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The Franchise Agreement:
What is a Franchise Agreement?

Contributed by John Pratt, Hamilton Pratt
Introduction

Either prior to pilot testing or once a prospective franchisor is able to establish that the pilot test has been successful, a franchise agreement will have to be prepared.  The care and skill taken in preparing the franchise agreement will be fundamental to the success of the proposed franchise for the following reasons:-

-              a badly prepared franchise agreement will have a negative impact on franchise recruitment.

-              the franchise agreement should reflect the current custom and practice to ensure that it does not  “stand out from the crowd” to its detriment in this respect.  

-              the franchise agreement  must accurately reflect the way that the franchisor intends to operate its business.  If it does not the franchisor may be unable to comply with its provisions and this will give franchisees an opportunity to claim breach of contract.  

-              the franchise agreement must protect the franchisor from franchisee claims so far as possible.  

Agreement – Guiding Principles

Franchise agreements are prepared by franchisors to protect their reputation and the reputation of their franchisees.  They are “tough” commercial agreements but nevertheless franchise agreements need to strike the right balance by following some guiding principles:-

-              Balanced – although franchise agreements are inevitably one sided in favour of the franchisor because they have been prepared to protect the franchisor (who after all is providing franchisees with all of its know how and allowing franchisees to use its brand), there are limits to how one sided they should be.  Some clauses simply give too much power to a franchisor.  An example of such a provision is a “time of the essence” clause.  The BFA has recently published a technical bulletin to the effect that franchise agreements should not contain time of the essence clauses.  The reason for this is that they entitle a franchisor to terminate for very minor breaches of contract.  The BFA’s position is summarised in the following extract from the technical bulletin:-

                “If an offence is minor, and the franchisor attempts to use the power of the clause to terminate the contract, it could well be ruled “unreasonable”. It would certainly be unethical to use one or more minor breaches, over a period, to justify heavy-handed action against a franchisee.  A clause that stipulates that payment of the management services fee by a due date is “of the essence” could be reasonable, whereas on-time submission of weekly sales returns should not be “of the essence”.  Whilst it may seek to focus the franchisee’s attention on the franchisor’s desire for prompt reporting, a consequential right of the franchisor to terminate the agreement for failure to report on time goes beyond what is reasonable.  Such a test of reasonableness will come into much sharper focus if, in the future, the draft Unfair Contract Bill should pass to legislation.”

Neither, for instance, should agreements give the franchisor too great a discretion on matters such as fees – franchisees need to know how much they are expected to pay and know that this cannot be altered (upwards!) by the franchisor; or minimum performance – a number of franchise agreements require franchisees to prepare annual business plans (no bad thing!) which have to be approved by the franchisor (again no problem) but if the business plan is not approved or the franchisee fails to achieve the figures in the business plan, the franchisor - may take certain specified actions which includes termination. Quite apart from mixing up two distinct concepts (business planning and minimum performance) this type of clause simply gives the franchisor too much power to move the goal posts.    Finally, although the agreement will refer to the operations manual, the manual should not override the provisions of the franchise agreement nor should the manual contain provisions which should, because of their importance, be in the franchise agreement itself.

-              Selling document – clearly contractual documents are not aimed at encouraging parties to enter into them, but they should not have the opposite effect.  In other words, for a relatively low cost or non complex franchise the franchise agreement should reflect that and should not be over detailed, complex or over burdensome.  Equally, the agreement needs to be well set out and contain no drafting errors or “typos”.  These will have the effect of putting off prospective franchisees and, in particular, their legal advisors. 

-              No legal terminology – franchise agreement are, by their nature, complex commercial agreements.  They last for considerable periods of time (longer than the great majority of commercial agreements) and are very prescriptive as to what the parties can and cannot do, but one of the parties – the prospective franchisee – is unlikely to have entered into similar commercial contracts in the past and it is essential that franchisees are able to read and understand the agreement.  For this reason franchise agreements should contain plain English and avoid legal terminology.   The use of latin terms such as, “inter alia” or “ex parte” should be avoided as should terms such as “hereinafter written”, “hereinbefore” etc.  Further, there is no reason why punctuation should not be inserted in franchise agreements!  This would certainly make an understanding of the agreement easier.  It is a sad indictment of the legal profession that the only reason legal agreements do not contain punctuation is that in the 19th Century legal agreements were prepared by clerks using quill pens which dripped ink.  It was not clear whether a little mark on a contract was an accidental drop of ink or was punctuation.  As a result all small marks were ignored and, therefore, there was no point in putting in punctuation.  In the day of computers and word processing there is absolutely no reason to continue this approach! 

-              Well presented – it is, of course, quite possible for franchise agreements simply to be photocopied and stapled.  Indeed most franchise agreements are sent out in this way but there are significant advantages in ensuring that franchise agreements have been printed and bound properly before they are forwarded to prospective franchisees and their lawyers – this will discourage them being amended – and highlights the importance the franchisor attaches to the quality of the franchise agreement.

-              Easily understood – as already indicated, franchise agreements are, by their nature, complex and are likely to be submitted to prospective franchisees with little or no experience of commercial contracts.  It is therefore essential that they are written in terms that are easily understood.  For instance, many franchise agreements contain a provision which reads:-

                “The Franchisee shall comply with the Trading Schemes Act 1996”

                This sort of provision should not be included because prospective franchisees will have little or no knowledge of the Trading Schemes Act – why should they?  If there are specific things that franchisees should or should not do then these need to be listed so that instead of a clause requiring a franchisee to comply with a law which he has never heard of the clause should require the franchisee:

-              to be VAT registered;

-              to maintain VAT registration throughout the term of the agreement; and

-              not to take on self employed persons without the franchisor’s consent. 

These are easily understood obligations which do not require any further research on behalf of the franchisee to ensure compliance and is, after all, the effect of an obligation to comply with the Trading Schemes Act. 

Complex clauses should be avoided to reduce the risk that a franchisee can argue that he did not understand the provision.  A further way of reducing this risk is to require franchisees to obtain legal advice.  Whilst at one level this may, from a franchisor’s perspective, slow down the recruitment process and result in extra expense for the prospective franchisees, franchisors are well advised to make it a requirement that franchisees obtain legal advice on the franchise agreement because if the franchisor can prove that this was indeed a requirement and the franchisee chose not to obtain legal advice or did obtain legal advice and the consequences of the agreement were explained it is less likely that the franchisee will be able to argue that he did not understand a provision in the franchise agreement. Requiring franchisees to obtain legal advice is, in any event, a requirement of the BFA disclosure requirements.  

Franchisees should be discouraged from obtaining advice from lawyers who do not specialise in franchising because very often they advise that the one sided nature of the franchise agreement is unacceptable and try to amend the franchise agreement.  Many franchisors provide franchisees with a list of BFA affiliated lawyers who are able to review their franchise agreement.  Some go further and recommend one or two specific lawyers.  Mostly lawyers will prepare written reports on franchise agreements for a fixed fee of approximately £400 plus VAT.  It should, of course, be stressed to prospective franchisees that the lawyers that they use should report on the agreement, highlight those provisions which are unusual, unfair or unworkable, but should not seek to amend the agreement.  In other words the franchisee’s lawyer  role is simply to draw the franchisee’s attention to problems rather than to try to redraft or amend the agreement.   Most lawyers who are not experienced in franchising have difficulty in grappling with the concept that the agreement cannot be amended and end up costing their client a great deal of money.

-              Not changed – it is one of the guiding principles of franchising that franchisors should not change their franchise agreement.  There are any number of reasons for this principle.  The first is that if a franchisor negotiated franchise agreements, then this would involve the franchisor in a very substantial amount of management time and, if it involved its lawyers, n a substantial amount of legal costs.  Further, a franchisor would be likely to experience difficulties with the franchise network if some franchisees had different or better terms to others as well as causing administrative nightmares because the franchisor would have to refer constantly to each individual franchise agreement to establish precisely what its rights and obligations were.  These are all powerful reasons for franchisors to ensure that their franchise agreement are not altered.  Not only should this be the case but franchisors should make it clear that there will be no alteration to their agreements.  Certainly, in the early days this requires a high level of self confidence to be displayed by franchisors who, of course, at that stage are extremely keen to recruit franchisees. 

                Having said this it is permissible, certainly when pilot franchises are granted to third parties, for beneficial terms to be granted to those pilot  franchisees to reward them for the extra risk that they are taking and for their contribution to the development and refinement of the franchise system.  There may also be an argument for encouraging the “early bird” franchisees on to the system by offering beneficial terms.  They too will be taking a greater risk.  If any beneficial terms are to be offered they need to relate to financial aspects of the franchise, either in terms of a reduced initial fee or reduced continuing fees.  Furthermore, they should be personal to the franchisee – in other words they should not be capable of being passed on to purchasers of that franchisee’s business.  They should be set out in a side letter to the franchise agreement because this highlights the personal nature of the benefits offered. 

                One final point need to be made in relation to changing the provisions of the franchise agreement.  Franchisors should, of course, constantly review their franchise agreements to ensure that the agreement reflects what they are currently doing and is updated to reflect any legal developments.  It is sensible for franchise agreements to be reviewed every two to three years.  These reviews will undoubtedly bring up amendments to the agreement which would need to be incorporated from that moment on.  Updating a franchise agreement is permissible and is entirely different to granting “one off” amendments for a particular franchisee.

-              Variables – all franchise agreements will contain variable elements such as the premises from which the franchisee will operate, the equipment package, the persons involved (whether they are a sole trader/partnership or limited company and so on).  It is essential that these elements are correctly set out in the agreement and that the agreement is executed properly.  If it should become necessary to take action on the agreement any such action could be substantially prejudiced if the franchise agreement has not been properly executed or has not been completed properly.  Anecdotally, some 40% of franchise agreements are not executed properly.  Franchisors should consider instructing their franchise lawyers to issue agreements on their behalf.  Most franchise lawyers are prepared to do this for a relatively modest fixed fee.  This will relieve the franchisor of having to deal with franchisees’ lawyers, will ensure that the agreement is executed properly and, if so required, the franchisor’s lawyer will deal with all relevant aspects of the transfer of funds.

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