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The fundamental aspects of the franchise agreement

Written by : Joseph Adler
2008-05-15

Territory

As noted above, the grant of the right to carry on the franchised business is usually limited to a defined territory. This territory may or may not be protected. The scope of the territory will vary depending on the nature of the franchised business. In some cases, the territory may be limited to the franchisee's actual premises, or parts of a shopping mall. In other franchise systems, the territory may be as large as an entire city or province.

Where the franchisor has decided to grant an exclusive right to carry on the franchised business within a defined territory, it is prudent to impose certain minimum performance standards on the franchisee. This will allow the franchisor to address situations where a franchisee may not be adequately serving the needs of all customers within the protected territory. Failure to meet or exceed the minimum performance standard may result in a reduction in the scope of the protected territory or the revocation of the franchisee's exclusive rights altogether.

An alternative approach seen in some franchise agreements is to provide the franchisee with a right of first refusal in the event the franchisor determines that the protected territory can support another franchise. In such event, and generally provided the franchisee is in full compliance with all of its obligations under the franchise agreement and meets the franchisor's financial and management capability requirements for multiple unit operators, the franchisor must first offer the new location to the existing franchisee in the protected territory. If the franchisee does not exercise its right of first refusal, then the franchisor is free to offer the franchise to a third party and to re-describe the existing franchisee's protected territory accordingly.

Protected Territory

In the event that Franchisor intends to establish or operate, or license any other person, firm or corporation to establish or operate, another Business within the Protected Territory, it shall first offer such Business to Franchisee on the same terms and conditions which would be offered to a prospective Franchisee at that time. If Franchisee does not agree to acquire such Business on such terms and conditions within thirty (30) days after notice of such offer is given to Franchisee, Franchisor shall then be entitled to operate such Business directly or offer such Business to any person, firm or corporation upon substantially the same terms and conditions as are offered to Franchisee hereunder, whereupon the description of the Protected Territory set forth in Schedule "A" to this Agreement shall be deemed to have been reduced to reflect the creation of a new protected territory for the new Business, which new protected territory shall be determined by Franchisor in its discretion. The exercise of the right of first refusal in this Section ?? by Franchisee shall be subject to the condition that Franchisee shall have substantially complied with all of the provisions of this Agreement and any other agreement to which Franchisor and Franchisee are parties and shall have complied with Franchisor's then current conditions and requirements for operators of multiple Business franchises including, without limitation, Franchisor's requirements for Satisfactory financial resources and management ability.

Site Selection

A franchisor will wish to control the location of the franchised business, the construction of the store and the general appearance of the franchised unit, particularly when franchising in the retail store-front context. Where the franchise takes the form of a store-front operation, the location, nature and quality of the franchised site obviously assumes a much greater significance. This is because the franchisor will require that the site be consistent with the kind of image and branding that the franchisor wishes to project to the public. A properly selected and constructed site therefore is not only often critical for the success of the franchise itself, but is also an integral element of the franchisor's maintenance and promotion of its brand and the franchise system itself. Where the selection of a site is an integral part of the brand protection strategy, a franchisor should first determine whether it or the franchisee should initiate the site selection process.

Where a franchisee is given the task of selecting the site, the franchisor should nonetheless retain the right to approve or disapprove the location and appearance of the site so as to ensure that it meets the criteria of the franchisor. Site selection provisions therefore often contain language that gives a franchisor the right to reject the franchisee's desired choice for a location. Where this is the case, a franchisor should provide its franchisees with a reasonable and objective rationale for its objections, even though the franchise agreement will not require an explanation from the franchisor. A reasonable explanation is helpful for the franchisee to then meet the franchisor's criteria and to proceed with a better choice of a location at a later time.

In addition to actually reserving the right to select the franchised site on behalf of its franchisees, a franchisor will often wish to retain the right to either construct the store itself or to ensure that the franchisees utilize only building plans, contractors and constructions supplies approved by the franchisor. Depending on the level of control desired, a franchisor will in any event wish to participate at some level in the construction process so that, at a minimum, its trade-marks and overall branding are protected.

Another important element of the site selection provisions pertains to the identity of the party entering into the lease for the real property for the franchised location. A franchisor may enter into the lease itself and then sublease the franchised site to its franchisee or it may allow the franchisee to enter into the lease itself, provided that the lease contains certain provisions that protect the franchisor, its trade-marks and the franchise system. Alternatively, or in any event, a franchisor may wish to simply negotiate the lease for the franchised location with the landlord on behalf of its franchisee. A franchisor does the latter to ensure that the lease does not contain provisions that might prevent the franchisee from operating the franchised business at the leased location in the manner contemplated by the franchise agreement, to allow a franchisor to sublet the premises without first obtaining the consent of the landlord in the event that it is on the head lease, and for other various related reasons. Once again, a critical concern for the franchisor is to ensure the location's suitability for the franchisee and ultimately the franchise system, particularly if the franchise is terminated and another franchisee is to replace the terminated franchisee at the relevant site.

In any case, the franchise agreement should make clear that the selection and securing of a site, review of documents and the negotiation of a lease, the selection of developers, real estate agents, site selection specialists, contractors, etc., financing, construction, build out, compliance with local requirements, suitability for any use or purpose and/or any other aspect of the development process and all other matters related in any way to the franchisee's site are exclusively and entirely the franchisee's sole and ultimate responsibility, even when the franchisor provides assistance in this regard. The franchise agreement should further explicitly stipulate that neither the franchisor nor any other person or company affiliated or associated with the franchisor is in any way liable with respect to any matters related to the site selection process, all such responsibilities being solely the franchisees. Alternatively, and as noted above, a franchisee may be encouraged to perform more of the site selection duties, that is, to obtain, at its sole expense, all qualified architectural and engineering services to prepare surveys, site and foundation plans and adapt any plans and specifications for its location and to otherwise construct the store all in accordance with applicable laws, regulations and by-laws and the franchisor's requirements. In this fashion, the franchisee benefits from participating in the site selection and construction process, and are thereby possibly less likely to feel aggrieved should anything go awry.

Finally, a franchisor should clearly state that it has made no representations, guarantees or otherwise as to the costs of development and build-out of the franchised store, the date on which the franchise will be open for business or otherwise, such matters often not being within the franchisor's sole control. The franchisor's review of and/or consent to any plans (or modifications) submitted by the franchisee, its development, construction and/or other activities, and the franchisor's provision of any plans or other assistance, or otherwise, should be solely identified in the franchise agreement as being for the purpose of determining compliance with the franchisor's system standards and the franchisee should be held solely responsible for constructing and operating its franchise in compliance with all applicable legal requirements.

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