How does a franchise agreement work? Important things to know
How does a franchise agreement work? Important things to know
Are you about to take on a franchise, or perhaps you already run a franchise but need specialist legal help with your agreement? As a prospective franchisee looking to take on a franchise, you may find yourself presented with a lengthy franchise agreement. In this blog we outline some of the most important things to look out for, and also give you some practical guidance on how a franchise agreement works.
What is a franchise agreement, and why do people use them?
The franchise agreement is the legally binding document between a franchisor and a franchisee . The document sets out the legal terms underpinning the relationship between the two parties.
Unlike some other countries, there are no specific franchising laws in the UK. Instead the relationship is governed by the contractual terms set out in the Franchise Agreement, which will typically represent the ‘entire agreement’ between the parties as well as general contractual principles. It is important that you have been told anything by a franchisor that has induced you to enter into the Franchise Agreement, that this is covered in the Agreement itself.
The essence of a Franchise Agreement is to ensure that the ownership and control of the business brand and system of doing things, remains with the Franchisor (who has created the business) when it wishes to grant a franchisee the right to be able to operate under the same name and brand using its system. The franchisee is only entitled to “rent” the business for the duration of the agreement granted.
What is the benefit to you?
The main benefit of a franchise agreement to a franchisee is that they acquire the rights to open a business using a pre-established brand. The agreement works to essentially ‘licence’ certain elements of the franchisor’s intellectual property and systems to the franchisee, helping them skip certain elements common to setting up a business from scratch.
You can expect to receive adequate support from the franchisor in terms of advertising, training of the franchisee (and staff members) and general business and accounting support, which the franchisor may be contractually obliged to provide both initially and during the term of the franchise agreement. The exact form of training is not always clear from the agreement, so a prospective franchisee should always check with the franchisor what form the training will take and what will be covered.
Assistance with advertising is also advantageous, whereby the franchisor may be obligated to supply marketing, advertising and other promotional material to a franchisee.
Taking on a new franchise business is not without its costs. The franchisee can expect to pay numerous amounts to the franchisor that relate to the set-up and running of the franchise business. This may include an initial fee, management service and marketing fees, and the costs of any materials or products supplied by the franchisor.
Some of these costs may be high, for which it would assist to evaluate how much you expect to pay in fees under a franchise agreement as opposed to the costs associated with setting up a business from scratch.
The franchise agreement should specify what fees are payable and when. However, if there is any ambiguity in this, an experienced franchise solicitor would be well placed to identify if anything should be raised directly with the franchisor for further clarification or amendment.
Because the franchisee is assuming the mask of a pre-established brand, the franchise agreement will invariably be biased in favour of the franchisor. The franchisee’s obligations will be extensive and specific, and are primarily focused on ensuring the franchisee devotes their full efforts into running the franchise business. At the end of the day, the franchisor is allowing a franchisee to use their intellectual property, for which they will expect the franchisee to run the business to the highest standard in return to protect the brand and the reputation of the franchise network generally.
A franchise agreement may split the obligations of a franchisee into two categories: initial and continuing obligations. It is important to remember that the document is created with the purpose of ensuring the smooth running of the franchisee’s business over the whole duration of the agreement, and so you should refer to it frequently to refresh your understanding of the continuing obligations.
A franchise agreement will impose certain restrictions on the franchisee. Many of these provisions will be based on protecting the franchisor’s goodwill and future business, which may be at risk if an ex-franchisee sets up a competing business after the franchise agreement expires. A franchisor does not want to train and support a franchisee only for them to instantly use this training and know-how against them. Therefore, your franchise agreement may contain restrictive covenants preventing you from approaching any customers, employees or staff linked to the franchisee business, or from running a competing or similar business in the future. Normally such restrictions are linked to the geographical territory in which the franchisee traded or the territories of other franchisees in the network.
Such restrictions will not last forever, with most franchise agreements preventing such activity for a period of 1-2 years following its termination. The Courts will only enforce post-termination restrictions which they view as reasonable, go no further than is strictly necessary and which are there to protect the franchisor’s legitimate business interests. It is very important that a prospective franchisee understands the implications of any restrictions which will apply to him/her on termination of the franchise agreement.
Often the franchisor will require a named individual to enter into a personal guarantee for the obligations of the franchisee company. This will usually be given by a shareholder(s) or director(s) of the franchisee company, who may become personally liable to the Franchisor for the franchise agreement, whereby their personal assets could be at risk. Again, it is crucial that the implications of this are understood by the prospective franchisee before they sign up and that they seek legal advice as necessary.
What should you do if you are offered a franchise agreement and why do you need to see a solicitor?
As a starting point, you should carefully read through the franchise agreement, and ensure that you understand every aspect of it before signing on the dotted line. There is no general principle that the franchisor must act reasonably or that the franchise agreement must be reasonable or fair and therefore prospective franchisees need to enter such agreements with their ‘eyes open’ and see it as a fixed term commitment. Most UK franchise agreements are for a 5 year term and the franchisee is unlikely to have a contractual right to terminate early, if they have simply changed their mind or the business isn’t doing as well as they hoped.
Regardless of whether you are able to negotiate or re-negotiate certain terms of the agreement with the franchisor, it would assist to take the document to a franchise solicitor to review (please see the BFA website for a list of accredited legal advisors). The solicitor will explain what the key provisions mean, and point out anything which is missing. It is critical that you understand fully what you are signing up to and what your liabilities may be. They may be able to provide you with a written report, highlighting any irregularities or areas which the solicitor feels your attention should particularly be drawn to.
Have we missed anything?
This is only a selection of the key points you may encounter in a franchise agreement, and so it is not a comprehensive list. Hopefully this article has helped you understand the key aspects of a franchise agreement. If you are presented with a franchise agreement and need guidance on its various implications to you or your business, then please do not hesitate to contact our Franchising team who regularly advise individuals and businesses on franchise agreements. Alternatively, take a look at our dedicated “Franchising” page on our website.