Who Takes Control of the Lease in a Franchise Relationship?

Author: Chad Finkelstein

Date: MAR 17th, 2015

Topic: Industry Experts

The old adage “location, location, location” has been proved to be one of the truest statements one can make about the success of a business, and franchised businesses are no exception. Determining where to place a franchised unit is one of the most important decisions that needs to get made before a franchised business is opened to the public. But, first, you will need to figure out who takes control of the lease in a franchise relationship, and each franchise system may treat that element differently.

In some cases, a franchisor (or an affiliated company of the franchisor) will enter into the lease directly with the landlord, and then sublet the premises to the franchisee. A franchisor may prefer this structure because they retain complete control over the location and the relationship with the landlord. That way, if the relationship with the franchisee sub-tenant does not work out for any reason, the franchisor head tenant can automatically step in, take over the location or re-franchise it without missing a beat.

Franchisees may prefer that franchisors enter into leases directly with landlords since, unless a franchisee already has a relationship with that landlord, a franchisor may be better able to negotiate certain concessions under the lease, especially in cases where that franchisor already has units in other locations owned by that landlord. It should come as no surprise that some landlords prefer to deal with franchisors directly where they perceive the franchisor as the party with deeper pockets.

Franchisors, however, may seek to avoid this type of relationship since more leases means more potential liability.

Alternatively, some franchisors may prefer a different leasing relationship, pursuant to the terms of a document which can go by different names, including ‘collateral assignment of lease’ or ‘tripartite agreement’. Putting aside the question of whether the franchisor or franchisee is responsible for actually finding the location, under this structure, the franchisee would enter into the lease directly with the landlord. Then, the franchisor, the franchisee and the landlord would enter into a side agreement together whereby everyone agrees that if the franchisee defaults under the lease (by failing to pay rent, for example), the franchisor will have the option to step in, have the lease assigned to them and either operate the location or re-franchise it.

Franchisors may prefer this relationship since there is less exposure to liability for them, and some degree of control as the assignment option is precisely that – an option to assume the lease, not an obligation. This can save the franchisor considerable expense should a franchisee default and the franchisor not want to take the location over. However, it is for this very reason that some landlords may resist the assignment option relationship since they have less of an assurance that someone will be operating from that location and paying rent should something happen with the franchisee tenant.

There is no right or wrong way to structure the franchise-leasing legal relationship – it is a matter of preferences, system policy and may need to be determined on a franchisee-landlord-location by franchisee-landlord-location basis!

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