Investing in a franchise is an attractive option for many entrepreneurs. While such business ventures offer immediate branding and operational benefits for the franchisee, as well as the opportunity to run their own business, the franchise agreement that they enter into with the franchisor can often create a number of financial and legal obligations and burdens. As a potential franchisee, it is important to be aware of what you are signing because not only does the agreement govern the period in which you own and operate the franchise, it also defines the post-franchise relationship. In general, franchise agreement language can be overwhelming and complex, and it is important for prospective franchisees to consult with an attorney before entering into any such agreement.
Many prospective franchisees are familiar with the franchisor’s “franchise fee” which is essentially the cost of buying into the franchise (typically an upfront fee), and “franchise royalty fees,” whereby the franchisor takes a percentage of the franchisee’s revenue (not profit), either as a flat fee or formula. But there can be other mandatory costs and fees associated with owning and operating a franchise (for example, a requirement to purchase certain products and merchandise from the franchisor), and it is important to ensure that they are clearly defined in the franchise agreement to avoid unexpected surprises.
Often franchises are national or regional and as such, their agreements will contain very specific choice of law provisions where the franchisor selects the jurisdiction and the law to be applied in legal disputes with the franchisee. Under such a scenario, the jurisdiction is often the state of the franchisor’s base of operations. Furthermore, franchisors most often include an alternative dispute resolution (“ADR”) provision into their agreements, such as arbitration. ADR can be a good thing because it can control the cost and scope of litigation, but it also can place limitations on the type of relief that can be provided.
Exclusivity is another significant issue with franchise agreements. Many franchisors grant franchisees exclusive territories where they can operate. Clearly this is a way to control competition within the franchise system between franchisees, but if the territory language is not well defined, it can create legal disputes with other franchisees and the franchisor.
And of course there are always issues with non-compete provisions. Franchisors are understandably very protective of their intellectual property, and typically ensure that a franchisee will not be able to misappropriate their trademarks, copyrights, or engage in unauthorized competition during the term of the franchise agreement. In some instances, these non-compete provisions can be unreasonable, overly broad, and too restrictive. For example, a franchise agreement may prohibit a franchisee from engaging in or owning a “competing business” without defining what a competing business actually is for the purposes of the agreement. Another factor to pay attention to is how long the non-compete provision is applicable if there is a termination of the franchisor/franchisee relationship. It is imperative that prospective franchisees understand the specific terms of such provisions.
Beware of operations manuals. In general operations manuals are very powerful tools for franchisors. They often reserve the right to “revise” the manual as often as they see fit, and it provides franchisors with unilateral power to add restrictions and obligations (and fees) on the franchisee that they did not have to bargain for.
Default and termination provisions are very serious. They define the events and conduct that allows the franchisor to terminate the franchise relationship, and in some instances, force a buy-back of the franchise. The terms need to be clearly explicit with no ambiguities so a franchisee does not find itself in a dispute with a franchisor looking to take control of a franchisee’s business through bad faith conduct. Additionally, a franchisee needs to have clearly defined terms of how they are compensated for fair market value for the business if they decide to terminate the agreement and/or sell the business. Franchisees need to review these provisions very carefully to ensure their investment is protected.
A very important aspect to all of this is that often there is very little ability for a prospective franchisee to negotiate the terms of franchise agreements. These agreements are generally standard, unilateral contracts. However, if a prospective franchisee consults with an attorney and discovers issues with the proposed franchise agreement, they can attempt to negotiate certain terms, and at the very least, clean up ambiguous or problematic language that does not change the basic terms of the deal and deprive the franchisor of its rights, but that makes the contract more equitable for the franchisee.
If you are considering entering into a franchise agreement, please contact Andrew W. Urias, PLLC for a consultation on how we can assist you.