee is subject to onerous provisions in respect of its liability.
The agreement I alluded to above also included a liquidated damages clause stating that, in the event of termination, the franchisee was immediately liable to a penalty of tens of thousands of pounds regardless of the franchisor’s actual loss. The clause was drafted in such a way that the amount was stated to be a genuine pre-estimate of loss, although it is difficult to see how that could actually be the case in all circumstances.
There are many other examples where you can see an imbalance of the limitations of liabilities and the bfa, quite rightly, has made it clear that such imbalances are not compliant with the Code. A franchisor cannot expect to have its cake and eat it.
Commissions on resale
One of the most fundamental rights available to a franchisee is the right to be able to sell its franchise in order to realise its investment in and development of its business. All franchise agreements should contain a resale clause which stipulates the process through which a franchisee will need to go through in order to resell its franchise.
Typically, the franchisor reserves the right to approve the buyer (who will become a franchisee), and quite often the franchisor has a right of first refusal to acquire the franchised business. Further, the franchisor will seek to recover its costs incurred in facilitating the business transfer and may also charge a commission where it has found the buyer; known as a finder’s fee. However, where a buyer is an existing franchisee within the franchisor’s network, the bfa has recently issued guidance to make it clear that such a transaction should not attract a finder’s fee for an amount greater than the actual (and reasonable) costs incurred by the franchisor.
It is quite clear that any franchisor operating in the UK should read and understand the bfa’s Code of Ethics and ensure that its franchise agreement is compliant and, in any event, that it operates its franchise network in the spirit of good ethical franchising.
There should be no place in the UK’s franchising industry for aggressive, bully-boy tactics. Hard-working, dedicated franchisors who permanently seek to develop their system and operate ethically and fairly deserve to flourish in the market.”Leathes Prior, the law firm.”