Franchise Lingo - What Does it Really Mean?

By Philip Colman, Partner, Mason Sier Turnbull Lawyers

This article appeared in Issue 3#5 (July/August 2009)of Business Franchise Australia & New Zealand

It must be daunting, once you have made a decision to at least think about running your own business, to surf websites and attend expos only to be hit with sales pitches and brochures that contain words that you may not have come across before.

To assist, I thought it appropriate to attempt to explain the meaning of some of the words and phrases commonly used in the franchise sector in Australia. The words and phrases used below are by no means exhaustive, but in my experience they are those which are most commonly used.

In a general sense, a "Franchise" is a right or permission given by one person to another person to do something.

A "Franchise Agreement" is the contract that defines what rights have been granted and the rules and regulations under which the person who receives the rights or permission may operate the franchised business.

Under Australian law, a franchise agreement can be in writing, it can arise from oral conversations or it can be implied from circumstances, but it must contain the following 3 elements:

  1. One person granting to another person the right to conduct business in Australia under a system or marketing plan substantially determined, controlled or suggested by the first person;
  2. The second person operating the business under a brand, logo or trademark owned or controlled by the first person; and
  3. An obligation on the second person to pay money to the first person.

The parties to the franchise agreement are most often called the franchisor and the franchisee.

The "Franchisor" is the person who grants the rights and effectively controls the network. In some agreements, this person is called the "Licensor" or "the Company".

The "Franchisee" is the recipient of the rights - the person who is at the coal face dealing with customers and working hard to make a buck. In some agreements, this person is called the "Licensee" or "the Retailer" or "the Member" or "the Store Operator" or "the Distributor".

It is not uncommon to see a franchise agreement where there are other parties called guarantors. A "Guarantor" is a person who promises to the franchisor that the franchisee will honour the franchise agreement and who agrees to accept liability to the franchisor for any non-compliance by the franchisee.

In some franchise systems, the person granting the franchise is sometimes called the "Master Franchisee" or "Sub-Franchisor". This indicates that that person has gained the right to grant the franchise from a franchisor under a "Master Franchise Agreement".

A master franchise agreement is an agreement between the franchisor and the master franchisee/sub-franchisor under which the master franchisee is given the right to sell/grant franchises within a geographical territory (for example a particular country or state). In these circumstances, franchisees are often described as "Sub-Franchisees".

"Cooling off" is a right given to a franchisee to withdraw from a franchise purchase within 7 days of signing the franchise agreement or making any non-refundable payment under the franchise agreement. Not all money paid gets refunded when a cooling off right is exercised - the franchisor can retain some money to cover its costs.

"Term" is the length of time for which a franchisee is granted the right to conduct business as a franchisee. Franchisees must remember that they do not have infinite rights.

Some franchise agreements contain an "Option to Renew" for a "Further Term". This means that, provided certain criteria are met, a franchisee can require the franchisor to extend the term of the franchise until the end of the further term.

Franchise Agreements often contain reference to a "Territory". This is an area within which a franchisee might be given exclusivity (there will be no competing franchises from the same network) or it might be an area that determines where a franchisee can or cannot market or perform work under the franchise agreement.

Critical to a franchise system is the existence of written or electronic material that spells out how franchisees are supposed to operate their business. Such information is contained in an "Operations Manual". This can often run to many volumes and it may include various forms which a franchisee is required to complete from time to time. The operations manual contains the minute detail of the franchise system and the policies and processes required to be followed in the day-to-day running of the business.

"Intellectual Property" is a legal term that is often found in franchise agreements. In a franchise system, the relevant intellectual property is owned or controlled by the franchisor who, in turn, gives franchisees a limited right to use it. In a franchising context it includes the branding, trade marks, logos, commercial symbols, secret processes (11 herbs and spices), designs and colour schemes, copyright in written material (such as the operations manual), trade secrets and confidential information.

Many fees are often payable under franchise agreements.

The "Franchise Fee" is the upfront component of the purchase price of a franchised business usually payable in consideration for the grant of the franchise.

The "Royalty" or "Service Fee" or "Management Fee" is a recurring fee paid by a franchisee to the franchisor in consideration for the ongoing right to operate the franchised business. Most often it is calculated as a percentage of sales, although in some systems it is a fixed sum that is reviewed annually.

The "Marketing Levy" or "Advertising Levy" is also a recurring fee paid by a franchisee to the franchisor. Most often it is calculated as a percentage of sales, although in some systems it is variable at the option of the franchisor. These amounts are paid into a marketing fund.

The marketing levy/advertising levy must be accounted for by the franchisor in the "Marketing Fund". Marketing funds can be for the whole system, a particular region or a mixture of both.

The "Assignment Fee" or "Transfer Fee" is the fee payable to the franchisor by an outgoing franchisee when the franchisee sells the franchised business. Sometimes this is a fixed dollar amount and sometimes it is a percentage of the sale price.

The "Renewal Fee" is the fee payable to the franchisor by a franchisee who wishes to extend the term of the franchise agreement, having exercised an option to renew for a further term.

Many franchise agreements contain a "Restraint" or "Restrictive Covenant". These are provisions that usually prohibit the franchisee and those behind the franchisee from being involved in a business that might compete with the network, either during the term of the franchise agreement or for a period of time after it ends.

Very often, the franchised business is conducted from business premises that are owned by or leased to the franchisor. In these circumstances the franchisor grants to the franchisee an "Occupancy Licence", that is, permission to occupy those business premises for the purpose of conducting the franchised business. In nearly all cases, the franchisee must pay amounts akin to rental and outgoings under an occupancy licence. Sometimes the occupancy licence is contained within the franchise agreement and in other cases it is a separate document.

"Assignment" means transfer and is a term often seen in those parts of franchise agreements that deal with the circumstances in which a franchisee can sell the franchised business.

Often in assignment provisions you will find a "Right of First Refusal". This is a right reserved to a franchisor to buy the franchised business on the same terms as another willing buyer was prepared to pay.

If a franchisee breaches the franchise agreement, very often a franchisor will serve a "Breach Notice". This is a notice that will set out the alleged breach and explain to the franchisee what has to be done to remedy the breach to avoid the risk of termination of the franchise agreement.

A "Termination Notice" is a notice that is served on a franchisee when the franchisor wants to terminate the franchise agreement. The franchisor must have proper grounds to do this and, usually, non-compliance with a breach notice will provide proper grounds for termination.

A "Dispute Notice" is a notice that either party can serve on the other if they feel there is a dispute and they want to invoke the dispute resolution provisions contained in the franchise agreement or the Franchising Code of Conduct. The dispute notice must outline the nature of the dispute, state what outcome the giver of the notice wants and state what action the giver of the notice thinks will settle the dispute.

"Mediation" is a process that often follows the service of a dispute notice. It entails the engagement of an independent mediator whose job it is to get the parties together and assist them in resolving the dispute. Mediators try to encourage the parties to focus on their needs rather than their legal rights and very often the mediation will conclude with signed terms of settlement.

The "Franchising Code of Conduct" is the law that governs the conduct of participants in the franchising sector. Its primary purpose is to cause franchisors to ensure that franchisees and prospective franchisees are better informed before they make decisions.

This is primarily done via a "Disclosure Document", a document (usually quite lengthy) that franchisors must give to franchisees and prospective franchisees prior to a franchise purchase or renewal.

Some franchise systems have established a "Franchise Advisory Council" or "Franchisee Association". This is a separate body, usually with elected representatives, who are the voice of the franchisees in relation to network wide concerns or issues. Franchisees sometimes make financial contributions to cover the cost of these bodies.

Given that many franchise agreements contain glossaries than can run into tens of pages, it is not possible for me to go beyond the explanations given above. Good luck with your endeavours in the franchising sector and I hope that you can now understand some of the lingo.

Philip Colman
315 Ferntree Gully Road
Mount Waverley Vic 3149

T: (+61) 03 8540 0240 / (+61) 0417 438 259