We outline possible issues when dealing with franchise agreements, along with good practices for the benefit of franchisors and franchisees.
There are over 44,000 franchise businesses in the UK, collectively generating close to £15 billion annually and employing more than 620,000 people. However, unlike in the USA and many other countries, franchise agreements are largely unregulated. We see this reflected in many variations of franchise agreements, both in larger well established networks and some of the smaller operators.
We see a number of issues (which frequently crop up) when franchisors are selling franchises to new franchisees, which can lead to a sale being abortive and/or slowing the sale process. We set out below some points from recent franchise matters that we have dealt with.
British Franchise Association (BFA)
The BFA is a voluntary association which requires its members to comply with its rules, which are based on the European Code of Ethics for Franchising ("Code"). More than 250 franchisors are members of the BFA including some of the most recognisable franchise businesses in the market such as Costa, McDonald's and the Co-op. BFA membership is also available to professional franchise advisors such as lawyers and accountants.
The Code and BFA guidance sets out what is good practice for the
benefit of franchisors and franchisees. Following this guidance can
help with the issues that we encounter with franchise
If a franchisor wants to join the BFA they will need to have a compliant franchise agreement.
Franchise agreement – recent issues
A BFA compliant franchise agreement should deal with the following:
- Initial fee - the initial fee should cover costs and not have a significant mark-up. The main benefit should come from the franchisee trading within the network and paying their franchise fees.
- Term - be for long enough to enable the franchisee to realise a return on their initial investment. Five and 10 year terms (with a right of renewal for the same period) are common. It's difficult to see how a term of less than five years meets the criteria.
- Renewal fee - have no renewal fee, save for covering the costs of the renewal. Renewal fees are often seen as revenue generating by some franchisors.
- Obligations - set out the parties' respective obligations clearly – don't include huge lists of obligations that are not required – if you don't need them, delete them! Whilst any franchisee is to expect hefty obligations imposed on them, are they drafted clearly and are they enforceable? A number of agreements we have recently reviewed go way too far in their quest for protection of the franchisor and in certain circumstances this can lead to the relevant provisions being unenforceable.
Other recent points of interest:
- PG's - It is perfectly fine (and advisable) to obtain a personal guarantee form the individuals/directors of the franchise company. These are essential where the franchisee company has no assets or trading history.
- Accounting - clauses specifying the accounting requirements, including what records must be kept and how these must be delivered to the franchisor, are acceptable. Where, however, there is a requirement to use the franchisor's accountant (or recommended advisers) problems can occur, as the advisers can find themselves in a conflict position.
- Sale of franchise - we see a variety of clauses with regard to the sale of the franchise business – some agreements allow a relatively "light touch" process, where the franchisor's consent is required to the buyer and new franchisee. As part of the consent, the franchisor will then approve the payment of fees and the relevant transactional documents. At the other end of the spectrum, some franchisors control the process, draft the initial documents and are very involved throughout. It can work well either way, but generally it is better for the franchisor to take more of a light touch approach and not get dragged into the transactional process.
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.