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Drafting an effective franchise agreement

Written by : Thomas M. Pitegoff
2009-09-14
A franchise is a creature of contract; it is defined by the franchise agreement. The extent of the franchisee's "ownership" interest in the franchise is defined in particular by the provisions dealing with the scope of the grant, transfers, termination and renewal. Franchises come in endless varieties. One franchise may be granted for a fixed term at a specific location with a requirement that the franchisee surrender the premises to the franchisor upon termination, and have no renewal rights. Another may allow the franchisee to continue in business after the expiration or termination of the agreement at the same location under a different name and identity.

While many franchisees are individual entrepreneurs, some franchisees are corporations, some own a number of franchises, and some are larger and more profitable than the franchisor. While many franchisors require that the franchise location be devoted solely to the franchised products or services, some franchisors allow franchisees to sell other products and services, and to enter into other franchise agreements for the same location. While some franchisors own the premises at which the franchised business is located, in other cases, such as many hotels, the franchisee owns the premises and may simply enter another franchise system after one franchise agreement ends.

In each of these systems, the relative values of the franchised business and that portion of the business that is independent of the franchise will vary. Franchisors must be sensitive to the fact that the structure of the system will greatly influence the franchisee's incentive to devote money and effort to develop the franchised business. The more value that accrues to the franchi-see, the more the franchisee will be willing to invest.

Drafting in the Context of the Franchise Relationship Laws

Because of their importance to the economics of the franchise relationship, it is not surprising that contractual provisions dealing with the scope of the grant, transfers, termination and renewal have provoked a great deal of controversy over the years. Encroachment, transfer prohibitions, unjust terminations, and refusals to grant renewal rights are also the subjects of the franchise relationship laws of several provences. These laws may limit or simply complicate the enforcement of the agreement, or impose requirements not contained in the agreement.

Because the franchise relationship laws can impede the uniformity that franchisors like to have in their agreements, one approach would be to draft the agreement to comply with the requirements of the toughest state franchise relationship laws. This enables the franchisor to have an agreement that is uniformly enforceable throughout the country. Not all franchisors take this approach. According to one source, approximately 4% of franchise agreements permit the franchisor arbitrarily to terminate, and approximately 7% permit the franchisor to refuse to renew or to permit the transfer of the franchise. The relationship laws would not permit such arbitrary actions by the franchisor.

An agreement drafted to comply with the requirements of the toughest state franchise relationship laws is likely to be or be perceived as a fair agreement. This is important because franchise agreements are not like other business agreements. In the give and take of a typical negotiated business agreement, the first draft of an agreement will be one-sided in favor of the drafter's client, and will then be changed in the course of negotiation, ultimately reflecting the relative strengths of the parties. The model in franchising is radically different. A franchise system is planned by the franchisor and presented as a package to franchisees uniformly in the form of a franchise offering circular. The attorney for the franchisor will draft the agreement and offering circular with the interests of the franchisor in mind. The drafter must remember, however, that the franchisor will be extremely reluctant to negotiate changes in the standard franchise agreement. This compels the franchisor's attorney to look at the agreement from the point of view of both the franchisor and franchisee. Because the franchisee is not involved in the drafting, the franchisor's attorney might consider with the client positions favorable to the franchisee that would not be seriously considered in a fully negotiated agreement.

Aside from the advantages of having uniformly enforceable agreements, the franchisor's business incentive to be fair is simply that a fair agreement will sell more franchises than a one-sided agreement. A new franchisor trying to sell its first franchise must be especially mindful of the salability of the agreement. A powerful, well-known franchisor may be able to sell franchises with less "fairness" in the agreement because it has a proven record of profitability. Even for large franchisors, however, fairness makes for good public relations. Franchise agreements are public documents, and larger franchise systems are subject to more public scrutiny.

While fairness addresses the substance of the agreement, the drafter can also make cosmetic changes in the agreement that will enhance its appeal to potential franchisees. To protect the franchisor, it is not necessary to say, for example, that the franchisor has the right, "in its sole and unfettered discretion," to do this or that. It suffices to say that the franchisor has the right to do this or that. In other cases, it may be possible to make rights mutual without really giving anything up.

A fair agreement in both form and substance will not only allow for uniformity, sell more franchises and enhance the franchisor's image. It will also avoid disputes later on and put the franchisor in a better light when disputes do arise. In that sense, a fair agreement is a long term investment.
Fairness in drafting, then, is a marketing and public relations tool, and the first line of attack or defense in the event of a dispute.

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