What is a Franchise Agreement?
The franchise agreement is the legal agreement executed between the franchisor and franchisee that creates the legal foundation for the franchise relationship. It defines the parties’ rights, obligations, and protections. There is no standard form for a franchise agreement because each agreement varies greatly depending on the applicable industry and business model being offered. A clear and well-drafted franchise agreement protects both the franchisor and the franchisee.
For franchisors, the franchise agreement will protect your brand, grant the licensing of your marks, detail the development of territories, and establish the royalties and other fees that franchisees will need to make. While the brand standard manual will also provide governance for the franchise relationship, the terms, and conditions set forth within the franchise agreement will remain for the entirety of the initial term of the franchise relationship.
As a franchisee, the franchise agreement will protect your business investment. It is important to understand the rights and obligations that are granted to you within the franchise agreement. Furthermore, if you have been promised certain terms, ensuring such terms are written in the franchise agreement or as an addendum to the franchise agreement is important.
Common Provisions Within a Franchise Agreement
There are many facets to a franchise agreement, here we will discuss some of the common sections, and while no two franchise agreements will be the same, most franchise agreements contain the following sections within the franchise agreement:
1. Grant and Term
The franchise agreement will grant a territory the right to use certain marks, trade dress, and obtain access to proprietary manuals in exchange for recurring fees and/or royalties over a set term – often between 5 to 10-year intervals. It is important that both parties ensure that the duration of the term aligns with the parties’ business plan, allowing enough time for the franchisee to recoup its investment.
2. Initial Training and Ongoing Support
Initial training is critical to onboarding a franchisee with the knowledge and skills necessary to operate the franchise business successfully. This section within a franchise agreement should state where training will take place if it will be at the franchisee’s location or a corporate office. It should also state how many people may attend initial training, who is required to attend, and the costs for additional people to attend. Additionally, the franchise agreement will detail the additional ongoing support services that the franchisor will provide to the franchisee.
3. Initial Fees and Ongoing Fees
The franchise agreement will define any fees that the franchisee will pay to the franchisor prior to the opening of the franchised business. This can include the initial franchise fee paid to the franchise at the time the franchise agreement is signed, plus any initial inventory or other required purchases that may be due. Additionally, the franchise agreement will include any ongoing fees required by the franchisor. This will include, among other fees, the royalty structure, which may be a percentage of gross revenue or a flat amount due at monthly or weekly intervals.
4. Marks and Brand Manual
This section outlines how the franchisor’s marks may be utilized, as well as any restrictions placed on the use of those Marks. One common restriction is that franchisees may not utilize the marks in their entity name. Additionally, the franchise agreement will require that the franchisee adhere to the brand manual. The brand manual is a comprehensive document provided by the franchisor to the franchisee on loan for the operation of the franchised business. Unlike the franchise agreement, the brand manual is a living document, meaning that the franchisor may make changes to the brand manual from time to time.
5. Advertising
The advertising section discusses the advertising requirements and responsibilities under the franchise agreement. Advertising is crucial for brand visibility, customer acquisition, and maintenance of a consistent brand image for all franchise locations. The franchise agreement will set minimum amounts of advertising spend based on percentages of revenues or flat amounts that must be spent or contributed on a weekly, monthly, or annual basis by the franchisee. Typically, this section is subdivided into the following categories:
- Brand funds: Collected and utilized to finance the development of the franchise system as a whole.
- Local advertising: Promotes the individual franchise location and targets a specific customer base.
- Marketing cooperatives: Allows a group or subgroup of franchisees to target a specific region at a larger scale in a collective group.
- Grand opening: Specifies a certain amount that must be spent by the franchisee to jump-start marketing efforts when beginning operations in a new territory.
6. Site Selection and Development Schedule
The site selection and development schedule section outlines the process and responsibilities related to finding and establishing a suitable location for the franchised business. This section is critical for both the franchisor and the franchisee as it ensures that the franchised business is in a location that meets the brand’s standards and has the potential to succeed. The franchisor will often require that any location must be approved by the franchisor prior to the franchisee signing a lease. Additionally, this section will provide deadlines for when the location must be acquired and when the franchise business should commence business operations.
7. Transfers and Assignment
The transfer and assignment section details the procedures for transferring the franchise agreement, either in whole or in part, to another individual or entity. Franchisees will need the franchisor’s prior approval before proceeding with a transfer to ensure the new owner meets the franchisor’s requirements and is capable of upholding the brand standards and operating the franchise successfully.
8. Termination and Post-Termination
The termination section in the franchise agreement addresses circumstances and procedures under which the franchise agreement may be terminated. The termination section is divided into two parts, termination with no opportunity to cure and termination if no cure is made within a certain amount of prescribed time. Events such as filing for bankruptcy, dissolving the franchisee entity, insolvency, being convicted of a crime, and ceasing to operate for a pre-determined period will allow the franchisor to terminate without the opportunity to cure.
9. Indemnification and Insurance
The indemnification section outlines the responsibilities and obligations of both the franchisor and franchisee to indemnify or protect the other party from certain liabilities, losses, or claims that may arise during the course of the franchise relationship. The franchise agreement also requires that the franchisee obtain certain insurance policies with minimal coverage amounts and name the franchisor as an insured party.
10. Disputes and Forum Selection
The dispute resolution section in a franchise agreement outlines the procedures and mechanisms to be followed in the event of disagreement, dispute, or conflict and set forth the terms such as venue, choice of law, limitations to bring suit, damage limitations, and whether the dispute requires mediation, arbitration, or litigation. Many franchise agreements require the parties to attempt mediation or negotiation as the first step in resolving a dispute. Mediation and Arbitration are known as alternative dispute resolutions. Mediation involves the use of a neutral third party to facilitate discussions and assist the parties in finding a mutually acceptable resolution. Arbitration involves referring the dispute to an arbitrator or a panel of arbitrators instead of pursuing litigation in court.
Negotiating and Drafting Franchise Agreements
Many prospective franchisees ask whether franchise agreements are negotiable. Typically, certain terms of the franchise agreement may be negotiable, whereas other areas of the franchise agreement are not due to the franchisor’s need to maintain uniformity within the franchise system and implement protections for all franchisees within the franchise system.
If you are looking to purchase a franchise as a prospective franchisee and need legal assistance reviewing the franchise disclosure documents and franchise agreement, or if you own a business and are looking to take the next step into franchising, please contact Elliot Boerman or one of our Franchise attorneys at Manning Fulton or visit our website at www.manningfulton.com/services/franchise-hospitality to review our Franchising services.
