The Franchise Agreement Defined
What is a Franchise Agreement?
The franchise agreement is the legal agreement that creates a franchise relationship between a franchisor and a franchisee. Within a franchise agreement the franchisee is granted the legal right to establish a franchised outlet and operation wherein the franchisee, among other things, obtains the license and right to utilize the franchisors trademarks, trade dress, business systems, operations manual and sources of supply in offering and selling the products and/or services designated by the franchisor. The Franchise Agreement must be legally disclosed as an exhibit to a franchisor’s Franchise Disclosure Document which must be disclosed to prospective franchisee’s prior to offering or selling any franchises.
What Start-Up Franchisor’s Need to Know About the Franchise Agreement
As a franchisor your franchise agreement will serve as the primary and most important legal document that will govern and define the legal relationship with your franchisees. Within your franchise agreement you will be granting your franchisees the legal right to establish and develop their franchised locations and, in turn, the franchisees will be undertaking the obligation to establish and maintain their franchised operations in accordance with the mandates of your system and to pay to you certain on-going fees.
What Franchisees Need to Know About the Franchise Agreement
As a franchisee or prospective franchisee, the franchise agreement is the most critical document to your franchise investment. If you are promised something from a franchisor and you are relying on this promise, it must be contained in the franchise agreement or an amendment to the franchise agreement. To learn more about buying a franchise and due diligence steps to evaluate, click here.
Legal Rights Typically Defined and Established By Franchise Agreements
Within your franchise agreement, some of the substantive legal rights and obligations that will be established include:
- The Grant of Franchise Rights and Term. Granting the franchisee the right to establish and operate a franchised location or outlet. The granted franchise rights include the license to utilize the franchisor’s trademarks, trade dress and business systems. Typically franchise rights are granted for a term of 10 years but the term may vary depending on the type of business, the franchisees initial investment and the length of time for the franchisee to generate a sufficient return on their initial franchise investment.
- Franchisee’s Development Obligations. The franchisee’s obligation to establish a franchised location or locations and the designated time period within which the franchisee must establish and commence its day-to-day business operations.
- Initial and On-Going Training. The initial training that the franchisor will provide to the franchisee prior to opening and any on-going training that may be offered or required by the Franchisor.
- Territorial Rights. Whether or not the franchisee is granted a form of territorial protection wherein, for example, the franchisor will not grant competing franchises. Typically franchisees will be granted an operating territory within which they are required and restricted to conduct the operations of their franchise business. The franchise agreement will define where the franchisee may operate the franchised business, who the franchisee may or may not sell products or service to and any protection that may be afforded to franchisee regarding his or her territory.
- Operating Procedures. The franchise agreement will mandate that the franchisee must follow the systems and procedures established by the franchisor. The Franchisee will be required to offer and sell only those products and services authorized by the franchisor and will mandate that the franchisee follow the mandates and operating procedures contained in the franchisor’s confidential operations manual.
- Initial Fees. The franchise agreement will define the initial fees to be paid by the franchisee to the franchisor. The most common initial fee is the initial franchise fee which is the primary fee paid by the franchisee at the time of signing the franchise agreement. Other initial fees may include upfront software license fees and initial inventory requirements and purchases.
- On-Going Fees. The franchise agreement will define the ongoing fees that the franchisee must pay to the franchisor. The most common on-going fee is the royalty fee which is typically charges as a monthly or weekly fee paid by the franchisee to the franchisor. Royalty fees are most commonly calculated based on a fixed percentage (the royalty rate) of the franchisee’s on-going monthly or weekly gross sales. However, alternative royalty structures exist where a franchisee pays a royalty that is based on a fixed dollar amount or other structure defined in the franchise agreement.
- Marketing Fees and Marketing Obligations. The franchise agreement will mandate and define whether or not the franchisee is required to pay any marketing fees to the franchisor. The most common marketing fee charges by franchisors is typically referred to as a “brand development fund” to which a franchisee will contribute to. The franchise agreement will establish whether or not a franchisee must contribute to a brand development fund and other obligations which the franchisee must satisfy regarding the franchisee’s local marketing efforts.
- Restrictive Covenants and Non-Competes. To protect the confidentiality of a franchise system and to prevent franchisees from establishing competing businesses, the franchise agreement will include in-term and post-termination restrictive covenants. The “in-term” restrictive covenants will, typically prohibit the franchisee from establishing, operating or participating in any competing business during the term of the franchise agreement. The “post-termination” restrictive covenants apply when the franchise agreement is terminated and will prohibit the franchisee from establishing, operating or participating in any competing business for a designated time period that accrues following the date that the franchise agreement was terminated.
- Legal Rights and Jurisdiction. The franchise agreement will define the state law (typically the law of the State where the Franchisor’s corporate headquarters are located) that will govern the interpretation of the franchise agreement. The franchise agreement will also define the state courts, federal courts or arbitrating entity that will possess exclusive jurisdiction should a dispute arise between the franchisor and franchisee.
Franchise Agreements Are Negotiable
An issue that comes up extremely often relates to whether or not franchise agreements are negotiable. The answer is that they are negotiable provided that the negotiated changes are based on a request of the franchisee and to provide the franchisee with more favorable terms and rights but not less favorable terms or rights. While franchise agreements are typically negotiated and are frequently modified, the modifications are most commonly of a limited nature as franchisors do and must insist on uniformity within its franchise systems. Franchisors should never negotiate or modify structural items like initial franchise fees and royalty obligations.