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Understanding and dealing with the problems of leases in franchising

There are many ways in which franchised businesses may be classified to better understand the issues, opportunities and problems the franchisees face. The most obvious classification is between franchised businesses that require a business premises and those that do not, such as online businesses or mobile businesses.

Examples of online franchised business may include online support, IT businesses and online learning. Examples of mobile businesses are a pet grooming franchise that uses a specially designed trailer, a tiling and grouting franchise, road repair business or a coffee franchise based on sales from a van. Other businesses by their nature require a business premises. Think of your shopping centre food court business, cafes, gymnasiums, clothing retailers.

There are trends in retailing that impact on some premises based businesses such as the growing prevalence of online shopping. There are specific legal and intersecting commercial issues that relate to premises based franchise businesses. The fundamental difference between premises based franchised businesses and those not needing business premises is the introduction of a significant third party, the owner of the business premises. Occasionally that may be the franchisor but often it is a
third party. If the owner of business premises is a third party, which has been the case in hundreds of franchise matters in which Morgan Mac Lawyers have acted, then there are two main arrangements that determine the relationship of the franchisee to the business premises. Either the franchisor requires the franchisee to find and lease its own business premises or sublet premises leased by the franchisor, or the franchisor chooses (with or without consulting the franchisee) and leases the business premises and grants an occupancy licence to the franchisee. Each type of arrangement has distinct and common risks to the franchisee and franchisor.

Lease of sublease by franchisee

A lease or sublease gives a franchisee an interest in land that may be registered. This gives the franchisee greater security of tenure. If the franchisee leases the premises from the owner of the land it gives the franchisee greater independence.

In franchise dispute mediations this greater independence strengthens the franchisee’s negotiating position if they exit from the franchise continuation of the business from the site as an independent business is a viable commercial settlement option for both parties and there is no impediment to the landlord accepting. The franchisor may be satisfied that such an exit relieves it from its obligations under a lease and of a franchisee who is problematic, and the franchisee may wish to continue to operate the business and the premises with a fitout designed for that type of business.

 

Licence to occupy

A licence to occupy is not an interest in land and is a contractual right to occupy and use the premises for the franchised business. It gives the franchisee less security of tenure and less independence from the franchisor. It puts the franchisee in the franchise exit scenario referred to above in a weaker negotiating position. If the franchisee has the benefit of a licence to occupy, the franchisor has a corresponding risk of obligations to a landlord that it wants the franchisee to meet but which may not be met.

The franchisor remains the lessee in this type of arrangement and its lease obligations must be met even if the franchisee’s right to occupy is terminated or the franchisee abandons the premises. The risk of meeting the lease obligations ultimately remains with the franchisor under its lease with the landlord.

Although the franchise agreement or an occupancy licence agreement will usually make the franchisee and/or guarantors liable for the franchisor’s liabilities to the landlord under the lease, the franchisor remains immediately exposed to meeting its obligations until damages can be recovered from the franchisee or guarantors and ultimately liable if the franchisee and guarantors are impecunious and the contractual obligations imposed on franchisees and guarantors to meet the franchisor’s lease obligations under the lease are not adequately secured by appropriate security over property of the franchisee and/ or any guarantors.

 

Recurring problems

There are several problems that apply to all the above different types of arrangements that recur all too frequently. One of these is explained below.

Remarkably, although the lease or licence occupancy agreement term and the franchise agreement term should end on the same dates they often for no obvious commercial purpose or legal requirement, end on different dates.

They should in fact be coterminous and end on the same date. If the right to possession by the franchisee under a lease, sublease, or occupancy licence agreement ends on a date prior to the franchise agreement expiry date the franchisee may be left without a premises but with an unexpired term under the franchise agreement and ongoing obligations to the franchisor, including payment of franchise fees.

Conversely, if the lease expiry date extends beyond the franchise agreement end date, and the franchise is not renewed, the franchisee may be left to meet obligations to a landlord under a lease, including paying rent and outgoings, without the right to further operate the franchised business and earn income to pay the rent. The impact of inconsistent lease and franchise agreement terms can also have an adverse impact on the franchisor if the term of the franchise expires before the term of the lease and no new franchisee is found who wishes to operate a franchised business from the premises for the balance of the term. This problem of inconsistent franchise and lease end dates should not arise if there has been a proper due diligence by the franchisee guided by sound legal advice, but not all legal advice is sound and not all franchisees and franchisors seek legal advice.

Franchisors and franchisees need to be aware when entering transactional documents such as franchise agreements, occupancy licence agreements and leases for premises based franchised businesses that these documents may impose interrelated obligations, and several different legal relationships involving landlords, franchisors, franchisees and guarantors giving rise to risks not relevant to other types of franchised businesses not operated from business premises. The key is to understand all the relevant material legal and commercial risks before signing the relevant legal documents.

 

Bill Morgan has over 25 years of experience in Commercial Litigation and Dispute Resolution with a focus on the franchise sector.  He is a nationally accredited mediator and is a panel member of the Australian Small Business and Family Enterprise Ombudsman.

Morgan Mac Lawyers T: (07) 3221 2221 | E: info@morganmac.com.au

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