Gurmeet S Jakhu, Partner
Hamilton Pratt Solicitors
Birmingham
United Kingdom
Topic 5:
Successful Franchising: Key Terms of a
Franchising Agreement
1
CONTENTS
1. An Introduction into Franchising
2. Pilot Testing
3. Franchise Agreements
a. Introduction
b. Guiding Principles
c. Outline Agreement
4. Operations Manuals
5. Property Documents
2
1.
An Introduction into Franchising
•
What is a franchise?
•
Types of Franchises
•
What are the alternatives to franchising
3
What is a franchise?
Business Format Franchising contains 4 essential
elements
– The Fr’sor allows the Fr’ee to use a name which is
associated with the Fr’sor
– The Fr’sor exercises continuing control over the Fr’ee
– The Fr’sor provides assistance to the Fr’ee
– The Fr’ee has periodically to make payments to the
Fr’sor.
4
Types of Franchises
Two main types:
1.
Product distribution franchises –licences TM & logo, Fr’ee not
provided with entire system for running business.
Product distribution
Eg: soft drink distributors, car dealers and gas/petrol stations
2.
Business format – replicate business format. Most common
form of franchise –Fr’ee uses/replicates the complete method
to conduct the business.
Business format
Eg: fast food, retail, restaurants, business services and lodging
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Alternatives to Franchising
1.
Distributorships
•
D purchases products in his own name
•
Has no connection with Supplier/wholesaler
•
Familiar with local markets
•
Deals with more than one supplier/producer;
•
No/limited support, training from the supplier/producer
•
D free to operate business, maybe regulation relating to stock levels, turnover
& advertising Cf: franchising
•
Fr’ee pays an initial fee and continuing fees
•
D pays a one off purchase price. Profit element to supplier is difference in
manufacture/purchase costs and that which he sells at
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Alternatives to Franchising
2. Agency:
1.Agents do not purchase in their own name
2.Contracts directly by supplier and customer or agent
on supplier’s behalf
3.Few restrictions t - relate to the agent’s powers to
incur liabilities
4.Some Franchises have agency-principal relationship
– eg: parcels delivery franchises customers contracts
with Fr’sor but delivery/collection by Fr’ees.
3. Licensing
1.IP rights licensed to a manufacturer to enable
manufacture to produce/sell
2.Pay for rights to use particular trademark
3.Supervise the use of the license - limited
4.Most FA contain a licence to use TM & Brand –
however FA more heavily regulated
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Alternatives to Franchising
4. Acquisition/Setting up a Subsidiary;
Straight acquisition of an existing business or
establish a wholly owned subsidiary - provides
maximum control
5. Joint Venture:
•
•
•
2 or more companies/firms agree establish a
common enterprise in which they intend to
participate jointly;
Frequently international in nature
Advantageous
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(2) Pilot Testing
• Why pilot test - Purpose
– prove the financial viability
– ensure Fr’sor able to transfer its know how
and
– Chance to refine the franchise process itself
• 2 way process for transferring know how and
experience
• Enables Fr’sor to develop its Operations Manual
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(3) Franchise Agreement
Introduction
• Care and skill required in drafting FA
• FA fundamental to success of franchise:
– Negative impact
– Reflect current custom and practice
– Accurately reflect the way the Fr’sor operates the
business
– Protect from Fr’ee claims
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Franchise Agreements – Guiding
Principles
– Protect reputation of the Fr’sor;
– “tough”
– but to strike correct balance
• Achieved by:
•
•
•
•
Balance
Limit Discretion
Selling Document
No legal terminology and well presented
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Franchise Agreements - Guiding
Principles
• Easily understood – otherwise slow down process
• Do not change FA for individual Fr’ees
• Variables – premises, equipment package, minimum
performance, key people often set out in Schedule
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Outline Franchise Agreement
• No two FA are the same - are some basic
provisions
• ‘Skeleton’ form of FA and notes in Handout
• Parties: Franchisor, Franchisee, Individuals
– Natwest/BFA Survey: 36% Sole Traders; 22%
Partnership & 41% Companies
• Corporate Fr’ee – New Co, no assets; desirable to
obtain individual guarantee
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Outline Franchise Agreement
• Directors/major Shareholders:
– restrictions on transfer of shares &
– subject to Restrictive Covenants
• Recitals:
– set out the background and could form part of factual
background in which to construe contract
• Definitions:
– essential that all terms used in FA are clearly set out.
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Outline Franchise Agreement
• Rights granted
• Exclusive FA: Fr’sor not appoint another Fr’ee in
the Fr’ee’s territory; Danger for new Franchises.
• An exclusive/non-exclusive licence to :
• Operate Business within the Territory (from Premises)
• Use of trade names and trade marks
• Use Fr’sors copyright, material, know-how, knowledge
• Benefit from Marketing knowledge & experience of Fr’sor
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Outline Franchise Agreement
Term
– Usual initial term is 5 years
– If less than 5 years unlikely to be a franchise
– BFA’s code of Ethical Conduct: Extension and
Interpretation and Art.5.4 of the European Code of
Ethics
• term to be sufficiently long to pay back the Fr’ee initial
investment
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Outline Franchise Agreement
• Franchise Fee (Initial Fee)
– Fr’ee should not be trained until full fee has been paid
off
– Initial fee should not contain a profit element
– Amount will depend on reputation of Fr’sor and
profitability of his franchise
– Fr’ee to pay Fr’sors legal costs – discourages
attempts by Fr’ee’s legal advisors to negotiate the
terms of the FA
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Outline Franchise Agreement
• Rights of Renewal
– Essential to enable a Fr’ee to renew term
– At the end of initial term – optional for Fr’ee
– Renewal should be exercised without further payment
– Not to be lost for trivial/minor breaches of FA
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Outline Franchise Agreement
Renewal (contd)
• Fr’sor may introduce further requirements:
• A“re-vamp” clause & relocation clause
– Must be necessary to revamp or move; costs effective
– Demonstrate that the revamp resulted in better financial
performance for other Fr’ees
– Fr’sor to assist with sourcing finance
• Indiv/Fr’ee to give up all claims against Fr’sor
– Enforceability issues in light of UCTA
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Outline Franchise Agreement
Rights of Renewal & Minimum Performance clauses
• Which apply on renewal only are acceptable
• Appropriate if all franchise territories are comparable &
some form of exclusivity has been granted
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Outline Franchise Agreement
• Fr’ors initial obligations – to provide advice on:
–
–
–
–
–
Finding premises & alterations to the premises
How to set up the franchise
Such equipment, stock etc as set out in the Schedule
PR launch
Initial training programme
• right not to enter into FA and
• reimburse costs
– Operations Manual on loan to Fr’ee
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Outline Franchise Agreement
• Franchisor’s continuing obligations
– Provide Fr’ee with know how, advice & guidance
relating to the Business
– Supply products to the Fr’ee
– Supply stationery when required
– At cost, train Fr’ee’s personnel
– Organise an annual conference for Fr’ees
– Try and set out Fr’sors obligations extensively
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Outline Franchise Agreement
• Franchisee’s Obligations
– Refurbish & equip the Premises as required by Fr’sor
– To use Fr’sor supplied stationery, invoices & products
– Operate the Business in accordance with Operations
Manual
– Use only signs & packaging in connection with the
Business as approved by the Fr’sor
– Premises:
• Maintain to the highest standards and
• not to carry out any alterations without Fr’sor’s consent
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Outline Franchise Agreement
• Fr’ees Obligations (contd):
Use best endeavours to promote & extend Business
– Operate the Business during specified hours
– Ensure that staff are well dressed clean and polite
– Not employ a manager unless:
• been approved by the Fr’sor and
• completed Fr’sor’s training course
– At the request of the Fr’sor provide potential Fr’ees
with information as reasonably requested
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Outline Franchise Agreement
• Training
– For Individuals – corporate Fr’ee (no charge)
– For Fr’ee’s employees and subsequent managers (at
cost)
– Initial training often FOC but during term – at cost
• Continuing Fees
–
–
–
–
Management Fee 6-10% average of Turnover
In high turnover franchises can be paid weekly
Payment by Direct Debit
If Fr’ee purchase goods/services from Fr’sor, Fr’sor
will have a mark up on such gods/services supplied
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Outline Franchise Agreement
• Accounting Records – Fr’ee shall:
– Maintain record of gross turnover & submit to Fr’sor
– Records needed to calculate Management Fee &
Marketing Levy as specified in the Operations Manual
– Maintain records to verify gross turnover for 6 years
– Fr’sor’s right to enter the Premises to review
– Supply to the Fr’sor copies of all VAT returns
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Outline Franchise Agreement
• Advertising/Promotions
– Fr’ee to contribute to national advertising and
marketing by way of a Marketing Levy (2-4%)
– Marketing Levy received kept in a separate marketing
account - audited annually
– All advertising is to be approved by the Fr’sor
– Fr’ee free to advertise on internet – as long as not
active selling
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Outline Franchise Agreement
• Insurance
– Uncertainty - Fr’sors liability for act of Fr’ee
– Relate to conduct of the Business & as Fr’sor shall
reasonably require (Ops Manual)
– Fr’sor’s interest to be noted on policies &/or
– Provide Fr’sor with copies of policies and evidence of
payment of premiums
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Outline Franchise Agreement
• Trade Marks
– Fr’sor has to warrant that it is able to licence the use
the Trade Marks?
• If it has Registered TM – no problem
• If not no warranty should be contemplated
– To bring a passing off action in relation to
unregistered trade marks, the Fr’sor must be able to
show that it has retained goodwill in them
– Fr’ee to notify Fr’sor if it becomes of any
unauthorised use
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Outline Franchise Agreement
• Improvements
– Right during term to introduce amendments and
improvements
– Who is to pay for the new technology
– Ensure not impose too high a financial burden on
Fr’ee
– Not require Fr’ee to make extensive improvements
just before expiry of the initial term of FA
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Outline Franchise Agreement
• Manual
– Deals with day to day operations
– Power to amend the Manual during term
• If not, will be unable to introduce modifications or
amendments to the system
– Definitive copy of Manual to be retained
– In event of conflict between the FA and the amended
Manual, the FA would prevail
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Outline Franchise Agreement
• Telephones, fax & domain names
– Main source of advertising will be directories hence
control of numbers is important esp. on termination
– Fr’ee only to use the telephone numbers which have
been notified to the Fr’sor for the Business
– Consider:
• Fr’sor to subscribe to the number or
• Request Fr’ee to sign undated mandate which is exercisable
on termination (transferring numbers/names to Fr’sor)
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Outline Franchise Agreement
• Sale of Business
– Fr’ee’s right to transfer subject to Fr’sor’s consent
– The Fr’sor shall consent to a transfer provided that:
• The purchaser meets Fr’sor’s min. standards
– To include business experience and financial resources
• Payment of investigation and training cost
• There are no subsisting breaches of the FA
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Outline Franchise Agreement
• Sale of Business (contd.)
– Option to match offer made to the Fr’ee
– Fr’sor may require payment of a “finder’s fee”
– Other matters may be taken into consideration such
as aptitude for the business, references, etc
• Must ensure that tests are not too subjective otherwise the
Fr’sor would effectively have a right of veto
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Outline Franchise Agreement
• Non-Competition
During the term of the franchise neither Fr’ee nor the Individuals will:
• Carry on any other business
• Entice employees from the Fr’sor or other Fr’ees
• Use or disclose confidential information for any purpose other than
a purpose set out in FA
• Staffing
– Senior employees of Fr’ee not to make use of Fr’sor’s confidential
information
– Consider use of Side Letter/Deed of Confidentiality hence will be subject
to restrictive covenants and obligations of confidentiality
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Outline Franchise Agreement
• Death of Individual
– FA does not bind the Individual’s personal
representatives
– A manager for a period of 3 months, on payment of
the Fr’sor’s then current costs and expenses
– Within the 3 months period the Individual’s personal
representatives or beneficiaries must either:• Qualify as a Fr’ee by training (same a for new incoming Fr’ee) or
• Notify the Fr’sor of their desire to sell the franchise
failing which the Fr’sor may terminate the FA
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Outline Franchise Agreement
• Termination (1)
– It is unusual for Fr’ees to be given an express right to
terminate
– If Fr’sor wishes to terminate because of Fr’ee’s
breach, the Fr’ee should be given notice of any
breach and reasonable time to remedy a default
– The Fr’sor may terminate the FA if the Fr’ee:
• Fails to commence business within 3 months of execution of
the FA
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Outline Franchise Agreement
Termination (contd) 2:
• Breach of specific terms of the FA – list out those
terms which amount to fundamental terms
• Persistently defaults in payment of any amounts
due to Fr’sor
• Is found to have supplied materially false or
misleading information in or supporting the
franchise application
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Outline Franchise Agreement
Terminations (contd) 3
• Failure to rectify in specified period – breaches
which can be remedied
• Goes into liquidation/bankruptcy or is insolvent
• Abandonment of business
• Serious criminal convictions
• Note: Consider inserting a liquidated Dm clause for sums payable
by Fr’ee on termination – issues of enforceability.
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Outline Franchise Agreement
• Consequences of Termination
Following termination of the FA the Fr’ee:
•
•
•
•
•
Must cease use of the Fr’sor’s trade name and trade marks
Not hold itself out as being a Fr’ee of the Fr’sor
Pay all sums due
Return all manuals, literature, promotional material etc
Provide the Fr’sor with a list of all customers and potential
customers of which it is aware – problematic due to
ownership issues
• Not make use of or disclose confidential information relating
to the system of the franchised business
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Outline Franchise Agreement
Restrictive Covenants:
• Drafting Note:
– Will only be enforceable if it is reasonable to protect legitimate
interest of Fr’sor – ‘blue pencil’ test.
– Make sure that RC does not simply prevent Fr’ee from carrying
on business as Fr’sor
– Need to ensure that Fr’ee does not compete with Fr’ee business
and that of the Fr’sor
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Outline Franchise Agreement
Fr’ee & Individual shall NOT:
• Compete with the former Fr’ee’s business/Fr’sor:
– Expressed by reference to geographical limit and temporal (time)
restrictions eg:
• 1 mile or 700 yards of the former premises or any other
franchised or corporate owned premises
• For 6 or 12 months
• Solicit or entice customers of the former business
– Actual or those who had expressed an interest
• Recruit former employees
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Outline Franchise Agreement
• Individual’s Guarantee
– The Individuals shall indemnify the Fr’sor against any
breaches of the FA by the Fr’ee
• Representations
– the Fr’ee and the Individuals confirm that they have
not relied on any representations or warranties from
the Fr’sor in entering into this Agreement
– Must be drafted with great care to ensure
effectiveness of the clause in order to protect the
Fr’sor from misrepresentation claims
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Outline Franchise Agreement
• Acknowledgement & Non Reliance Clause
• Not exclude liability for fraudulent
misrepresentation eg: where Fr’sor made wholly
unrealistic forecasts and representations
• Acknowledge that Fr’ee has not relied on any
statements made by Fr’sor
• Remember UCTA and any similar legislation.
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4.
Operations Manual
1. Introduction
•
•
•
•
Brief summary of the franchise business
What the franchisee will have to do
What the franchisor will provide
Details of the existing franchise network - The
franchisor’s business philosophy
2. System
•
A detailed description of the system and each of its
elements
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Operations Manual
3. Operating Methods
A list of what is required in the business should be
set out and should include:-
Equipment
•
How the equipment is to be operated
•
•
•
•
Equipment problems
Stock requirements
IT requirements (hardware and software)
Vehicle requirements
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Operations Manual
4. Operation Instructions
All matters relating to the operation of the business
should be set out in detail and will include:•
•
•
•
Standard procedures
Financial records
Financial reporting
Payment of franchise fees
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Operations Manual
• General accounting, (VAT, PAYE and
Income/Corporation tax) information on how to complete
necessary forms
• Cash control and banking procedures
• How to deal with cheques, debit cards and credit cards
• Staff requirements
• Staff uniforms
• Advertising
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Operations Manual
•
•
•
•
•
•
•
•
•
Staff training
Procedure for disciplining staff
Summary of employment legislation
Breakdown of job description for staff
Opening times
Trading patterns
Purchasing requirements and stock levels
Pricing policies
Insurance
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Operations Manual
5. Outlet
•
•
•
•
•
Suggested location of store
Store layout
Display and merchandising techniques
Cleanliness
Complaints procedure
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Operations Manual
6. Standard Forms
•
All standard documentation and forms required to be
used in the business should be set out.
This may include:•
Business Names Act notices
•
Accounting and financial forms
•
Ordering forms
•
Stationery
•
Data Protection Act forms
•
Contracts of employment
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Operations Manual
7. Legal Issues
•
A summary of relevant legislation should be provided.
8. Franchisor's Directory
•
•
A list of the franchisor's employees with their job
descriptions and reporting structure
Useful telephone numbers and contact details
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5.
Property
These could include:
• Lease (if the Fr’sor is the immediate LL – on termination
just take over the premises)
• Deed of Option – upon termination, the Fr’sor has the
option to take over occupation of the premises subject to
LL consent
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