All about Franchise License Agreements
Franchise license agreement is a contract or series of contracts that govern the relationship between a franchisor and a franchisee. It sets out in detail the respective rights and obligations that each party has to the other. Like all contracts, the terms of a franchise license agreement can be the subject of negotiation prior to signing, but care must be taken to ensure that the agreement continues to be enforceable after it is signed. If either party fails to meet their obligations under the franchise licence agreement, the other party has a right to sue for damages and/or to request that the agreement be enforced. Franchisors regularly and selectively enforce , maintain and neutralise developments in respect of their respective franchise licence agreements so as to ensure a symbiotic relationship with their franchisees and maximise their profits.
There are a number of different types of franchise arrangements that are recognised in law, such as the business format franchise, the distribution franchise and the trade marks franchise. A franchise licence agreement can either be in the form of a single document (where the parties execute the entire franchise agreement at once) or several contracts (where the parties enter into various contracts pertaining to the franchise agreement). The salient provisions of the franchise licence agreement are outlined in the rest of this article.
The Essential Ingredients of a Franchise License Agreement
The franchise license agreement is the umbrella document between a franchisor and a franchisee. It contains the binding requirements of franchise fees, intellectual property rights, and operational guidelines under which the parties will operate. The following subsections will delve further into the nuances of each of these essential elements.
Franchise Fees
The most important aspect of a franchise license agreement for many new franchisees is the list of franchise fees. This schedule of fees may be broken down into a one-time initial fee, on-going minimum fees, and various elective fees.
The one-time initial fee is typically set at the franchise’s inception and will not be subject to change, but the on-going minimum fees may increase over time. Those on-going minimum fees are the franchise royalties, or a percentage of sales that is paid to the franchisor for the life of the agreement. The elective fees are payments that the franchisee may make at their discretion, such as for training programs, national advertising or insurance.
Much like a company carefully examines a supplier contract, a new franchisee should consider the ramifications that the various fees will have on the profitability of the franchise. It may not make good business sense to sign a contract if the franchise fees will outstrip profits after only a few years of operation.
Intellectual Property Rights
In exchange for the franchise fees, the franchisor offers to the franchisee the right to use its proprietary business model. This includes many facets of intellectual property rights. These rights should be carefully explored in the franchise agreement and should include the following:
Consultation with an experienced franchise attorney may be advisable to fully understand the ramifications of relinquishing certain intellectual property rights, such as the right to operate within a set radius of a popular location of the franchised business.
Operational Guidelines
In order for a franchise to operate, it needs to have certain operational guidelines in place. This includes things like the proper operation of a storefront location, adhering to a cleaning schedule and following a specific order of food preparation. These operational guidelines will be included in the franchise license agreement and the franchisee will be expected to follow all of these guidelines and any future changes to them. While the agreement is a binding contract, it is not written in stone and may be amended when necessary.
Some franchisors have strict operational guidelines while others are less rigid, but regardless of the degree of flexibility, a franchisee should ensure that they agree with these guidelines before signing the license agreement.
Requirements for Franchisors and Franchisees
Legal Obligations Of Franchisees And Franchisors
By the very nature of their relationship, both the franchisee and franchisor are subject to certain legal obligations under the franchise license agreement. It is sensible, therefore, for each party to undertake to be familiar with their respective obligations before the parties embark on their joint commercial venture.
For example, the franchisee’s legal obligations are discussed at great length in the franchise license agreement. Usually, subject to the nature of their business, the franchisee will undertake to operate the business for the duration of the franchise, or other specified period. In addition, the franchisee will be required to (amongst other things):
obtain applicable permits and licenses
make available and/or train staff
observe the specified hours of operation
maintain specified records and accounts
maintain appropriate insurances
keep the premises in clean condition
observe relevant regulations and by-laws and
conform (also) to reasonable quality specifications.
In turn, obliges the franchisor to (amongst other things):
provide to the franchisee materials and training to operate the business
provide support services
licence to the franchisee a specified trading name and logo
provide access to the franchisor’s business systems and
be as explicit as possible in the franchise license agreement and
through the provision of supporting materials.
If either party is found to have breached or failed to perform their obligations under the franchise license agreement, the other party is entitled to seek recourse. Possible avenues include:
action for breach of contract and damages
specific performance (as per specific orders of the Court and/or VCAT)
injunctions (to prevent the other from breaching their obligations and/or take steps to rectify or mitigate any potential damage).
Common Issue Areas in Franchise License Agreements
There are also clauses that could be problematic during the term of the franchise agreement. Particularly, you want to look for clauses to ensure you have some kind of flexibility. If you are signing a 20 year franchise agreement with no early termination right on either party you may not have much flexibility.
You should also watch for clauses that require you to build out your store (if you are entering a restaurant franchise) in a fixed period of time. You want to make sure you have a reasonable time to build and open your store if such a fee is required. The clause should state when the franchisee is required to open its doors to the public.
You also want to avoid clauses that require you to pay the franchisor’s costs for everything , including lease negotiation of your space. If the franchisor is spending time or money on your behalf for site selection, lease negotiations, demolition, etc., it would be customary for them to charge you for their actual cost. However, there is no reason they should make you pay for the legal work that they have the capability of doing themselves at a much lower rate.
Negotiating a Franchise License Agreement
Negotiating a fair and mutually beneficial franchise license agreement is crucial for both franchisees and franchisors to ensure long-term success and profitability. Understanding what to look for and how to propose adjustments to the terms of the franchising agreement are vital to achieving satisfactory results for the franchisor and franchisee.
Any requests for negotiation of the franchise license agreement should be grounded with sound business rationale. If objections are made to provisions of an agreement, they should be accompanied by alternative solutions that would satisfy both parties. Franchisors should be prepared to provide justifications for why they have specific terms or conditions in the franchise license agreement.
Negotiating franchise license agreements should be taken seriously — simply objecting to certain provisions for no reason does not instill confidence in the franchisor. Franchise license agreements are not take-it-or-leave-it deals and should be reviewed by competent legal counsel as well, but having a solid offer and being open to certain negotiation points makes counter-offers more likely to be considered. The same is true for parties on the other side of the franchise relationship; franchisors are more likely to condone or consider reasonable request from franchisees if the franchisee is reasonable in its negotiations.
For successful negotiations, both parties should not only be familiar with the agreement, but also understand what is at stake. The components of a franchise license agreement represent monetary value for each party, so it is to their advantage to understand how the provisions in the agreement affect them financially. Approaching negotiations with an emphasis on the financial motivations of each party is more likely to lead to beneficial results.
This can be especially important for franchisees who may not understand the intricacies of a licensing agreement. Understanding how the franchisor might be impacted with an unfavorable change to a provision is important since it gives the franchisee a better understanding of where the franchisor may be willing to bend or compromise.
Franchisors also face financial motivations in negotiations and need to be steadfast about protecting their rights and interests. This can sometimes mean being difficult to deal with, since the primary goal of the franchisor is to protect their brand’s image through its franchisees. This can make negotiations difficult, but franchisees must understand how both sides are affected by each provision in the franchise license agreement. Without this understanding, it can be difficult for the franchisee to make a persuasive case for changes to the franchise license agreement.
At the end of negotiations, franchisors may agree to certain changes through the creation of side letters to help appease the franchisee who may be unhappy with certain provisions in the franchise license agreement. This can also make things easier for later discussions in the event of a dispute or litigation. Side letters are not always perfect solutions to problems and may not always satisfy a franchisee’s concerns, but they can certainly ease worries for the time being. It also provides some assurance that the franchisee’s voice was heard.
The Value of Legal Counsel in Franchise Agreements
Taking into account the above complexities and the importance of rigorous transparency and compliance in franchise license agreements, it is essential that entities and individuals entering into an agreement consult with legal experts early and throughout the process. Legal experts have the foresight and experience to anticipate, assess and identify any legal concerns or pitfalls that may arise during the drafting and review process, and can ensure that all interests are protected . Moreover, it is always advisable to seek the assistance of experts in international commercial law when entering into a franchise license agreement with a foreign entity. They will be able to determine the most advantageous form for the agreement and amend any clauses which may require alteration in order to ensure the protection of interests in foreign jurisdictions.