Starting a franchise business is not as easy as it may seem. The concept of franchise demands a high degree of co-operation from both the franchisor and the franchisees. The general concept of franchising is rather complex and may take time for interested parties to adequately grasp the underlying dynamics and the prevailing norms. It is therefore important for anyone aiming to start a franchise to take a critical look at what it entails before delving into it. For a franchise business to be successful, it requires a high degree of co-operation by all the parties involved, the failure of which can be disastrous not only for the franchisor but also for the franchisee. Thus, for a franchise to succeed, it must be well-structured, well-managed and most importantly the legal roadmap must be well-defined.
There is a myriad of legal issues that need to be considered before starting a franchise and where the available resources permit, the interested party should endeavour to check each of them off their list of pre commencement activities. However, due to budgetary constraints which most new franchises face, it may be difficult or impossible to go through the list in one fell swoop, thereby making it necessary to prioritize by drawing up a legal road map which helps navigate the issues one step at a time, focus on the areas of risk first and consider the legal issues which don't cost much now but may be expensive down the line if not tackled immediately.
This article aims to take an in adept look at some of the legal issues that need to be addressed in order to ensure a successful new franchise.
HIGHLIGHTS OF LEGAL ISSUES TO CONSIDER FOR A SUCCESSFUL FRANCHISE
There are many structures to consider when starting up a franchise. A franchise owner may operate as a sole proprietorship, a partnership or a limited liability company. An investor in this field should not take these choices lightly as each of the structures comes with its own peculiar advantages and down sides. We shall evaluate the comparative pros and cons for each of these corporate structure in turns.
Pros and cons of each Legal Structure:
Sole Proprietorship and Partnership:
These are essentially incorporated entities with the business promoter(s) dealing on the strength of his or their respective identities and assets. They bear personal liability for the actions of the business and take full benefit of the same in their own names. These structures do not offer protection from individual liability. Thus, any liabilities or claims brought against the franchise would strictly be the obligation of the franchise owners. This presents a potential source of discouragement to potential investors or equity partners.
As a counterbalance, the structures offer some level of tax relief and flexibility advantage as compared to a limited liability company. These structures also afford the owners unbridled access to the profits made by the business.
Limited Liability Company:
This structure presents numerous advantages in a franchise arrangement. For instance, an LLC constitutes a separate legal entity with a subsistence that is distinct from those of its promoters. Generally, therefore, the death of a shareholder does not extinguish the subsistence of the franchise. Also, the liability of the promoters is limited to the proportion of their respective individual subscriptions to the company's issued share capital. A limited liability company can easily raise funds for expansion purposes through public issue of shares.
As promising as this looks, this structure is not without its owns cons. For instance, any profit declared is subject to corporate tax, and for a sizeable profitable company, this could run into millions or billions of naira. Also, the operations of a LLC are usually restricted to the objects set out in its memorandum of association, thereby eroding the flexibility advantage inherent in an unincorporated entity.
It is very essential to ensure that a strong trade mark protection is in place at the onset of any new franchise, not only because it is the bedrock of a veritable franchise but also because such protection is necessary to protect the franchisor's interests.
What are trademarks?
The word trademark signposts the distinct symbols, words, pictures and other components that represent and project the identity of your trade or business. These distinct symbols, together with their colours, fonts, general appearance and optics are collectively referred to as the mark of your trade. In practice, the name of your business, the brand names, logos, your tagline are important components of your trademarks. With a few exceptions1, any word, phrase, or symbol that identifies the goods or services you provide and sets you apart from the competition can be trademarked. Trademark protection offers immeasurable advantage to a franchise owner in more ways than one.
Franchisors must ensure that they own all other intellectual property in logos, material, company website and business operating system. Franchisor has a general duty of brand reputation management of its franchise. Franchise agreement protects certain proprietary right from unauthorised uses and exploitation by franchisees. An ex-franchisee may continue to use some or all of the franchise trademarks and/or other IP. Effective and comprehensive trademarks and other IP protection is vital in protecting the franchisor. A franchisor can apply to court to stop the use of his or her registered trademark or unregistered brand name.
The starting point for an entrepreneur setting up a franchise, is usually to record a description of the business format model that they have developed. This will, naturally, involve the drawing up new documentation including franchise operations manuals, training material, terms and conditions of sale, and other legal documents that clearly defines the distinct identity of the business and its process. This invariably sets the tone for the potential evolution of the business and its process into a veritable body of franchise. These contents are generally subject to, and protected by copyright law.
The protection offered by copyright laws do not avail and undocumented idea in the head of the aggrieved owner. Therefore, a franchisor intending to enjoy the protection under the relevant copyright laws must take deliberate steps to draw up and document these ideas and in a tangible and journalised way. Once these measures are in place, the franchisor would enjoy the necessary safeguard and tool to pursue any action against a competitor who infringes on the franchisor's copyright.
Patents protect the technical and functional aspects of products and processes. All patents must be registered in each country where the franchisor seeks to enjoy the protection of his invention2. Where a franchise business is dependent on a computer program or any other type of equipment or machinery, that technology may require specific patent registration.
The level of trust a franchisor places on a franchisee is high, and it is incumbent on a diligent franchisor to balance this with the necessary rock-solid legal and contract safeguards to match. For a franchisor, the brand is always at stake and there is a need to be certain that the people who represent this brand and its business will do so with a similar combination of passion and restraints.
Franchise agreements incorporate the respective rights and obligations of the franchisor and the franchisee as well as prescribe certain minimum standards and expectations around performance, evaluation and possible infractions and other likely triggers for terminating the relationship. Most of the Franchisor's standards and requirements often derive from the franchise architecture, which will usually set out in advance a fit for purpose internal policies for recruiting and dealing with franchisees.
When considering invoking his right to terminate the franchise, the franchisor must ensure that the franchisee's breach constitutes a solid ground within the contemplation of the agreement. If the breaches do not clear-cut constitute an infraction of the agreement, the franchisor may be faced with a more difficult task of establishing a chain of evidence illustrating the franchisee's pattern of poor performance over time. To avoid this burden, the franchisor should engage qualified advisors and draftsmen not only to the design the architecture of the franchise relationship but also draft out a franchise agreement that meticulously sets out the parties' obligations and rights to terminate (if any).
The place of a purpose structured relationship and detailed franchise agreement is at the centre of legally sound and commercially successful franchise arrangement. In the absence of this, a franchise is likely to be fraught with so many conceivable pitfalls.
Well-drafted employment contracts are equally critical to the success of a franchise business. The most important consideration in your employment contract is to attract promising new employees and retain key employees with capacity and technical know-how. This, it must also balance effectively with the need to protect the franchisor's business' assets and maintain their inherent comparative advantage over his competitors.
In its simplest form, an operations manual is effectively the instruction manual for running a franchise business. It should include information and guidance on all aspects of what a franchisee needs to do, to run their business in conformity with the operational and branding guidelines of the franchisor. Although similar in many respects, an operations manual is different from a franchise agreement.
A franchise agreement governs the franchise relationship between franchisee and franchisor. Once a franchise agreement is signed, it cannot be altered (without agreement from both parties) for the term of the agreement. However, the operations manual can typically be changed at the discretion of the franchisor, depending on the terms of the franchise agreement.
The operations manual is a critical tool in influencing the behaviour and operations of the franchisee over time. It provides a franchisor with a level of control and capacity to enforce desired behaviour and actions within the franchise's operation ecosystem. The justification for this widespread authority and influence derives from the franchisor's need to uphold and protect the brand, embrace the necessary flexibility to adapt the system to changing technologies and customer needs over the course of the term of a franchise agreement.
As the operations manual covers all areas of running a franchise business it should therefore be deployed as an effective tool to provide training to a franchisee. Using it as the basis for induction and training will also help the franchisee become familiar with the manual, increasing its use and effectiveness within the system.
REGISTRATION WITH REGULATORY AUTHORITIES
Although there are currently no specific laws in Nigeria regulating franchising in Nigeria, there are several regulatory provisions which broadly affects franchising in Nigeria. For instance, the National Office for Technology and Acquisition Promotion (NOTAP) Act3 requires the mandatory registration of any franchise arrangement that stipulates the transfer of foreign technology with NOTAP. In specifics, the Act requires that mandatory registration where the agreement pertains to:
- Use of trademarks
- Use of patented inventions
- Supply of technical expertise in the form of technical assistance of any description whatsoever
- Supply of detailed engineering drawings
- Supply of machinery and plant
- Provision of operating staff, managerial assistance, and the training of personnel.
However, if the franchise arrangement is between two local entities, there would be no need to register with NOTAP.
The Franchise Disclosure Document (F.D.D.)4
To set up a successful franchise business, a franchisor has to prepare an FDD. The purpose of the FDD is to provide prospective franchisees with information about the franchisor, the franchise system and the agreements they will need to sign so that they can make an informed decision. In addition to the disclosure part of the document, the FDD includes the actual franchise agreement as well as other agreements the franchisee will be required to sign, along with the franchisor's financial statements. The FDD is designed to give you some of the information you need in order to make an informed decision about investing in a particular franchise. The FDD includes some information like trademarks, patents, outlet and franchise information, financial statement, restrictions on what the franchisee may sell, and the territory where the franchisee is to be located.
The structure and contracting efforts that goes into a franchise relationship has far reaching import on viability of a franchise business. All seemingly insignificant decisions play a pivotal role in laying the groundwork for success, and poor choices in this sphere can often come back to bite. The most common mistakes include setting up a business/company without proper legal advice and implementing agreements involving your intellectual property (IP) that fail to properly protect your interests. As a franchisor, it is imperative that you are legally protected before setting out to create a new franchise. for the franchisee, the need is not any less important. Each party to a franchise relationship should therefore start their journey by seeking the necessary legal assistance to safeguard their interests.
1. Descriptive words that cannot be differentiated from those of other products, generic names, names that include a geographical location; are all some of the exceptions to the words or phrases that can be trademarked.
3. CAP N62 LFN 2004
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.