Franchising is without doubt a popular model for owning and operating a business in Australia. When buying a franchise, a prospective franchisee will receive a standard form and long-term contract from the franchisor, which formalises its legal relationship with the franchisor and sets out the rights and obligations of each party. From the outset, franchisees should be aware that the franchise agreement has been designed by the franchisor to protect its interests and to place most of the commercial risks, burdens and responsibilities of operating the franchised business on the franchisee.
When purchasing a franchise, franchisees should take the time to read through the franchise agreement and the franchisor's disclosure document to understand its rights and obligations as a franchisee and how it must operate the franchise. A franchisee should also be prepared to undertake their own due diligence and ask questions of the franchisor and existing franchisees in the network, to gain a thorough understanding of what is expected of franchisees in the network. It is also important that franchisees obtain independent legal advice from a suitably qualified lawyer to understand the terms of the agreement and answer any questions concerning any legalese used in the documents.
From our experience working with both franchisors and franchisees, we often see franchisees that are eager to "just do a deal" and forego undertaking any real due diligence or attempt to negotiate the terms of the franchise agreement with the franchisor. Given the significant investment that a franchisee will make, it is important for the prospective franchisee to carefully consider what they are signing, and the risks associated with becoming a franchisee, before entering into the franchise agreement.
In 2019, the ACCC released a report which indicated that 40% of prospective franchisees were not getting independent advice before buying a franchise. This statistic is particularly frightening, as often the individuals behind a franchisee will put their personal financial security at risk to finance the purchase and fit out of the franchise.
While by no means being an exhaustive list, below are 10 things that a prospective franchisee should be on the lookout for in a franchise agreement:
- The Term – A prospective franchisee should check the length of the initial term and whether there is an option for renewal. If the franchise is premises-based, a franchisee should also ensure that the term and any option for the lease for the premises required for the operation of the franchise runs concurrently with the term of the franchise agreement;
- Personal Guarantees – A franchisor will commonly require a franchisee to provide a personal guarantee. A personal guarantee makes the individuals behind the franchisee entity personally accountable to the terms of the franchise agreement, even if the franchisee operates the business through a separate franchisee entity (i.e. a company or trust). Once a franchisee signs the guarantee (which could form part of the franchise agreement or be provided as a separate document), the franchisor may have a claim over the franchisee's personal assets, which can be an alarming prospect for most franchisees;
- Fees – In addition to paying an initial franchisee fee upon entering a franchise agreement, franchisees should expect to pay on-going fees to the franchisor including but not limited to royalties, marketing fees, third-party fees for technology services or support services to the network;
- Intellectual Property (IP) – The franchise agreement should detail any Intellectual Property (IP) owned or licensed by the franchisor, which is in turn licensed on a non-exclusive basis to franchisees in the network. A franchisee should make themselves familiar with what IP they can use and how they are permitted to use the IP in the operation of the franchise, as a licensed user;
- Premises - If the franchise is premises-based the franchisee's obligations in relation to the fit out, location and upkeep of the premises should be included in the franchise agreement. The franchisee should also confirm with the franchisor who is responsible for the costs of the fit out if the site is a greenfield site or if the franchisee is required to undertake any refurbishments to the premises during the term of the franchise agreement. These costs can be significant, and the franchisee will need to factor these costs into their budget;
- Reports – These days most franchise networks utilise a centralised POS system that gives the franchisor oversight over the network, however individual franchisees may still have regular reporting obligations under the franchise agreement. Franchisees, at the request of the franchisor, may also be required to participate in audits or be asked to provide certain information during the term of the franchise agreement to satisfy any concerns that the franchisor may have in relation to the franchisee's ability to operate the business;
- Registration of Security Interests - Most franchise agreements provide for the franchisor to be able to register a debenture charge/general security agreement over the assets of the franchisee or a guarantor as security under the Personal Property Securities Act (PPSA). A security interest must now be registered on the Personal Properties Securities Register (PPSR). For a franchisee, if it were to default on payment of any fees payable under the franchise agreement, the franchisor would be entitled under the PPSA to enforce its security in order to satisfy the debt owed under the franchise agreement;
- Approved Products and Services – The franchise agreement should specify what goods and services the franchisee can offer (usually defined in the franchise agreement as Approved Products and/or Services) and their obligations in relation to offering the Approved Products and Services. The franchise agreement should also specify the process for obtaining and offering alternative products and services if for any reason the Approved Products and/or Services are not available;
- The Operation Manual - The operation manual will provide franchisees with the knowledge they need to operate the business. It's a good reference book for franchisees as it establishes the rules, standards and specifications regarding what must be done to accomplish a task, or to present a certain product or service. Before entering a franchise agreement, a franchisee should try to gain access to the franchisor's operation manual to gain an understanding of the franchisor's expectations as to how the business must be run. Franchisees should be aware that a breach of the operation manual could amount to a breach of the franchise agreement, which could have serious consequences for the franchisee; and,
- Termination – It is important that a franchisee is aware of the grounds on which a franchise agreement can be terminated, the process for termination and how much notice (if any) the franchisor must give should it wish to terminate the franchise agreement. The franchisee should also be aware of what grounds it can terminate the franchise agreement and any time restrictions for doing so. Generally speaking, there are limited grounds and only a small window in which a franchisee can terminate a franchise agreement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.