In the animal kingdom of business contracts franchise agreements are a breed unto themselves and present their own unique set of issues. Before you commit your career, your time, energy and tens of thousands of dollars of your family’s resources in purchasing a franchised business, you would be well advised to devote some time, attention and resources on the front end to understanding this particular species of contract and its peculiar characteristics.
Here are seven questions to ask before you negotiate your franchise agreement:
1. Are all franchise agreements the same? Yes and no. While franchise agreements all typically address the same topics (e.g. grant of territory, license of trademarks, royalties, advertising funds, transfers, etc.) the differences in how they do so are significant from company to company. There is no such thing as a “standard” franchise agreement. Franchise agreements are drafted by the franchisor with the franchisor’s best interests in mind, and that is to be expected. Beyond that however their terms can range all over a very wide spectrum from relatively even-handed all the way to downright one-sided in favor of the franchisor. You never know exactly what you’re dealing with until you dig into the details. An initial analysis of the relative even-handedness of the agreement in itself however can tell you a lot about the franchisor with whom you are considering teaming up. If the franchisor is even-handed in their document, chances are they’ll be even-handed in other aspects of your relationship going forward. The converse is likewise true. Pay attention to the overall flavor of the proposed agreement and where it lands on the even-handedness spectrum.
2. Are franchise agreements even negotiable? Franchise agreements have an aura of “non-negotiability,” both as a matter of the franchisor’s intent and simply by the means in which they are communicated. Tucked away in the bowels of an often-voluminous and intimidating Franchise Disclosure Document the franchise agreement form takes on a “carved in stone” vibration. This aura of non-negotiability however is not exactly reality. Many items within a franchise agreement are in fact subject to negotiation, items that can make a big difference to you the franchisee. Generally items that impact the overall desired uniformity of a franchisor’s system are off limits and items that are specific to the franchisee are fair game. The size, age and geographic ambitions of a franchise system also can come into play—a bigger, more established franchisor may be less likely to negotiate than a smaller, newer one, or a franchise system that is eager to expand into your area. One thing is for sure, however, when it comes to franchise agreements, “if you don’t ask, you don’t get.” Asking in the right way is critical too. Making realistic requests in a non-alienating way is important. Remember, you’re going to live with this franchisor after this negotiation. Scorched earth is not a good way to start a relationship.
3. What is one of the least negotiable franchise agreement provisions? Although franchise agreements differ all over the board in how they address certain issues and the extent to which those issues are negotiable, there is at least one issue that is almost uniformly non-negotiable – the jurisdiction for the resolution of disputes and the law applicable to the franchise agreement. Almost uniformly the franchisor will insist upon resolving disputes by arbitration or litigation on its home turf and applying the law of its home jurisdiction. (The frequent exception to this rule of thumb is franchisors headquartered in California. Often they will insist on the application of the law of the franchisee’s home state, on the assumption that the law of any state in the union will be more pro-business and thus more favorable to the franchisor than that of their own home state, California. This is not an unreasonable assumption.)
4. What if the franchisor “dies?” An important point to bear in mind when reviewing any franchise agreement is that fact that the friendly folks with whom you negotiated prior to executing the contract may not be around when push comes to shove several years later. Virtually every franchise agreement goes out of its way to make the point that the franchisor can sell, merge or otherwise transfer your agreement to another party without your prior consent. As a result franchisor-favoring language that you may have accepted in the agreement due to the fact that it would be in the hands of a set of people you liked and trusted, might not be acceptable to you if wielded in the hands of someone you don’t know. For instance, most franchise agreements will have a provision stating that you the franchisee will rebrand/change trademarks at your expense upon a timetable dictated by the franchisor. This may seem innocuous when dealing with a franchisor who you don’t think will ever change concepts, but may take on an entirely different cast when the franchise is transferred to a new owner, one who may be an erstwhile competitor in the same industry. Consequently you need to review the proposed franchise agreement as if it is in the hands of a successor franchisor with whom you did not negotiate when you entered into the system.
5. What if I die? Just as franchise agreements frequently give the franchisor unfettered rights to transfer your franchise agreement to a third party and go away, they typically impose restrictions on your ability to transfer your agreement to a successor franchisee such as transfer fees, franchisor prior approval of the proposed new franchisee and a franchisor right of first refusal to purchase your franchise rather than allow it to be transferred to your intended franchisee. There is one form of transfer however that even the franchisor can’t stop: your death. What happens then? Does the franchise agreement terminate? Does the franchisor buy back your franchise, and, if so, at what price? May your franchise be transferred to your surviving family members? If so, will they have to pay a transfer fee to keep the family business in the family? If your family doesn’t take over the franchise, will your executor be allowed to sell it? If so, how long will they have to find a buyer acceptable to the franchisor and close a deal? Proceed into your franchise ownership as if you are going to see it through the entire term of the agreement, but negotiate this particular provision as if you’re going to be hit by the proverbial bus as you walk out of the closing.
6. What if the franchise agreement itself dies? A franchise agreement can die a natural death of old age at the expiration of its term, a death that can be postponed by successive renewals upon the agreement of the parties. More threatening however is the untimely death of the franchise agreement due to a termination by the franchisor for cause. Franchise agreements typically will provide for termination by the franchisor prior to the expiration of the term upon the franchisee’s commission of one or more of a laundry list of offenses. Given the severity of the potential punishment, you should pay close attention to the list of offenses and whether and how they might be “cured” by you prior to the pulling of the plug on your business. Frequently the agreement will have a category of offenses justifying immediate termination by the franchisor without notice to you, a category of offenses justifying immediate termination by the franchisor after notice to you, and a category of offenses justifying termination by the franchisor upon notice to you and an opportunity by you to cure the offense before it results in termination. Are the offenses in the proper categories? How broad and vague is the definition of the offense? How realistic is the threat of occurrence? The prospect of cure in the case of occurrence? Finally, be on the lookout for the “three strikes you’re out” termination provision – which makes the occurrence of a certain number of offenses (frequently 2 or 3) within a certain time period (frequently 12 to 24 months) in and of itself grounds for immediate termination without further notice to you, even if the underlying offenses were themselves cured at the time.
7. What will I have to pay upon early termination? Franchisors can seek “prospective” or “benefit of the bargain” damages from a franchisee when the franchise agreement is terminated prior to the end of its term. That is the amount of royalties and advertising fund contributions the franchisor would have received if the franchise had operated to the end of its contractual term, i.e. the benefit of the franchise agreement for which the franchisor bargained. This naturally raises the related issue of the length of the term of the franchise agreement. If the term of the agreement is five years and you terminate operations after three years, then you potentially are exposed for two years’ worth of royalties. If however the term of the agreement is fifteen years and you terminate operations after the same three years, then you potentially are at risk for much more. The length of the term and the exposure for damages upon early termination thus need to be considered in tandem. Some franchise agreements deal with this issue explicitly, some do not. Be aware of this issue and, if it is not addressed explicitly in your proposed agreement, give careful consideration as to whether you want to raise the issue.
Summary: Franchise agreements are a different breed of cat. Before you tackle that cat alone, protect yourself by devoting some time, resources and attention to addressing the questions presented by this unique species.
Matt Joyner is a business lawyer who represents entrepreneurs who are starting, running, buying or selling businesses, including franchises. His series of videos on business law topics may be found on his YouTube channel and his LinkedIn page and he may be reached at firstname.lastname@example.org. Mr. Joyner is a member of the Renaissance Executive Forum of Charlotte, North Carolina.
Reach him at email@example.com or online at www.bdjalaw.com.