Franchise law: potential pitfalls for franchisors

Franchising can be an excellent route to grow your commercial empire, entailing fewer risks than those involved in building a traditional business. However, this is not to say that franchising is without its fair share of statutory snares; ensuring that you don’t fall foul of any regulatory pitfalls is absolutely critical to a successful franchise story. That’s why we’ve assembled a crack team of lawyers to help you navigate the hazards that come with franchising a business.

Ignorance of the law is no excuse

Perhaps one of the most important steps for any business that is getting into franchising is familiarising itself with the various pieces of legislation that apply to the sector. “There is no franchise-specific legislation in the UK,” says Gordon Drakes, senior associate at Fieldfisher. “However, the general principles of contract law still apply to franchise agreements.”

One example he gives is that of UK and EU competition law. “Many businesses that are looking to franchise for the first time do not always appreciate the impact of competition law,” Drakes says. Common mistakes include attempting to dictate the prices at which franchisees can sell their products or services or prohibiting them from selling online. And whilst these mistakes may be easy to make, they come with harsh consequences. “Franchise agreements that do not comply with competition law may be unenforceable, either in whole or in part,” he says. “[And] a non-compliant franchisor may be liable to hefty fines or even imprisonment for its officers.”

Disagreeable terms

In legal terms, the franchise agreement is the foundation upon which an entire franchise operation rests. “You will be licensing your intellectual property rights and system to a franchisee as well as divulging substantial know-how and information concerning your business,” says Emily Sadler, solicitor at Paris Smith. “You will therefore want to ensure that your agreement is robust.” Having an airtight franchise agreement is ultimately worth the investment, which is why Sadler recommends seeking the input of a British Franchise Association-approved lawyer.”

Although some in the franchising sector may claim it’s cheaper and easier to crib a template agreement from the internet, Sadler stresses that Google is not your friend in these circumstances. “Not only does this raise issues of copyright infringement but it will not be tailored to your particular business,” she says. “[It] will almost certainly not be as protective as it could be.” Getting a bespoke agreement drawn up by an experienced hand will ensure you aren’t exposed to loopholes or litigation.

Fudging the numbers

One of the main things a prospective franchisee with the slightest nous will ask from a franchisor is a detailed set of projections for the opportunity in question. “Your lawyers will encourage you not to provide any financial information to prospective franchisees but in the real world it is very difficult to sell franchises without providing some financial information,” says John H Pratt, partner at Hamilton Pratt.

Given that a franchisor is going to be obligated to provide some kind of financial account of its business, it’s vital that the numbers provided are an accurate reflection of the average performance of a franchisee, rather than data cherry-picked solely to present the operation in a favourable light. “You cannot simply pluck figures out of the air,” Pratt says. “If you do, your franchisees may have a misrepresentation claim against you.” Ultimately, gaining a quick sale isn’t worth the risk of a protracted lawsuit.

Brain drain

Without a doubt, the most valuable asset of any franchise is its intellectual property (IP) and this makes it one of the prime areas where franchisors can be tripped up. “[You need to] ensure you have the proper protection for the business, that the unique business name or trading style are trademarked and any unique process or equipment is patented,” says Helen Hall, associate solicitor for litigation and dispute resolution at Simpson Millar. It’s also vital for a franchisor to check that the processes and branding it has established don’t infringe on the IP of others, which can severely devalue its package and potentially land it in court.

Additionally, given that meeting with potential franchisees will, by necessity, involve sharing at least some of a franchise’s inner workings, it’s important to put in place some protections to ensure that you’re not giving away your secret sauce. “Make sure information about the business model provided pre-contract is done under terms of confidentiality,” says Hall. And these kinds of protections shouldn’t only apply to those outside the business; they’re just as important for those who are already on the inside. “Include restrictions in the franchise agreement that prevent franchisees from setting up in competition or using your industry know-how if they leave,” she says.

With your eyes closed

Whilst franchisors can’t be expected to be perfect prognosticators, attempting to look into the future can certainly help protect a franchise from any hidden pitfalls that might lie ahead. “In the absence of a crystal ball, it is important that the shareholders in the franchise consider what their future plans for the business might be and discuss this with their legal advisors,” says Drakes.

Perhaps one of the most important considerations will be the provisions that need to be made for when a franchisor wants to sell the business. “It is important to ensure that the franchise agreements that underpin the network give the franchisor the flexibility to accept investment or sell the business,” Drakes says. For a franchisor to be able to make a major decision like this without having to undergo a lengthy consultation with its franchisees, it’s important to ensure the relevant documents contain the right caveats. “It can cause significant issues down the line if franchisee consent is required for investment or a sale,” he says.”