Navigating Franchise Agreements is a Complicated Process. Here’s What You Need to Know
If you are serious about buying a franchise, one of the key steps you will need to take before moving forward is to carefully review—and potentially negotiate—the franchise agreement. Franchise agreements govern the relationship between franchisees and franchisors, and they are lengthy, complex and legally binding contracts that are usually heavily one-sided in the franchisor’s favor.
At Goldstein Law Firm, we review franchise agreements for prospective franchisees as part of our franchise business review process. We examine the entire franchise agreement for potential issues and inconsistencies, and we place particular emphasis on scrutinizing the provisions that present the greatest risks for our clients. If desired, we can propose revisions in a draft addendum as well; or, if you prefer, we can negotiate directly with your franchisor on your behalf.
Is the Franchise Agreement Really Negotiable?
Some franchise salespeople will claim that their franchise agreements are offered on a take-it-or-leave-it basis. Or, they may say that there is no point in trying to negotiate because they’ve never seen the franchisor approve any changes. These are often sales tactics more than anything else.
Franchisors know that their franchise agreements are one-sided, and they know that strong franchise candidates will want to negotiate. In contrast, their salespeople often won’t know what goes on behind the scenes. In our experience, good franchisors will be willing to negotiate reasonable concessions—and, as a prospective franchisee, seeking revisions to a franchise agreement’s most one-sided provisions can be critical for balancing the risks and potential rewards of franchise ownership.
Common Franchise Agreement Provisions: An Overview for Prospective Franchisees
Every franchise agreement is unique. This is critical to keep in mind. However, most franchise agreements include the same core provisions, modified to suit the specific franchisor’s goals and needs. Here are some common examples:
Grant of Franchise Rights
The first section of the franchise agreement typically contains an express grant of the right to operate a franchise in accordance with the agreement’s terms. This provision will typically be structured to ensure that the relationship is structured as a true franchise rather than a bare license or business opportunity.
Franchise Territory
If you will be receiving a protected or exclusive territory, this should be unambiguously explained in the franchise agreement. Your territorial rights should be clear, and your territory should be clearly defined.
Opening Deadline
In many cases, franchisors will include a deadline to open in their franchise agreement. Essentially, this means that the clock starts ticking once you sign. If you don’t open your franchised business in time, this may justify immediate termination.
Lease Approval, Design and Build-Out
If you will need to lease an office, gym, warehouse, garage or other space for your franchise, the franchise agreement will most likely include a provision stating that the lease is subject to the franchisor’s approval. In this scenario, the franchise agreement will typically include design and build-out specifications as well.
Initial Term
The initial term of your franchise should be clearly spelled out early in the franchise agreement. You will have both the right and the obligation to operate your franchise throughout the initial term, subject to the franchise agreement’s termination provisions.
Initial Franchise Fee
The franchise agreement should clearly state the amount of your initial franchise fee and when it is due. Franchisors typically require payment of the initial franchise fee in a single lump-sum payment, though some may offer financing options. If you will be financing your initial franchise fee, the financing terms should be clear as well.
Royalty and Advertising Fees
The franchise agreement should also clearly state the royalty and advertising fees you will need to pay during the initial term of your franchise, including how they will be calculated if they are percentage-based. Franchise agreements will typically include provisions regarding payment dates and method of payment (i.e., via ACH) as well.
Other Fees
If you will be required to pay any other fees during the initial term of your franchise, these fees should be spelled out in the franchise agreement. It should be clear what the fees are for as well as when (and how) you are required to pay.
Operating Standards and the Operations Manual
While the franchise agreement may include certain operating standards directly in the contract language itself, most of the franchisor’s operating standards will likely be contained in its Operations Manual. The Operations Manual will likely be “incorporated” into the franchise agreement—which we discuss in greater detail below.
Renewal and Transfer
Franchise agreements will generally include separate sections addressing renewal and termination. These sections will establish the franchisor’s conditions for renewal and transfer, and it will be important for you to ensure that you are reasonably confident that you will be able to satisfy these conditions when (or if) necessary.
Termination and Post-Termination Obligations
The termination provisions are among the most important (and often most one-sided) provisions in any franchise agreement. You should review these provisions very carefully. You should also carefully review the obligations that will apply in the event of termination.
Dispute Resolution
The dispute resolution provisions in your franchise agreement will dictate the steps you need to take (and the options you have available) in the event that you need to take legal action to enforce your rights. Most franchise agreements include mandatory alternative dispute resolution (ADR) provisions that require franchisees to pursue mediation or arbitration instead of going to court.
“Miscellaneous” Provisions
Franchise agreements will typically contain several “miscellaneous” provisions as well. Despite their label, these terms can be hugely important—especially in the event of a dispute—so they require equal consideration alongside the franchise agreement’s more substantive terms.
5 Key Issues When Reviewing a Franchise Agreement
When reviewing any provisions of a franchise agreement, it is important not only to examine the contractual language itself, but also to consider the language within the broader context of the franchise offering and the potential franchise relationship. With this in mind, here are five examples of key issues to consider during a franchise agreement review:
1. Inconsistencies Between the Franchise Agreement and Franchise Disclosure Document (FDD)
Inconsistencies between the franchise agreement and the franchisor’s Franchise Disclosure Document (FDD) are a potential red flag. While these types of inconsistencies may be the result of a simple oversight when updating one or both documents, the details matter—and sloppiness here could indicate sloppiness elsewhere. If the franchise agreement and the FDD are inconsistent, you will need to find out which document is accurate before completing your review.
2. Inconsistencies Within the Franchise Agreement Itself
Inconsistencies within the franchise agreement itself can present both similar and different concerns. Not only can they be indicative of a lack of care and attention to detail, but they can also create serious issues when it comes to franchise agreement compliance and enforcement.
If two franchise agreement provisions are inconsistent, which one controls? The answer to this question is not easily (or cheaply) resolved once a dispute arises. As a result, these are issues that it is critical to address during the franchise buying process.
3. Provisions that “Incorporate” Other Documents by Reference
Franchise agreements routinely “incorporate” other documents by reference. Essentially, this means that the terms and conditions in the incorporated documents are treated as if they appear in the franchise agreement itself.
One example of a document that franchisors frequently incorporate into their franchise agreements is the Operations Manual. Not only do franchisors incorporate their Operations Manuals into their franchise agreements, but they also typically reserve the right to modify their Operations Manuals over time. This can present significant challenges (and risks) for franchisees.
4. Provisions that Seem Unreasonably One-Sided
If a provision in your franchise agreement seems unreasonably one-sided, it probably is. You should make note of provisions that stand out as being particularly one-sided to discuss with your attorney during your franchise business review.
As discussed above, these are often the provisions that you will want to focus on when pursuing negotiations. Franchisors (and their attorneys) know when they are overreaching, and they will often be willing to compromise when prospective franchisees bring these types of issues to the table.
5. Waivers, Disclaimers and Acknowledgements
While franchisors will incorporate the Operations Manual and other specific documents by reference, they will also use waivers, disclaimers and acknowledgements to ensure that any representations they made during the sales process are non-binding. If you are asked to waive your right to rely on the franchisor’s prior representations or acknowledge something that isn’t true, this is another factor that you will need to carefully consider when deciding whether you are comfortable moving forward.
Contact Us to Learn About Our Franchise Business Review Programs Today
If you are going through the franchise buying process and are ready to have an attorney review your franchise agreement, we invite you to get in touch. To learn more about our franchise business review programs for prospective franchisees, please call 202-293-3947 or request a free initial consultation online today.
