What are the key terms usually found in a Franchise Agreement?
Before entering into a Franchise Agreement, it is imperative that you understand all of your rights and obligations under the agreement.
It is here that you will find all of the commercial terms relevant to your relationship as well as your legal obligations for the term of the franchise and beyond.
The “term” of the Franchise Agreement refers to length of time that the Franchisee is permitted to operate its business utilising the Franchisor’s name, brand and system. Most, but not all, Franchise Agreements also contain a renewal term which can be exercised at the Franchisee’s option. The critical point to understand here is that you are being granted a specific and defined term, there is no entitlement for the licence to continue in perpetuity.
The Franchise Agreement and Disclosure Document should set out all payments required to enter and exit the franchise, as well as any recurring payments required over the life of the franchise. Such payments will likely include a royalty fee and a marketing fee, either expressed as a percentage of the Franchisee’s sales or as a flat fee, payable on a weekly or monthly basis. Additionally, there may be a requirement to upgrade the premises at your cost, pay a renewal fee at the beginning of any renewal term of the franchise, and attend any ongoing training and annual conferences. All of these fees add up to your cost of doing business and need to be factored into your business forecasting at inception.
Many Franchisors operate a marketing fund whereby they collect a prescribed percentage of the Franchisee’s sales, or a flat fee amount, to market and promote the franchise network at large. You should be aware that most Franchisors are not obligated to spend the marketing fund monies to benefit your particular franchise.
Minimum Performance Criteria
Many Franchise Agreements stipulate that the Franchisee must achieve a certain set of minimum performance requirements which will either be articulated in the Franchise Agreement itself or in the operations manual. Such requirements may be as basic as “the Franchisee must complete the store opening training program during the first year of operation” or be financial in nature such as “the Franchisee must achieve gross sales of at least 95 percent of the previous year”. It is important that you carefully consider whether the minimum performance criteria are reasonable and achievable. Failure to meet the minimum performance criteria can result in further training costs and, in a worst case scenario, termination of the Franchise Agreement.
Supply of Goods and Services
Most Franchisors require their Franchisees to purchase the goods and services sold in the business from the Franchisor or a nominated supplier to ensure consistency of supply and quality throughout the network. Such arrangement will also provide the Franchisor, and the network at large, with greater economies of scale or “buying power” which will result in a lower cost of goods and services to the Franchisees and a higher profit margin. In turn, this arrangement may allow the Franchisor to clip the ticket on the supply of goods and services down to the Franchisee or to receive rebates from nominated suppliers. Under the Code, any rebates received by the Franchisor must be disclosed in the Disclosure Document.
Records and audits
Most Franchisors will require its Franchisees to provide them with the records of the business including profit and loss statements and balance sheets on a monthly basis. Such records may also include any reports, sales information, invoices or bank statements as required by the Franchisor.
If the Franchisor suspects that the records are not a true reflection of the sales of the business the Franchisor will most likely have the right to inspect the records and have them audited by an independent auditor. You should be aware that in most cases if there is a reasonable discrepancy in the records the costs of such audit will be passed on to you as the Franchisee.
In essence, a Franchise Agreement grants the Franchisee a licence to use the brand, trade marks, systems and any other intellectual property of the Franchisor for the operation of the business for the term of the franchise. Franchisors are very protective of their intellectual property and will require its Franchisees and any key personnel of the business to hold any such information in strict confidence which obligation survives the termination of the Franchise Agreement.
Default and termination
In special circumstances, the Franchisor may terminate the Franchise Agreement by providing seven days’ notice of their intention to terminate the Franchise Agreement to you in writing. Such circumstances are prescribed by the Code and apply only where the Franchisee:
- No longer holds a licence that the Franchisee must hold to carry on the franchised business; or
- Becomes bankrupt, insolvent under administration or a Chapter 5 body corporate; or
- In the case of a franchisee is a company – becomes deregistered by the Australian Securities and Investments Commission; or
- Voluntarily abandons the business or the franchise relationship; or
- Is convicted or a serious offence; or
- Operates the business in a way that endangers public health or safety; or
- Acts fraudulently in connections with the operations of the business..
In all other circumstances, if you are in default or breach of your obligations under the Franchise Agreement the Franchisor must provide you with written notice that you are in default, set out the nature of the default and what you must do to rectify the default within a reasonable period of time. If the Franchisor provides you with such written notice and you fail to rectify the default within the allotted time, the Franchisor may have the right to terminate your Franchise Agreement.
Sale or transfer of your business
If you wish to sell your franchise during the term, the Franchise Agreement will set out the procedure that must be followed which will include seeking the Franchisor’s consent. It is likely that the Franchisor will have the right of first refusal to purchase the business which means that you must first offer to sell the business to the Franchisor.
In accordance with the Code, the Franchisor may not unreasonably withhold consent to you transferring or selling your business. Notwithstanding, there are certain circumstances where the Franchisor may withhold its consent which includes where the purchaser is unlikely to meet the financial obligations of the Franchise Agreement, or such transfer will have a significantly adverse effect on the franchise system, or the Franchisee is in breach of the Franchise Agreement among others.
Most Franchise Agreements contain provisions that will preclude Franchisees from setting up, operating or holding any interest in any competing business during the term of the franchise and for a period of time following the end of the franchise relationship. As the Franchisee, you will have the benefit of the Franchisor’s intellectual property, systems and know-how and the Franchisor will want to be sure that you or any of its Franchisees do not use such information to set up a business in competition with the franchise network.
The “non-compete” or restraint of trade provisions within a Franchise Agreement are often confusing to Franchisees. Several options may be provided in respect to the period of time (eg, twenty four months – twelve months – six months) and in respect to the geographical area (eg, 5km radius – 3km radius – 1km radius) in which you may not operate, or hold an interest in a competing business following termination of the Franchise Agreement. Clauses drafted in this manner are called “cascading provisions” or “ladder clauses.” The purpose of such drafting is so that if a court determines that the period of time or geographical area stipulated in the restraint of trade provisions are unreasonable, the provisions can be read down so that the lesser period of time and smaller geographical area may be enforced.
Where disputes cannot be resolved informally between the parties, the Code provides that parties to a Franchise Agreement are required to first trigger mediation before going to court over the dispute.
The dispute resolution provisions of the Code clearly set out the procedure which must be followed including formal written notice outlining the nature of the dispute, the desired outcome of the dispute, and a timeframe within which it should occur. Should the dispute progress to a point where mediation is required, it is advisable to then engage a specialist franchising solicitor to assist in your preparations for mediation or to enter into direct negotiations with the Franchisor to settle the dispute.
Entering into a Franchise Agreement may seem daunting but can be managed with the right expert advice to guide you through the documentation and process.
Bianca Sevastos is a Partner at Baybridge Lawyers where she specialises in franchising and licensing. Bianca advises on all aspects of franchising compliance with the Code, day-to-day management of franchise systems and relationships with suppliers and franchisees.
Baybridge Lawyers is a corporate and commercial law firm with a strong focus on franchising, support for real estate agencies and dispute resolution and litigation. They provide interconnected legal, strategic and advisory services to a range of commercial and private clients both nationally and abroad.