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Reading the fine print

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Most franchise agreements are lengthy documents weighted very much in favour of the franchisor. It is critical that franchisees obtain appropriate advice especially legal advice.

Seeking legal advice is considered to be so important that the Franchising Code of Conduct (the Code) requires a franchisor to advise each franchisee to seek independent legal advice and obtain a statement from each franchisee that it has either obtained legal advice or was advised to do so, but decided against it.

A lawyer’s role in reviewing franchise documentation is to advise a franchisee about key rights and obligations under the Franchise Agreement and highlight any onerous or unusual clauses in the franchise agreement.

This article addresses what a franchisee should be looking for in the ‘fine print’ of a typical franchise agreement.

Is the Territory offered really exclusive?

It is important to ask what rights are actually granted under the franchise agreement? Is the franchise for a specific territory or is it limited to a particular site? Is the territory (where offered) exclusive or are other franchisees or the franchisor going to be able to trade or market in the territory?

If the franchisor offers exclusive territories, the provisions in the franchise agreement dealing with the territory need to be examined carefully because often there are exclusions, for example:

  • the franchisor may reserve to itself the right to conduct business over the internet selling products or services available in the franchise online
  • the franchisor may reserve to itself the right to sell products available in the franchise business from non branded outlets (eg in supermarkets or departments stores)
  • the franchisor may be entitled to alter the territory in certain circumstances such as failure to meet minimum performance requirements

Any exclusions should be carefully examined and discussed with the franchisor.

Termination provisions

Like any relationship, the beginning is rosy and the parties do not at the outset examine what happens when the relationship ends.

Most franchise agreements do not specify grounds upon which the franchisee can terminate the agreement. Even if the franchisor is in breach the franchise agreement, generally speaking, the franchisee does not have a contractual right to terminate and may have to rely upon the common law or the Trade Practices law for a remedy. This is time consuming and costly.

A typical franchise agreement and the Code, provide various methods by which a franchisor can terminate a franchise agreement. Most franchise agreements and the Code specify a process to be followed by the franchisor if the franchisor wishes to terminate the franchise agreement due to franchisee breach.

Clause 23(g) of the Code specifies seven grounds upon which it is legitimate for a franchisor to terminate a franchise agreement immediately, for example the franchisee abandoning the franchisee or being guilty of fraud.

One of the seven grounds for immediate termination set out in clause 23(g) of the Code is where the franchisee agrees to the termination. The argument is that by signing the franchise agreement setting out the circumstances that give the franchisor the right to immediately terminate the franchise agreement, the franchisee agrees to the termination in that circumstance.

The franchisee’s lawyer should aim to confine the grounds for immediate termination to those grounds set out in clause 23(g) of the Code and should endeavour to negotiate a clause in the franchise agreement that allows the franchisee to give notice of breach to the franchisor, such notice to require the breach be remedied within a reasonable time, failing which the franchisee should be entitled to terminate the franchise agreements.

Transfer provisions

A franchisee cannot transfer or sell its franchise business without the franchisor’s consent. The Code requires the franchisor to act reasonably in giving its consent and also sets out some grounds upon which the franchisor can refuse consent.

The costs associated with selling a franchise business can be substantial. The franchisee may be required to pay the franchisor’s costs associated with investigating the prospective purchaser and approving them, the franchisor’s legal costs associated with terminating the existing franchise agreement and entering into a new franchise agreement with the new franchisee, the cost of training the new franchisee and often a transfer fee.

The transfer fee may be calculated in many different ways, including, a flat dollar figure or a percentage of the sale price. In some instances the transfer fee is calculated on a sliding scale so the transfer fee is higher in the first few years of operation of the franchise.

It is important that franchisees are aware of the possible costs associated with selling their franchise business so that these costs can be factored into negotiations with any purchaser franchisee.

Insolvency of Franchisor

Given the incidence of franchisor insolvency in recent years, franchisees must educate themselves on what happens to their investment if the franchisor becomes insolvent. Not many franchise agreements deal with this issue, but franchisees should be requesting clauses to better protect them. For example:

  • the head lease (where relevant) be held by the franchisee
  • the franchisee be entitled to terminate the franchise agreement if the franchisor becomes insolvent
  • the restraint clauses be waived in the event of franchisor insolvency
  • the franchisee be permitted to “debadge” the premises and continue trading from the premises.

Dispute Resolution and Jurisdiction

Another important consideration is when there is a conflict between the franchisee and the franchisor, how and where is that dispute to be resolved?

The governing law of and jurisdiction set out in the franchise agreement may be the law of another state or territory in Australia or in the case of a foreign franchisor, the law of another country. This may mean that a franchisee is required to travel interstate or overseas to initiate/defend proceedings or attend mediation. Where possible the governing law should be the law of the state or territory in which the franchise operates.

The above is by no means an exhaustive list of the key provisions that should be considered before embarking upon buying a franchise. Seeking a lawyer who is experienced in franchising will assist in wading through the fine print and ensure that the advice obtained is practical and cost effective.

For further information please contact one of our Franchising lawyers.

Author: Louise Wolf