Top 10 features of a franchise agreement02/11/2023
Franchising can be an efficient and cost-effective way of rapidly expanding your business. For anyone considering franchising their business, it’s important to ensure the franchise agreement is robustly drafted with safeguards in place to protect both parties. In the UK, franchising is an unregulated industry so franchisors are not required to adhere to any specific franchising laws or codes. However, the British Franchise Association (BFA) provides guidance as to how to run your franchise operation ethically and sustainably and its Code of Ethics has been described as providing “a good indication of what is to be regarded as fair practice in the industry”.
A franchise agreement is a legally binding document, which outlines the relationship and terms and conditions between the franchisor and the franchisee. We can assist you with creating a document that is commercially strong but also adheres to the best practice guidance on ethical franchising outlined by the BFA.
Franchise agreements can be very lengthy agreements and the detail can vary depending on the industry and who it was drafted by, however, there are some key features that should be present in all agreements.
- Rights granted
All rights which are being granted to the franchisee should be clearly laid out. These could include, but are not limited to, the right to use the brand name, the territory and systems and to sell their products or services in accordance with the terms of the agreement. The territory is the area in which a franchisee can establish and operate their business. It may be appropriate to offer a franchisee a defined, exclusive territory (which may consist of a postcode area or an area indicated on a map) or it may be advisable to offer a non-exclusive territory depending on the business model.
Another important consideration for a franchisor is appropriately reserving rights that are not granted to the franchisee and providing for additional protection and control (where appropriate) to the franchisor. The franchisor will likely want to include a clause that makes it clear that all rights not explicitly provided to the franchisee in the agreement, are exclusively reserved to the franchisor. Some franchisors include specific carve outs from the franchisees rights, such as the right for the franchisor to directly operate a concession in airport or railway station that may be located in the territory of a franchisee. It is crucial to document, in detail, the scope and limitations of any rights granted to the franchisee.
- Operations Manual
The operations manual is a document that contains the business-specific policies and procedures for the franchisee to follow. It is advisable to include all the operational detail in such a manual as, unlike the franchise agreement (which cannot be amended without approval from both parties once signed), the franchisor can update the operations manual whenever they see fit. As a result, most franchise agreements will have frequent references to the operations manual to allow the franchisor flexibility to change processes and procedures during the term – the operations manual should be a document that evolves with the business.
A key consideration is protection of the business know-how and trade secrets which may be contained within the Operations Manual – the franchisor needs to provide the requisite guidance and rules to the franchisee, whilst retaining control over the information. A practical way to mitigate such issues, is providing the operations manual electronically so that access is controlled and can be withheld if appropriate. This is also an easy way to ensure that updates to the operations manual are communicated to the franchisee from time to time.
The franchise agreement should outline all fees the franchisee will pay to the franchisor during the term of the agreement. It is usual for an initial fee to be paid to the franchisor, which varies widely depending on the business being franchised. The initial fee is designed to recoup some of the franchisor’s initial start-up costs, such as setting up equipment or IT systems (such as Electronic Point of Sale), and also provide training for the franchisee, and (as appropriate) their manager or employees.
It is also common for a franchise agreement to include management fees and/or an advertising levy. Fees are usually paid monthly and can be based upon a percentage of sales or a fixed amount to be reviewed or increased annually.
- Intellectual property rights
Intellectual property (IP) subsisting in the franchise system is one of a franchisor’s most valuable assets and typically includes any registered (or unregistered) trade marks for the brand name and logo as well as other IP rights such as copyright, patents, domain names, designs and any other goodwill. The franchise agreement should grant the franchisee a licence to use the IP rights in respect of carrying on the franchise business and may also include a number of warranties, obligations and restrictions in relation to the use of the IP rights.
- Duration and renewal
It is important that the agreement clearly demonstrates the duration of the contract. Generally, franchise agreements start with an initial term and often offers the franchisee the opportunity to request renewal for another fixed term when that comes to an end. It is worth noting that in the UK there is currently no maximum permitted term for a franchise agreement, so the document should include a precise end date even if both parties believe the contract will exist beyond that.
The franchise agreement should outline all of the specific obligations that a franchisee is expected to adhere to, such as ordering from a particular supplier, maintenance of certain equipment and any other responsibilities that are critical to the operation of the franchised business. Arguably, one of the most important obligations to impose on a franchisee are obligations as to minimum performance levels. This enables the franchisor to monitor the outlets, gain key insights into the market, and can give the franchisor the option to (for example) terminate the agreement or take control over an outlet from an under-performing or unsuitable franchisee. It may also include obligations on the franchisor, such as providing training to the franchisee and supporting the franchisee with marketing efforts, and the franchisor should very clearly set the scope of any obligations (for example, how much time is to be spent on initial training, and when does this need to be completed).
Nevertheless, a well-drafted franchise agreement details obligations clearly so that both parties are aware of their rights and responsibilities. This is important to reduce the scope for misunderstanding and for founding a strong business relationship. The BFA also has relevant guidance in its Code of Ethics that franchisors should be aware of when defining franchisee obligations, such as that minimum performance targets should not overstretch the franchisee and the consequences of non-compliance must be reasonable. There should be a drive towards helping the franchisee to improve, rather than jumping straight to termination.
- Restrictive covenants
Restrictive covenants – which can also be referred to as non-compete clauses – are in place to prevent a situation where the franchisor shares their knowledge and expertise with a franchisee, who could then exit the business and start a competing business. However, these clauses must be reasonable in order to be enforceable, so it isn’t advisable for a franchisor to include limits which are too broad in terms of geographical scope or length of time they apply. Courts will not permit clauses which seek to unfairly restrain the franchisee from trading. It is advisable to get restrictive covenants professionally drafted, as a legal professional will have a fuller understanding of the case law in this area, and many such clauses are struck out by the courts.
- Representations and disclosures
Typically, franchisors will want to exclude any liability for representations or statements made in the course of entering into the agreement. Franchise agreements have historically included a clause which essentially requires an acknowledgement from the franchisee that they have not entered into the franchise agreement on the basis of representations made by the franchisor (often referred to as “entire agreement” clauses). There has been a flurry of cases in recent years which struck out such clauses as being unfair (in the circumstances) – entire agreement clauses do not preclude claims for misrepresentation. Where there is unequal bargaining power, particularly onerous entire agreement clauses need to be brought to the attention of the weaker party (here, the franchisee), with the meaning being made clear and the weaker party being warned of the need to protect their interests.
In order to increase the likelihood that such clauses are fair and enforceable, franchisors can make disclosures (in the form of a disclosure letter) which have the effect of making the franchisee aware of certain matters and circumstances (for which they cannot later claim misrepresentation in respect of). The disclosure process improves transparency and – the franchisee to make a fully informed decision. The disclosure letter should be provided to the franchisee, alongside a properly drafted franchise agreement, and the franchisee should be given the opportunity to consider the franchise agreement (in its entirety), alongside the disclosure letter, and make the independent decision as to whether to enter into the agreement. Franchisors should be aware that presenting an agreement as being non-negotiable can be a factor considered by the court in this regard – if a franchisee does not seek legal advice for a non-negotiable agreement, they may consider that their resulting lack of legal/commercial knowledge was reasonable.
Additionally, franchisors should present any projected figures cautiously, as the most common cause for complaint from a franchisee is misleading figures – these should be based on past-performance and relevant for that franchisee. The BFA provides useful guidance, and it is advisable that someone in the franchisor’s business is familiar with this guidance and can control the flow of information to franchisees to avoid any claims of misrepresentation. The franchisee should be made aware that the franchisor does not guarantee the financial performance (forecast or otherwise) of any franchised business.
While both parties enter into a franchise agreement in “good faith” with the intention of completing the full term of the agreement, a termination clause will detail the circumstances in which one party wishes to terminate the agreement and bring the relationship to an end early. For example, in the circumstance where a franchisee fails to pay any fees, is not meeting any targets or does something to damage the reputation of the brand, the franchisor would understandably want to have the right to terminate the agreement. The franchise agreement will outline the consequences of termination, which may include the return of confidential information and (where a premises is involved) the de-branding of the franchise operation, and the removal of any sign or reference to the franchise. Franchisors should consider what they require a franchisee to do to protect the brand.
A franchisee will often have the opportunity to sell or assign the business, however this will likely need the approval of the franchisor who will want to carry out due diligence on the new buyer. The franchisor may list conditions precedent for any prospective assignee or buyer, in the franchise agreement.
It’s important to note that, whilst franchise agreements may often be initially presented as non-negotiable by the franchisor, this may be difficult to stick to in the early stages of running a franchise (when the franchise may not be proven and the franchisor is keen to recruit franchisees to grow its network). A franchisor may need to make concessions (usually in the form of a side letter) and should carefully manage any negotiated agreements so as not to have widely different agreements across franchisees. We always recommend seeking legal advice in relation to any negotiations, as franchise agreements are often lengthy, complex documents which can subsist for many years, and any side letters need to appropriately amend and work alongside the agreement.
Hannah Nagel, a solicitor in our commercial team, advises on franchising matters such as preparing and negotiating franchise agreements across a range of sectors, including education, leisure, and food and beverage.
“Our team routinely prepares franchise agreements in line with the British Franchise Association (BFA) Code of Ethics. This ensures a fair contractual position, which reduces the amount for negotiation between franchisor and franchisee at the outset of a new franchise relationship. It also puts the franchisor in a good position should they wish to join the BFA in future”, said Hannah.
Our franchising team has extensive experience in supporting both franchisors and franchisees at all stages of their business. For expert advice on franchise agreements or any other franchising-related matter, contact Antony Hall, partner and head of the team, on firstname.lastname@example.org