Franchise Documents: The Legal Landmine-Some Safety Tips

Date: OCT 11th, 2007

Topic: Industry Experts

For most the scariest part of buying a franchise is signing on the dotted line. And why not, it is a major investment and the documents put before you are not written in your language, but rather legalese, which we all know is meant to ensure lawyers will always have work! You will be given a thick package of documents to sign so let’s review the most popular ones.

Franchise Agreements are specialized contracts that govern the relationship between the franchisor and the franchisee, the rule book. They are often referred to as contracts of “adhesion” which are contracts that are heavily stacked in favour of the issuer and leave little, if any, room for negotiation. For example, an insurance contract or car lease is an adhesion contract in its purest sense. You take the terms or leave them-period. Franchise agreements though do have some room for negotiation but not much. Logically this may seem unfair but it actually protects each franchisee in the system and the integrity of the system as a whole and is a positive feature of franchising. Surprised? The success of a franchise system is based on consistency. The average consumer does not understand franchising so if they have a bad experience in one outlet they will not frequent another and worse, will discourage friends and family from doing so. They will not think “oh-I guess that one had a bad operator, let’s try another”. So one bad apple ruins it for everyone. The franchise agreement must have teeth and the rules must be enforceable uniformly across the board. Any modification that dilutes that ability, dilutes the integrity of the system as a whole, devalues your investment and your financial potential, as well as the system’s ability to grow due to poor overall results. Unless the terms are really unreasonable or abusive, I do not negotiate default provisions when I represent franchisees, as it is not in their interest to do so. Follow the rules and you will not have to worry about them-that’s a better approach. I negotiate what is in the interest of the franchisee that the franchisor is going beyond the boundaries of system interest in requiring, or is just plain unfair or not in the interest of the franchisee regardless. There are limits as to what the franchisor can claim is in the system’s interest!

The franchise agreement also sets forth the monetary obligations of the franchisee and what services the franchisee can expect to receive from the franchisor and when. There is a common misconception that the royalty fee paid is in return for the services, it is not. It is actually for the use of the trademarks and the system itself. Theoretically the franchisor could charge a royalty and provide no service. They are not linked. But, the provision of the services is a contractual obligation as per the agreement and is an integral part of what you are buying.

Other documents you can expect to see are a lease or sublease depending on who takes signs the head lease. If you are subletting from your franchisor, the sublease should be on exactly the same terms and conditions as the head lease, no rental mark-up, no administration fees, nada. The leasing process is not a profit making centre to the franchisor and it is frowned upon to do so.

And last but not least, are security documents such as a “moveable hypothec” and personal guarantee. Lenders, landlords and possibly the franchisor take security on the corporate assets which operates automatically upon certain types of default like bankruptcy. Personal guarantees are taken by the franchisor on your personal assets, but a court action must be taken to act on it.

The best advice I can give you, and not because I am one, is to hire a franchise lawyer. It will cost you about $1500-2500, but it is cheaper than losing your entire savings on a bad investment, and besides, what price can you put on peace of mind? I tell my clients that my role is to educate them so they can make an informed decision. You will never be 100% sure. The goal is to be able to say “I understand the risks and obligations I am undertaking and I am willing to accept them”. If you can say that and feel comfortable, then you are in the best position you can be. Most of all though-listen to your gut-it’s never wrong!

Best of luck,
Lori