How to Draft, Negotiate and Terminate a Franchise Agreement (with Examples)?

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Date Created: 7 Oct 2020

Franchise agreements are generally drafted by the franchisor with the franchisee given a template to sign. However, franchise agreements are not set in stone and can be negotiated by the franchisee. This article highlights the important contents of the franchise agreement for negotiation by the parties. In particular, how a franchise agreement can be terminated or exited by the franchisee. Samples of the franchise agreement are also included in the article.

 

What is a Franchise Agreement?

 

A franchise agreement is a legally binding agreement to govern the relationship between the franchisor and the franchisee. Through the franchise agreement, the franchisor grants the right to franchise its business to the franchisee.

 

The franchise agreement covers the franchise rights such as territory, term, minimum performance, franchise services, fees and payment, training provided, intellectual property rights, use of intellectual property, and other rights and obligations of the franchisee. In addition, there is usually an operational manual provided by the franchisor which may or may not be incorporated into the franchise agreement.

 

 

Types of Franchise Agreement

 

There are four main types of franchise agreements / arrangements:

 

1.     Single Unit Franchising

 

Single unit franchising refers to an agreement by which the franchisor grants the franchisee the right to open and operate one premises for the franchise business. This is the typical starting point for most franchisee to test the water.

 

2.     Multi-Units Franchising

 

If the initial franchise is successful, the franchisee may seek the right to open and operate multiple franchised premises.

 

3.     Territorial Development

 

This is a type of Multi-Units Franchising where the franchisee is given a territory to develop certain units within a period of time. The arrangement is generally exclusive, which means no other franchisee will be granted the same territory during this time. However, the franchisee may lose its exclusivity if it fails to meet certain milestones in developing the territory as required under the franchise agreement.

 

4.     Master Franchise

 

A master franchise is an expanded type of territorial development franchise with the franchisee not only has the right to open and operate franchise units in the designated territory, but also has the right to sell the franchise rights to others in the territory. The master franchisee is essentially a sub-franchisor, and therefore bears many rights and responsibilities of the franchisor to the franchise unit in the territory, such as providing support and training in the territory. As a sub-franchisor, the master franchisee will be collecting fees and royalties from franchisees in the territory.

 

 

How does a Franchise Agreement work?

 

1.     For the Franchisor

 

The franchise agreement is the most important legal document to manage and define the legal relationship between the franchisor and the franchisee. The franchisor grants the franchisee the legal right to establish and develop their franchise position, in turn, the franchisee will assume the obligation to establish and maintain its franchise business in compliance with the requirements of the system set by the franchisor (as set out in the operational manual). The franchisee is also required to pay franchise fees and ongoing royalties to the franchisor.

 

2.     For the Franchisee

 

As an investor to the franchise business, the franchisee should ensure that the franchise agreement includes all promises and representations from the franchisor. It should also include proper assistance, support and training from the franchisor to help the franchisee set up and run the franchise business successfully.

 

Contents of Franchise Agreement

 

A typical franchise agreement contains the following clauses:

 

1.     Grant and Reservation

 

The franchise agreement typically begins with a grant of franchise and any reservations by the franchisor. The franchised right is usually a limited, non-transferable, non-exclusive rights to use the franchisor’s name, trademark, logo and other intellectual property subject to the following restrictions:

  • franchised business;
  • at and from the premises;
  • within the territory;
  • under the permitted name / trademark; and
  • in accordance with the system and the operating manual of the franchisor.

 

2.     Term and Minimum Requirements

 

The franchise agreement would set out the minimum requirements and milestones for the franchisee to meet within a period of time in the territory. For example, the number of locations to be opened, the plan of the unit to be approved and the minimum sales target etc. This section may also specify other equipment or information technology system to be installed as part of the operational requirements.

3.     Franchise Fees and Royalties


Another important item to set out in the franchise agreement is the amount of initial franchise fees and ongoing royalties to be paid by the franchisee to the franchisor. In addition, there may be other expenses such as training fees or advertising fees which are to be borne by the franchisee.

4.     Services to be provided by the Franchisor

 

In exchange for the various franchisee fees, royalties and expenses, the franchisor should provide certain services to the franchisee, including but not limited to assistance with the setup and opening of the franchise business, advising on the plan layout and equipment to use, training of staff, supply of goods, seminars, post-opening services and advertising etc.

 

5.     Intellectual Property

 

The franchised right granted is a license to the franchisee and not a transfer of ownership right over the intellectual property by the franchisor. The franchisor will define each item of its proprietary intellectual property, confidential information and trade secret very specifically and explain the restrictions on the franchisee's right to use them in the franchised business. This is important for the franchisor to protect the brand value of its business.

6.     Quality Control

 

The franchisor will usually specify certain quality control requirements for the franchisee to comply with. This is necessary to maintain the quality of the brand and ensure that the goods and services provided by the franchisee meet the minimum standards of the franchisor.

7.     Sale of Franchised Business

 

The right of assignment in most franchise agreements is restricted and would require the franchisee to seek the consent of the franchisor before the franchise could be sold or assigned. In many cases, the franchisor would be given the right of first refusal to acquire the business on the same terms and price as the third-party purchaser.

 

8.     Restrictions on Franchisee

 

The franchise agreement will generally include certain restrictions on the franchisee including a prohibition on the franchisee from opening a competing business with the franchise business in the territory.

 

Other restrictions on franchisee may include:

  • not to commence operating the business until the franchisor’s approval;
  • not to operate the business at any location other than the approved premises;
  • not to sell, assign, transfer, charge or sub‑license the business;
  • not to use or publish any advertisements without the franchisor’s approval;
  • not to conduct the business outside the territory;


These restrictions usually last for at least one year after the termination of the agreement

9.     Relationship between the Parties

 

This is a common clause to clarify the relationship between the parties in the franchise agreement. The franchisee is not an agent, employee or a partner of the franchisor but an independent contractor. This means that the franchisee is responsible to pay its own taxes, conducting its own business, and are responsible for its own employees and insurance.

10.  Breach of Contract Limitation of Liability

 

Most franchise agreements (in favour of the franchisor) would limit the liability of the franchisor should there be a breach of contract. However, the liability of the franchisee tends to be unlimited. In addition, the franchisee will indemnify / compensate the franchisor for any losses suffered arising from the breach of contract by the franchisee. Arguably this is not necessarily unfair since the franchisee is responsible for the daily operation and maintenance of the business, not the franchisor.

11.  Termination of Franchise Agreement

 

Depending on the seriousness of the breach (whether the breach goes to the root of the contract), a breach of contract may not allow the innocent party to terminate the contract. For details, please refer to:

 

https://docpro.com/blog/terminate-contract-breach

 

The parties may list other events of termination of the franchise agreement, for example, if there is any material change in the management, ownership or control of the franchisee, if either party becomes insolvent, or if the franchisee is given a cooling-off period, a change of mind without reason. For more information on how to terminate an agreement, please see the below.

 

12.  Governing Law and Dispute Resolution

 

The franchise agreement stipulates the governing law of the contract, which is the normally the law of the territory of the franchised business (where the dispute has arisen).  In relation to dispute resolution between the franchisor and the franchisee, the parties would often agree to a face-to-face meeting or mediation first, before resorting to court or arbitration.

 

Negotiation between the parties tends to be the quickest and most inexpensive way to resolve a dispute, followed by mediation and arbitration. Going to court tend to be most expensive (unless it is a clear monetary claim on the franchise fee by the franchisor, which may allow for summary judgement) and can drag on for years.

13.  Boilerplate Clauses

 

A typical franchise agreement template would also include sample boilerplate clauses that can be found in most agreements. For example, no assignment, reservation of rights, waiver, severability, notices, force majeure, entire agreement, amendments and rights of third party etc.

 

For a comprehensive list of boilerplate clauses, please refer to:

https://docpro.com/doc303/general-boilerplate-document-standard-agreement

 

14.  Examples of Franchise Agreement Templates

 

DocPro has 6 different forms of franchise agreement templates to cater for different situations. In addition to the two parties versions between the franchisor and the franchisee, DocPro also has tripartite franchise agreement templates between the franchisor, the franchisee and the principal, whereby the principal (usually an individual) guarantees the obligations of the franchisee.

Version

Franchise Agreement (2 Parties)

Franchise Agreement (with Principal)

Franchisor

https://docpro.com/doc1786/franchise-agreement-franchisor

https://docpro.com/doc41/franchise-agreement-with-principal-franchisor

Neutral

https://docpro.com/doc1785/franchise-agreement-neutral

https://docpro.com/doc37/franchise-agreement-with-principal-neutral

Franchisee

https://docpro.com/doc1787/franchise-agreement-franchisee

https://docpro.com/doc42/franchise-agreement-with-principal-franchisee

 

 

How to Negotiate a Franchise Agreement?

 

Most franchisors will tell their franchisees that its franchise agreement is completely non-negotiable - take it or leave it. This may or may not be true, depending on the relative bargaining power of the franchisor and the franchisee. If the franchisor is McDonalds, then the room for negotiation is very limited compare with that of a new franchisor that is desperately looking for franchisees.

 

The following are some of the commonly negotiated terms in franchise agreements:

 

1.     Territorial Restriction

 

The territorial boundary of the franchise is usually negotiable. It should be clear which city or territory is covered by the franchise, in particular if the franchise is exclusive. Avoid setting distance as limits of the boundaries of the franchise as it is prone to dispute.

 

The other frequently negotiated point is whether the franchisee is able to sell online, and if the online customer lives outside of the territory, can the franchisee still make the sale? And vice versa, what if another franchisee infringe into an exclusive territory, would the franchisee have any recourse against the franchisor?

 

2.     Representations of the Franchisor

 

Whatever promises, representations and warranties made by the franchisor that are relied on by the franchisee should be included as part of the franchise agreement. In particular, if the representation goes to the heart of the contract, then it may be treated as a condition which would allow the franchise agreement to be terminated if breached. It is also a good defence should the franchisee fails to meet any milestones or targets under the franchise agreement.

 

3.     Restrictions on Franchisee

 

Most restrictions imposed by the franchise agreement on the franchisee are unduly restrictive. For example, the restriction to set up a competing business in a territory could be unduly wide in terms of area and duration. The franchisee should negotiate with the franchisor on something that is more reasonable.

 

4.     Property of Assets

 

The franchise agreement should make clear of what the property rights of various assets or equipment belong to. In particular, where these assets or equipment are provided by the franchisor to the franchisee and paid for as part of the franchise fee, the ownership should be clearly set out.

 

5.     Timing and Payment of Franchise Fee

 

The amount of initial franchise fee and the percentage of ongoing royalty may be negotiable. In addition, if the timing for payment by the franchisee is tight but the timing of provision of service by the franchisor is loose, the franchisee can seek to negotiate a fair timing to buy more time.

 

6.     Limitation of Liability

 

Another common unfair term is that the liability of the franchisor is limited whereas the liability of the franchisee is often unlimited, and often extend to the personal liability of the principal. The franchisee can seek to negotiate a fairer franchise agreement by making these unequal terms reciprocal. For example, if there is a liability cap on the franchisor to the amount of the franchise fee, then the same cap should apply to the franchisee.

 

7.     Right of First Refusal

 

Should the franchisee wish to exit the franchise through a sale, the franchise agreement generally restricts such sale to be subject to the consent or the first right of refusal of the franchisor (i.e. the franchisor has the right to purchase first the franchise on the same price and terms as the third party). Such consent should not be unreasonably withheld and any right of first refusal should lapse after a reasonable period of time.

 

The franchisee could also seek a right of first refusal to buy out any franchise within its territory on the basis of reciprocity.

 

8.     Breach and Termination of Agreement

 

Penalties for late payment of franchise fee by the franchisee may be excessive, whereas any breach of franchisor’s obligations carries little to no penalties. In addition, the termination provisions may provide for termination for a minor breach of contract by the franchisee, whereas the franchisee has no right to terminate against even a major breach by the franchisor. Again, the franchisee should seek to negotiate these provisions with the franchisor to ensure proportionality and fairness in the franchise agreement. 

 

9.     Dispute Resolution

 

If the governing law and jurisdiction of the franchise agreement is selected as the jurisdiction of the franchisor instead of the territory of the franchise (if different), the franchisee should negotiate with the franchisor on this point to ensure that common sense prevails. Given most elements of the disputes are likely to arise from the franchised territory, it is the most convenient forum for dispute resolution.

 

In addition, the franchisee should ensure that any dispute will be dealt with in a fair, cost-effective and timely manner such as first going through high-level negotiation or mediation.

 

 

How to terminate a Franchise Agreement

 

Most franchise agreement templates are in favour of the franchisor, which means that the franchisor is allowed to terminate the franchise agreement where the franchisee has breached the terms of the franchise agreement (however minor) or failed to meet certain milestones.

 

However, it is relatively difficult for a franchisee to terminate the agreement without compensating the franchisor with large amount of franchise fees, even if the franchise business is not as successful as expected. Below are some ways that may allow the franchisee to terminate the franchise agreement early:

 

1.     Breach of Contract

 

Not every breach of contract by a party would give the other party a right to terminate the franchise agreement. Unless the breach is expressly included as a terminable event in the franchise agreement, the breach will need to be significant enough to be a major breach that goes to the root of the agreement (i.e. breach of a condition of the agreement).

 

The innocent party should give the defaulting party a reasonable period to remedy the breach, failing which the innocent party would have the right to terminate the franchise agreement. A minor breach that does not go to the root of the agreement will simply be a breach of a condition and the appropriate remedy is damages.

 

2.     Cooling-off Period

 

In certain jurisdictions, the franchisee is allowed a cooling-off period (usually 7 – 30 days), during which it can terminate the franchise agreement without providing reasons. This is to prevent the franchisee from being lured into an unscrupulous franchise arrangement with long term payment obligations without thinking it through.

 

3.     Sale of Business

 

If the franchisee wishes to sell its business, the franchisor shall not unreasonably refuse to consent to the sale. The franchise agreement will usually stipulate the conditions for the sale such as the right of first refusal. If the franchisee followed the relevant notice requirements and the franchisor has not exercised its right of first refusal within a particular time period, the franchisee is generally free to sell its business.

 

4.     Walking Away without Clause

 

It is not advisable for either party to abandon the franchise without clause even if the franchise business is unsuccessful since the potential liability could be even bigger (similar to breaking a lease which the landlord could claim for all the unpaid rents under the lease from the tenant). This should only be considered by the franchisee where the liability is limited (if the franchisee is a limited company with no principal guaranteeing its liability on a personal basis, then one could consider walking away and wind up the company).

 

Please note that this is a general summary of the position under common law and does not constitute legal advice. As the laws of each jurisdiction may be different, you may want to speak to your lawyer.

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