Leasing the Franchise Premises: What a Franchisee Needs to Know
Leasing the Franchise Premises: What a Franchisee Needs to Know
Unless a franchisee is operating a mobile franchise or working from home, chances are the franchise will require a lease on physical premises. Although there is no ‘one size fits all’ approach to franchising and leasing, franchisees typically use either of the following methods to lease the premises:
Method 1: the franchisee locates the premises, negotiates the lease with the landlord directly and holds the lease in its name;
Method 2: the franchisor locates the premises, negotiates and enters into the lease, and then licenses occupation to the franchisee.
The following factors will ultimately drive the leasing method (which the franchisor often decides unilaterally):
- nature of the franchise system and the policies and procedures of the franchisor;
- risks that each party is prepared to take; and
- the level of control that a franchisor wishes to retain over the premises/site of the business.
Following, we set out some of the advantages and disadvantages of each method.
1. The franchisee locates the premises, negotiates the lease and holds the lease. If a franchisee enters into the lease directly with a landlord, the franchisee will have direct obligations to the landlord under the lease. The franchisor will not be involved in this aspect of the franchise business operations.
Key Terms to Look For in the Lease
Use of the Premises
Ensure the terms of the lease permit the operation of the franchised business from the premises and complies with any aspect of the franchise agreement in this regard.
Lease Term and Options
Ensure the renewal options and lease terms align with the franchise term and options. Otherwise, a costly relocation or an early end to the franchise agreement could be on the cards.
Will the landlord allow access to the premises before the commencement date to fit out the premises (noting any franchisor requirements for fit out)?
When did the lease commence? Does this align with the franchise agreement?
Option to Renew
Do any lease options align with options in “Committing to a lease is a serious responsibility, and if the franchised business does not work out as planned, the franchisee must answer to both the landlord and the franchisor.” Emma Heuston | Practice Leader, Commercial Leasing | LegalVision the franchise agreement? Ideally the same terms and options would be in both the lease and the franchise agreement.
Be aware of ALL costs associated with maintaining the premises, for instance, council rates, repairs or cleaning are sometimes payable in addition to rent. It’s important that the landlord provides you with an estimate of these costs so you can budget accordingly. If the premises is to be a retail premises, the landlord will have disclosure obligations under various state based retail lease legislation.
As set out above, where possible, franchisees should ideally ensure the franchise agreement and lease agreement aligns with their start date, term and option to renew. Otherwise, the franchisee could either have a business with no site or a premises with no business. If the two agreements don’t end at the same time, it is possible to negotiate a clause to end the franchise agreement early or relocate to alternative premises for the remainder of the franchise agreement.
It’s also important to consider whether the length of the lease will allow a franchisee to recover costs of investment in the business and premises. In other words, the period of the lease and franchise agreement should be long enough to obtain sufficient profits to cover the costly fit out and start up costs.
Committing to a lease is a serious responsibility, and if the franchised business does not work out as planned, the franchisee must answer to both the landlord and the franchisor.
As such, it is crucial for prospective franchisees to obtain independent legal advice in relation to the franchise agreement and lease documents to ensure that they understand the key commercial issues such as:
- plans for redevelopment that may exist at the time of signing, outgoings expenses,
- personal guarantees, and
- lease make good expenses. It is also worthwhile chatting to:
- existing tenants nearby to see what trading conditions exist and whet
- her they are aware of plans for the area; and
- existing franchisees in the franchise system to determine if they are happy with the franchise
2. The franchisor locates the premises, negotiates and enters into the lease, and licenses occupation to the franchisee.
Here, the franchisor and the landlord enter into the lease in a separate transaction which the franchisee is not involved in.
The franchisor then grants the franchisee a ‘licence to occupy’ the premises. The purpose of the licence is to place the franchisee in the shoes of the franchisor as if they were the tenant under the lease. The franchisee remains responsible for paying rent, the bank guarantee or security deposit as well as obtaining insurance.
Usually, the franchisee is not involved in negotiating the terms of the lease and must simply accept the lease. It’s often ‘take it or leave it’ and the franchisee usually only has the chance to make amendments to the licence to occupy.
Because the franchisor still exercises control of the premises, it’s easier to remove a franchisee for breaching the franchise agreement or lease and replace them with a new franchisee. This means that if a dispute arises in relation to the franchise agreement, the franchisee cannot merely ‘rebrand’ if the franchise agreement is terminated.
There are advantages with a franchisor often having greater negotiating power to obtain more favourable lease terms.
However, we still encourage franchisees to become involved in this process if possible and review the commercial lease and suggest amendments where possible. If, as a franchisee, you find yourself in this situation, ask to review or draft documents for input to ensure that the terms are balanced — this is especially important if you are the one paying rent each month and are responsible for the make good of the premises at the end of the lease!
It’s common for the landlord to provide a lease incentive to entice the tenant to lease the premises. For instance, a cash-payment to assist with fit-out or a rent-free period.
In this situation, the licence to occupy and any other associated documentation must be very clear as to who will receive this benefit. For example, the franchisor should not retain it and then expect a franchisee to fit out the shop without the benefit of the cash payment.
Franchisees should, therefore, ask the franchisor whether there was any lease incentive and obtain a copy of any Fit Out Deed along with a copy of the lease.
Franchisees should also pay particular attention to the lease terms. For instance, the franchisor may include a term that says if a tenant leaves the premises or assigns the lease within a period, they must pay back the rental incentive (or part of it) to the landlord. This is known as a ‘claw-back’ period, and franchisees should ensure they are not caught by such clauses.
The franchisee generally pays the franchisor’s legal fees. However, where the leased premises are to be a retail premises, the franchisee should be wary of paying the lessor’s legal fees to prepare and enter into a lease. The landlord cannot usually recover these fees under statebased retail lease legislation (unless in South Australia). In addition to paying rent, franchisees should also investigate the costs of any premises security deposit, upfront rent, fit out, and other business establishment costs to better budget for their franchise.
When buying a franchise, it’s easy to overlook the leasing aspect of the franchise opportunity. However, it’s an important piece of the puzzle that franchisees should not ignore. Seeking independent professional advice (legal, accounting and business) is a must to help identify and address any pitfalls before entering into a transaction.
Emma is the Practice Leader in LegalVision’s Commercial Leasing team. Emma has been practising law for 17 years with a focus on retail, commercial and industrial leasing and franchise law. LegalVision is a market disruptor in the commercial legal services industry and has assisted more than 50,000 businesses.