The franchise agreement

Understanding the franchise agreement

The franchise agreement is full of legal jargon with lots of references to “whereas” and “wherefore” and it can be double dutch to people who have never seen one before. But the franchise agreement is perhaps the most important document in the franchise process.   Once signed, both parties are bound by it, so it’s worth studying in detail.

The agreement outlines the responsibilities of both the franchisor and franchisee and should be well balanced in terms of rights and obligations. It should also be exactly the same for every franchisee in the network.

The agreement should achieve three fundamental objectives:>

  • First: in the absence of specific franchise legislation in Ireland it should contractually bind both parties and accurately reflect the terms agreed.
  • Second: It should seek to protect for the benefit of both the Franchisor and the Franchisee the Franchisor’s brand, reputation, and intellectual property.
  • Third: It should clearly set out the rules to be observed by the parties, such as:
    • Exactly what rights are being granted to the Franchisee and, if a specific territory or location is being allocated whether this is exclusive or non-exclusive.
    • The term or duration of the contract (usually, but not always, five years) must be long enough for the Franchisee to recover his initial investment. It should also explain his right to renew the contract when it expires, and at what cost.
    • The cost the franchise and what fees or royalties will be due—how much, when, and how.
  • Most contracts will have a Performance Clause, stipulating a minimum amount of sales (in numbers or as a percentage of gross revenue) to be achieved annually. These figures are always agreed before the contract is signed.

The franchisor’s obligations in the contract must be specific and extensive enough to warrant the fees payable under the agreement. The franchisee will expect the franchisor to:

  • Train and support the franchisee and his staff
  • To supply goods and/or services
  • To be responsible for certain advertising, marketing, and promotion
  • To assist the franchisee to locate and acquire property and fit out and convert into a franchised outlet. (Same for motor vehicles, etc.)
  • To improve, enhance, and develop the business system
  • To provide certain support functions such as bulk buying, accounting and management services

It must detail the way in which the franchisor wants the business to be run, and include confidentiality obligations, trade marks, accounting and reporting requirements, staff levels and behaviour, insurance, and what happens should the franchisee unfortunately die or become incapacitated.

The franchisee should have the right to sell or assign their business in order to realise a gain on their investment. This right will be conditional of the “first refusal” by the franchisor, the franchisor’s consent, and the payment of a fee.

Remember, most franchise contracts are one-sided in favour of the franchisor. They allow him to terminate the contract for any number of reasons. Justification for this is the franchisor’s need to protect the brand and his trade secrets. However, the franchisee has a right to terminate if the franchisor breaches his obligations.

The agreement will contain a number of non-compete clauses to protect the franchisor’s business from unfair competition from current and former franchisees. It will include provisions to stop the Franchisee from poaching employees or customers both during the term and for a period after it.

The agreement will refer to the franchisor’s Operations Manual, which sets out in detail how the business is run on a daily basis. This becomes part of the franchisee agreement so a franchisor may bring a claim against the franchisee if a provision of the operations manual has been breached.

Many agreements will have a clause agreeing that, in the event of a dispute, the parties will go to arbitration, which is a much less expensive than going to court.

Can I get out of a franchise agreement?

No-one should enter into a franchise agreement thinking they can walk away from it. It is not as easy at that. You don’t have the right to quit when it suits you.

A franchise agreement is a contract like any other. Before signing, both parties make a commitment to work together for an agreed term, usually five years. The franchisor will have invested time and money into the recruitment process and also into the training of the franchisee.

They want to see the franchisee put in whatever effort is necessary to make the franchise a success. And they will expect the franchisee to honour his commitment to pay royalties or management fees due under the agreement during the term. Should you want to terminate the agreement before it expires you would be in breach of contract and the franchisor could sue for the amount he would have earned had you continued to be a franchisee. This sum could be substantial.

Obviously, things can go wrong. There are winners and losers in franchising and sometimes a franchisee finds the going more difficult than he initially expected and wants out.

You have two choices: try to re-build the business and stick with it or try to sell it yourself. This won’t be easy if the business isn’t making money.

You would need to get help to turn things around and make the business attractive to a buyer. Either way you need to be discussing the issues with the Franchisor at an early stage. The franchisor will always want to help if they can. It is not good for them to have a franchise fail. Re-selling the territory can be difficult because any new prospect will want to know why it didn’t work for the previous franchisee. It will suit them best if you can find a buyer, someone who can slip into your shoes without anyone else knowing about it.

The situation is different, of course, if the franchisor is at fault. For example, if there is a fundamental flaw in the business system which prevents every franchisee in the network from being successful, or if the Franchisor is not providing the support or service the franchisee is entitled to, then the franchisee may have the right to terminate the agreement—without paying penalties.

By Tony Fitzpatrick, Managing Partner, franchiseyourbusiness.ie