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The fundamental aspects of the franchise agreement

Written by : Joseph Adler

Overview of key contractual terms

Parties to the Franchise Agreement

One of the first issues to address when drafting a franchise agreement is to determine the identity of the contracting parties. A franchisee may be an individual or a corporation or, in some cases, a partnership. Put simply, the obligations and debts arising under the franchise agreement are only binding on the parties to the agreement. For example, absent a personal guarantee, if a corporate franchisee enters into the agreement, the individual shareholders of that corporation cannot be sued in their personal capacity for the debts and obligations of the corporation. The enforceability of the non-competition and confidentiality provisions of the franchise agreement must also be considered when deciding how to approach this issue.

Many franchisors require an individual to enter into the franchise agreement in his or her personal capacity, either in lieu of or in addition to the corporate franchisee. Where the franchise agreement is executed by an individual, some franchisors will permit an assignment of the agreement to a corporation controlled by the individual, but will usually require the individual to personally guarantee the obligations of the corporate franchisee. In addition, many franchisors will require that all of the principal shareholders of the corporate franchisee guarantee the debts and obligations of the franchisee, thereby imposing personal responsibility on the individual shareholders for fulfilling the obligations of the corporate franchisee.

As noted above, guarantees are important not only because the individual becomes personally responsible for the payment of fees and other monetary amounts under the franchise agreement, but because the individual is then subject to the same non-competition and confidentiality obligations imposed on the corporate franchisee.

Grant and Reservation of Rights

This provision is arguably the most important provision of any franchise agreement. Pursuant to this provision, the franchisee is granted the right, licence and privilege to operate a business selling authorized products and/or services in association with the franchisor’s standards, procedures, methods, techniques, specifications, know-how and trade-marks. This licence is typically limited in both time and territory (as discussed further below). In addition, the licence may be exclusive, non-exclusive or exclusive within a specified territory. While it is important that the franchise agreement carefully describe all of the rights granted to the franchisee under the agreement, it is equally important that the franchisor specifically carve-out all of the rights that it intends to reserve to itself.

In a non-exclusive licence, the franchisor provides no guarantee whatsoever that it will not directly or indirectly compete with the franchisee through corporate outlets or other franchisees. In an exclusive licence on the other hand, the franchisor agrees not to compete with the franchisee within a defined territory by refraining from operating the same business or granting a competing franchise within that same area. However, even where the franchisor has granted an exclusive licence, the franchisor will typically reserve certain enumerated rights to itself. For example, the franchisor may reserve the right to operate or license others to operate a competing business (either within or outside the franchisee’s exclusive territory) using different trademarks. In today’s marketplace, the franchisor may wish to reserve the right to sell products and services by telephone sales, mail order or the Internet. A sample grant and reservation of rights clause is provided below.

Grant and Term

Subject to the provisions of this Agreement, Franchisor hereby grants to Franchisee the right, license and privilege to operate the Franchised Business at the Premises for an initial term of five (5) years and to use the System and the Trade-marks in connection therewith. Reservation of Rights

The Franchisee expressly acknowledges and agrees that, the rights granted to the Franchisee hereunder are non-exclusive, and the Franchisor expressly reserves the following rights:

  • the right to establish or operate, or license any other person the right to establish or operate, a [branded outlet] at any location outside the Exclusive Territory;
  • the right to develop, market, own, operate or participate in any other business under the Trade-marks or any other trade-marks; and
  • the right to distribute, sell or license other persons to distribute or sell non-System products and System Products whether within the Exclusive Territory or otherwise, through channels of trade other than traditional [branded outlets] such as kiosks, home delivery, centralized order taking, toll free telephone, mail order, electronic mail and the Internet .

    Term and Renewal

    The term of the franchise agreement determines how long the franchisee will be authorized to carry on business using the franchisor’s system and trade-marks. Normally, the grant of these rights is for a specified initial term (for example, 5 years or 10 years). The length of the initial term will vary depending on the nature of the franchised business, industry practice and the cost of the initial investment required by the franchisee.

    In some cases, a franchisor will offer the franchisee a right of renewal for a further specified period of time. The renewal period may or may not be for the same period of time as the initial term. Usually certain conditions must be satisfied by the franchisee in order for it to exercise its right of renewal. For example, the franchisor may require that the following conditions precedent be met by a franchisee wishing to renew the franchise agreement beyond the initial term:
  • the franchisee shall have substantially complied with all of the provisions of the franchise agreement and all other agreements between the franchisee and the franchisor during the term prior to renewal, and shall be in full compliance therewith at the end of the term prior to renewal;
  • all monetary obligations owed by the franchisee to the franchisor shall have been satisfied in full prior to such renewal;
  • the franchisee shall have made or agreed to make all reasonable capital expenditures required by the franchisor to renovate, refurbish, remodel, redecorate and modernize the premises so as to reflect the then current image of the franchised business;
  • d) the franchisee shall have made or agreed to make all reasonable capital expenditures required by the franchisor to upgrade its equipment, systems or software;
  • e) prior to the commencement of such renewal term, the franchisee shall have executed the franchisor’s then current form of franchise agreement and all other agreements, instruments and documents then customarily used by the franchisor in the granting of franchises;
  • f) the franchisee shall have given to the franchisor the required notice prior to the expiry of the current term of its intention to renew the franchise agreement;
  • g) the franchisee shall have secured the right to remain in possession of the current premises or other premises acceptable to the franchisor throughout such renewal term; and
  • h) the franchisee shall have paid to the franchisor the required renewal fee (often this renewal fee will be expressed as a percentage of the then current initial franchise fee being charged to new franchisees.

    As noted above, the franchisee may be required to renovate its space or upgrade equipment or systems prior to exercising its right of renewal. This requirement enables the franchisor to ensure that long-time franchisees do not fall behind newer franchises in terms of appearance, standards and quality and also allows the franchisor to ensure consistency across all franchises regardless of the length of time a franchisee has been part of the system. As a result, it is more common for a franchise agreement to include an initial term of five years with an option to renew for one further five year period, than it is for the agreement to provide one single ten year term.

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