A franchise agreement is the contract you have to sign when you buy a franchise. It sets out the period of the franchise; the obligations that franchisor and franchisee have to each other; and conditions that allow you to grow the franchise.
Even though a franchise agreement is perfectly legal, it may not be ethical.
A franchise agreement will tend to be more readily accepted in many jurisdictions (particularly within the European Union) if it satisfies, among others, any code of ethics that may be applicable, such as, for example, the European Code of Ethics for Franchising.
A franchise agreement should achieve three fundamental objectives:
- It should contractually bind the franchisor and franchisee, and accurately reflect the terms agreed upon.
- It should seek to protect, for the benefit of both of the franchisor and the franchisee, the franchisor’s intellectual property.
- It should clearly set out the rules that the parties are expected to observe.
In the absence of any specific legislation or regulation of franchising in any particular jurisdiction, the franchise agreement becomes important in determining the rights and obligations of the franchisor and of the franchisee, and the relationship between them.
In this respect the franchise agreement can be said to constitute the ‘engine room’ of the whole transaction. If difficulties should arise between franchisor and franchisee, they will need to turn to the contract to see what, if any, rights and obligations have been provided in the franchise agreement. This is particularly the case in common law jurisdictions.
What then should one look for in a franchise agreement?
A franchisee will look for promises from a franchisor to:
- train the franchisee and its staff;
- supply goods and/or services;
- be responsible for promoting the brand;
- assist, where appropriate, the franchisee to locate and acquire premises, and have them fitted out and converted into a franchised outlet (similar considerations apply with regard to the acquisition of vehicles, fitting them out, equipping them, etc);
- assist the franchisee to set up the business;
- improve, enhance and develop the franchisor’s business system; and
- provide ongoing support.
A franchisor will wish to:
- monitor the performance of the franchisee;
- protect itself and its franchisees from unfair competition;
- protect its intellectual property;
- and impose obligations and restrictions on the franchisee with regard to the use by the franchisee of its business system.
Unless the franchise agreement contains sufficient safeguards to protect the franchisor’s intellectual property rights, the franchisor may find that it is unable to prevent infringement of its rights by a third party or an ex-franchisee.
If the contract is weak on this point, franchisees should not consider that particular franchise to be a sound investment proposition. The franchisor will be limited in what it can do to prevent a copycat operation from being set up in direct unfair competition with a franchisee.
All franchisees should be treated as a family and, as such, there should be no room for favourites. Franchise agreements come in a standard form and best practice requires that all prospective franchisees are offered the same terms, with no special deals being done.
The franchise agreement should therefore clearly:
- specify in detail the duties and obligations both of the franchisor and of the franchisee;
- deal with the payment of franchise fees and the timing of those payments; and
- state the grounds upon which the franchisor will seek to terminate the franchise agreement.
For the franchisor, the franchise agreement is an income producing asset that will ultimately have a place in its balance sheet. If the franchise contract is defective, it can potentially cost the franchisor its whole network.
Although it may be tempting for both franchisor and franchisee to rely on goodwill, ultimately it is only the contract that matters. Whatever the size or reputation of the franchisor, prospective franchisees should always expect a high-quality franchise agreement, to preclude any policy changes within the franchisor company that would adversely affect them.
A franchise agreement is a double-edged sword, and once it has been signed both parties are bound by it – so check it thoroughly.