Don’t Get Caught Out By The Renewal Process

 

Don’t Get Caught Out By The Renewal Process

Most Franchise Agreements are for fixed terms. This fact is often overlooked by excited franchisees going into a new business venture.

Franchise agreements “do not run for infinity and beyond” and the renewal or extension of a franchise agreement is not always a given.

Some franchise agreements only provide for a fixed initial term with no right of renewal.  Others provide for a fixed initial term with one option or a number of options to renew.

In the case of fixed term franchise agreements with no options to renew, the franchisee will essentially be at the mercy of the franchisor at the expiry of the initial term. The franchisor will be under no obligation to renew the franchise agreement. If the franchisor agrees to grant a new franchise to the franchisee the new franchise will be on the franchisor’s then current terms which could be significantly different to the franchisee’s existing terms.

That said, even in the case where the franchisee has an option or a number of options to renew, renewal of the franchise agreement is not guaranteed. Most franchise agreements specify requirements that the franchisee must meet in order for its franchise agreement to be renewed.

Renewal Requirements

The typical conditions or requirements to the renewal of a franchise agreement where the Franchisee has an option to renew include:

  1. exercising the option within a specific timeframe, for example, not earlier than 12 months before and not later than 6 months before the expiry date. It is important that franchisees note these dates because failure to meet the timeframes can have fatal consequences – the franchisor may not agree to renew the franchise agreement;
  2. payment of a renewal fee.  This may be the equivalent of the upfront fee payable by new franchisees coming into the network. Franchisees should budget to pay this fee right from the outset;
  3. possible upgrade of the business premises and equipment where the franchise is conducted from static premises. Again, franchisees should budget for this financial outlay from the outset and also review the premises lease to determine the frequency of upgrades that may be required by the landlord;
  4. the remedy of any breaches of the franchise agreement;
  5. the signing a new franchise agreement. In many cases the franchisee is required to sign the franchisor’s franchise agreement current at the time of the renewal. The franchisee should request a copy of this agreement before it has to exercise any option to renew. This agreement may contain different terms, including different financial terms. If the financial terms of the new franchise agreement are more onerous, the business may be less profitable and worth less if the franchisee wants to sell.

The above are not an exhaustive list of the requirements for the renewal of a franchise agreement but they represent the most common requirements. If they are not met the Franchisor will not be obliged to renew the franchise agreement.

Code Requirements:

In the case of franchise agreements that are for longer than a 6 month term, franchisors are required, under the Franchising Code of Conduct (“the Code”), to inform Franchisees whether or not they will extend the franchise agreement or enter into a new franchise agreement. The term extend is defined in the Code and, in the context of an extension of the term of a franchise agreement, occurs when the period of the franchise agreement is extended other than because of an option exercisable by the franchisee. The notice must be given at least 6 months before the end of term of the franchise agreement.

If the franchise agreement is for a term of less than 6 months, the notice period is reduced to one month before the end of the term.

Is a franchisor proposes to renew or extend the term or scope of a franchise agreement, the franchisor must provide the franchisee with its current disclosure document, a copy of the Code and the franchise agreement in the form in which it is to be executed at least 14 days prior to the renewal or extension of the franchise agreement.

This will be too late to enable a franchisee to conduct due diligence in order to make a reasonably informed decision on whether or not to accept a renewal or extension of the franchise agreement. Where the franchisee has an option to renew the franchise agreement this time period will be well outside the time period within which the franchisee must exercise its option to renew.

Under the Code franchisees have the right to request a copy of the franchisor’s current disclosure document once in a 12 month period and franchisors are obliged to provide a copy of their current disclosure document within 14 days of a request being made by a Franchisee. We recommend franchisees request a copy of the franchisor’s current disclosure document and franchise agreement at the time the franchisee is considering a renewal or extension of the franchise agreement.

Once the disclosure document and franchise agreement are received the franchisee should examine them carefully, in particular, the terms of the franchise agreement to ascertain whether any of the terms of the franchise agreement have changed.

Franchisees should also seek legal advice in respect of the documents and where a franchisee has an option to renew the legal advice that should be sought should include advice as to whether the franchisor can change any of the terms of the franchise agreement and require the franchisee to enter into a new form of franchise agreement or whether the franchisor must renew the franchise agreement on the same terms.

Ensuring Renewal:

What can franchisees do to ensure the renewal or extension of their franchise agreement?

  1. attempt to negotiate one or more options to renew the franchise agreement.
  2. where the franchise agreement contains an option or options to renew, take a note of the option dates to minimise the risk that the dates may be missed and any right to renew lost.
  3. comply with the terms of the franchise agreement.
  4. not leave the renewal or extension process to the last minute. Franchisees should start discussions with the franchisor early. If the discussions start early the decision to renew or extend can be made well before the expiry date of the franchise agreement and avoid the uncertainty and lack of security created for both parties when a franchise agreement expires with no agreement having been reached.

Points to Remember:

Franchisees must always remember:

they do not own the brand and the systems – they are only given permission to use the brand and systems for a finite period of time – either an initial term or an initial term with a prospect of renewal for a further term or series of further terms;

were it not for the franchise agreement, they would not be allowed to use the brand and the systems; and

when the franchise agreement comes to an end, they can no longer use the brand and the systems.

Situations can arise where a Franchisee, through hard work, effort and toil, can build up a business worth many times the initial outlay, only to face the possibility of that value evaporating when the franchise agreement comes to an end and is not renewed or extended.  At that point, the Franchisee’s only assets are the tangible assets used in the business, such as the plant and equipment.

It is important that Franchisees not only seek appropriate legal advice at the outset but also financial advice to ensure the duration of the franchise agreement gives them sufficient time to make a return on their investment.