To promote the franchise business, both the franchisor and the franchisee, including developers and master franchisees, will need to undertake advertising and promotional activities. Where the franchisor undertakes international, national or regional advertising, the franchisee is typically obliged to pay advertising fees to the franchisor. These fees can either be a flat, weekly, monthly or quarterly fee, or calculated as a percentage of the franchisee’s monthly gross turnover. Alternatively the franchisor may provide the franchisee with advertising and marketing materials for a fee or simply oblige the franchisee to obtain the franchisor’s pre-approval to any advertising and marketing materials that the franchisee produces.
Advertising fees paid by franchisees may be held in a separate advertising fund by the franchisor. This fund can then be used by the franchisor for marketing campaigns with a right for the franchisees to audit the financial statements relating to the fund.
Alternative dispute resolution or ADR is a means of resolving franchise disputes without resorting to court action. The best known method of ADR is mediation but other options include arbitration, expert determination and direct settlement negotiations. The UK courts are very much in favour of ADR and parties will often need to show that they have, at the very least, considered ADR before resorting to court action.
Arbitration is perhaps best thought of as private litigation. The parties to a franchise agreement might agree that in the event of a dispute they will follow the rules of an international arbitration body such as the London Court of International Arbitration or UNCITRAL (the United Nations Commission on International Trade Law). These rules set out procedures very similar to those used by the courts, with exchanges of relevant documents and statements of case in preparation for a trial of the issues in dispute.
Arbitration clauses in franchise agreements are not uncommon, although arbitration can be as time-consuming and expensive as litigation at court. Its most obvious advantage is perhaps that where court proceedings are mostly public, arbitration is usually secret, enabling the franchisor to protect its brand from bad press. In addition, instead of a judge being allocated to the case by the court, the parties to arbitration can often select a decision-maker with specialist experience of their market sector and a legal background.
During the term of the franchise agreement, and for a period thereafter, the franchisor should be contractually permitted to audit the franchisee’s books of account. The main purpose for the audit will be for the franchisor to determine whether it has received the royalties and advertising fees to which it is entitled.
Where any such audit reveals a discrepancy in the fees paid or payable to the franchisor, the franchise agreement should oblige the franchisee to redress the discrepancy and in certain scenarios to cover the franchisor’s audit costs.
This is a set of business systems and procedures that are capable of replication by franchisees. It is these operational elements that define how the franchise business works.
This refers to an option whereby the franchisor has a right to purchase the franchise back from its franchisee. If the option is granted the franchise agreement should set out those scenarios where a buyback is possible – usually where the franchisee wishes to sell its franchise business to a third party or on termination of the franchise agreement – and the terms and conditions that would apply.
Where a franchisor wishes to expand its franchise business into relatively large new territories – which may include new regions within a country, or whole new countries – one option is to appoint a developer (another being to appoint a master franchisee). The developer will be granted the non-exclusive or exclusive right to expand the franchised business within its designated territory usually in accordance with a development or roll-out schedule. Subject to certain terms and conditions the developer will be granted the right to operate individual franchise businesses within the territory. The developer will therefore have two roles:
i. as the developer for the territory; and
ii. as the franchisee for individual outlets, stores and/or franchise business units.
Disclosure within a franchise context is where a franchisor provides information to prospective master franchisees, developers or unit franchisees before a franchise agreement (which here includes a master franchise agreement or a development agreement) is concluded. In a number of countries the provision of certain franchise-related information – prior to the grant of franchise rights – is a legal obligation on the franchisor. Disclosure is not a legal requirement in the UK but it is recommended best practice. It is also recommended by the British Franchise Association.
The typical information that is required to be disclosed includes: details of the franchisor; details of the franchise business; number and location of franchisees; key legal and operational obligations; intellectual property rights that form part of the franchise; and details of any franchise litigation. Disclosure has a different meaning in legal proceedings, where it can refer to the exchange of documents that are relevant to a claim.
Expert determination is a form of alternative dispute resolution. Whilst it might be most appropriate for a franchisor and franchisee to engage in litigation, arbitration or mediation where they do not agree on the facts or law of a dispute, and need an impartial referee to decide who is right , expert determination is often most useful in very technical disputes where specialist knowledge is vital. The expert will be appointed by the parties to evaluate their position, and the issues at stake, and make a final decision on the issue put to him.
An example might be where a franchise agreement contains particularly complex royalty payment provisions and a financial expert is needed to confirm which party has applied them correctly. An expert determination is – like arbitration and mediation – usually private, and will provide a binding decision that might resolve the dispute in its entirety, or might help the franchisor and franchisee narrow the terms of the dispute before it is referred to the courts.
A legal and commercial relationship between a franchisor and a franchisee that allows the franchisee to operate a business, under the franchisor’s established brand and in accordance with the franchisor’s systems, knowhow and business format.
The franchise agreement is the legal document that contractually binds the franchisor and franchisee. It should contain each party’s legal obligations, and is the framework within which the franchisee’s business must operate (although elements of the business format, knowhow and system should be described further in an Operating Manual).
This is the term used to describe a party appointed by the franchisor to run an individual franchise business. Master franchisees will also appoint franchisees. The franchisee’s legal obligations and responsibilities will be set out in the franchise agreement. Another term that may be used to describe a franchisee, particularly in a master franchise structure is a ‘sub-franchisee’ or ‘unit franchisee’.
Essentially franchising is a business model where one party (the franchisor) has developed a successful product or service and allows another party (the franchisee) to operate under its brand name in accordance with its business methods (which includes the business format, knowhow and systems), in exchange for a fee. As a result the franchisee benefits from consumer goodwill towards the franchisor’s brand and product(s) or service(s), and access to the franchisor’s proven methods of doing business.
This is the ultimate owner of the franchised business, including the intellectual property rights and particularly the brand, the knowhow and the system. It is the franchisor who appoints developers, master franchisees, unit franchisees or a combination of these.
This refers to the reputation amongst consumers enjoyed by the franchisor as a result of selling its product(s) or service(s) under its brand. In time a franchisee will also develop local goodwill through the operation of the franchised business.
In a franchise context a franchisor’s intellectual property rights typically include unique trade marks, copyright and patents. Typical examples of intellectual property rights include a business logo protected as a trade mark i.e. the brand, a secret recipe protected by copyright, and/or a unique product protected by a patent.
A franchisor’s knowhow is the franchisor’s knowledge and experience of how to operate its particular business within the industry sector. The knowhow forms a key part of the business format and the system. The franchise agreement should expressly grant franchisees the right to use the franchisor’s knowhow. As knowhow is not intellectual property it does not have the same level of statutory protection as, for example, is enjoyed by copyright or patents. Therefore it is essential that the franchise agreement provides protection for the franchisor’s knowhow, typically by ensuring the franchisee keeps it secret and confidential.
Where a franchisor wishes to expand its franchise business into relatively large new territories – which may include new regions within a country, or whole new countries – one option is to appoint a master franchisee (another is to appoint a developer). The master franchisee will usually be granted the exclusive right to expand the franchised business within its designated territory. Subject to certain terms and conditions the master franchisee will be granted the right to appoint its own franchisees in the territory. The master franchisee effectively becomes the franchisor for its franchisees. Another term which may be used to describe a master franchisee is “subfranchisor”.
Mediation is a form of alternative dispute resolution and is designed to help the parties to a dispute resolve their differences without the cost of time-consuming litigation. Unlike litigation and arbitration, mediation is less a battle of statements prepared by lawyers and more an effort to resolve the dispute by dialogue between the parties. It is relatively informal and, where successful, produces a settlement that is generally not binding until recorded in a settlement agreement.
The parties will try to select a mediator who will either discuss the dispute with both parties together or perform shuttle diplomacy between parties that don’t see eye to eye. The mediator will not make a formal judgment or decision, but will assist the parties in agreeing a voluntary resolution. Even unsuccessful mediation can be beneficial in helping the parties to a franchising dispute identify the real issues and thus save costs in any subsequent litigation.
A misrepresentation is a statement of fact made (in the franchise context usually by the franchisor) prior to the signing of the franchise agreement that induces or partially induces the other party (in this case the franchisee) to enter into the agreement, only for the franchisee to later discover that the statement was not correct at the time it was made. Misrepresentations are often in the form of exaggerations of the estimated success of the franchise, such as unrealistic earnings projections based on assumptions rather than previous data. A franchisee (including developers and master franchisees) that purchased its franchise in reliance on untrue statements may be able to bring a claim against the franchisor for misrepresentation.
The franchisor itself may have built up a portfolio of certain clients or customers for its products or services, which due to the customer’s size, geographical coverage or purchasing power, are accorded special status compared with smaller, less frequent customers. Such customers may be termed ‘National Account clients/customers’. National Account customers may enjoy preferential terms compared to other customers of the franchise business. These preferential terms are often set by the franchisor for franchisees to follow and adhere to. In some franchise businesses, the franchisor may itself provide the services or products direct to National Account customers – even in scenarios where the National Account customers are located in a franchisee’s territory.
The franchisee and principals are taught how to operate the business of the franchisor. It would be unfair (and destructive of franchising) if they could divert business away from their franchisor's business (which pays fees to the franchisor) and so avoid paying fees, also causing the franchise business to be less successful and to pay less fees to the franchisor. Accordingly Franchise Agreements typically prevent the franchisee and the principals from being involved in competing businesses without the franchisor's express consent both during the term of the franchise and for a reasonable period thereafter. The latter restriction enables the franchisor, or a successor franchisee in the local market, to continue the business under the brand, and not to lose to a competitor the goodwill for the brand which has developed in the local market.
The operations manual should contain all the information that is needed by the developer, master franchisee or franchisee to run its business in accordance with the franchisor’s systems, business format and knowhow.
Sometimes, before setting up a full network of franchisees, a franchisor might run one or more outlets in exactly the same way as it proposes the franchises be run. The pilot operation is essentially the franchisor’s learning or testing ground. The franchisor will appoint one or more pilot franchisees who may, for the term of the pilot franchise relationship, be granted more favourable commercial terms as an acknowledgement that the franchisor is still refining the franchise concept and system.
The pilot operation allows the franchisor to develop its operations manual based on the pilot franchisees’ operating experiences. It also enables the franchisor to test its franchise agreement to see which provisions work and which do not. Taking this approach means the franchisor might better understand its franchisee’s businesses, and might lessen the risk of making statements that misrepresent the truth.
Many franchise agreements contain a prohibition on the franchisee from being involved in a business that is similar to, or competes with, the franchisor’s business for a certain period of time after expiry or termination of the franchise agreement, Such a restriction is, on its face, in restraint of trade and therefore void pursuant to Competition Law. However, the courts have held that the franchisor/ franchisee relationship is similar to a vendor/purchaser relationship, rather than a consumer or employee/employer relationship, and therefore a post-termination restriction in a franchise agreement is enforceable provided that it goes no further than is reasonably necessary to protect the franchisor’s legitimate business interests. Such clauses need to be carefully drafted by an experienced professional to ensure their enforceability as what is and is not reasonable will vary from business to business based on a variety of different factors.
Franchisors almost invariably require the right to buy the franchisee's business or company if it is to be sold. This enables a franchisor that wishes to buy back the outlets in its network to do so. In the day-to-day operation of a franchise network, franchisors generally do not exercise this right, preferring to allow the business to be sold on to a new franchisee it has approved.
This term is frequently used in Franchise Agreements to refer to the key individual or individuals responsible for the franchised business where the agreement is signed with a small limited company as the franchisee. The principals are invariably required to guarantee that their company will pay the franchisor the amounts it owes under the agreement. In addition the principal is usually also bound by confidentiality and non-compete restrictions.
A franchisee, or indeed a developer or master franchisee, will be permitted to conduct business in accordance with the franchise agreement only for a specified period of time. It is only granted the use of the franchisor’s brand for that period. Some franchise agreements will contain terms and conditions that dictate what needs to be undertaken by the franchisee and franchisor to allow the franchisee to continue after the original franchise agreement would have expired. These are the terms and conditions for a renewal of the franchise.
As consideration for the grant by the franchisor to the franchisee of the right to use the franchisor’s knowhow, system and brand, and in return for ongoing training and support, the franchisee is obliged to pay the franchisor royalties on an ongoing, usually monthly basis. These royalties are often calculated as a percentage of the franchisee’s monthly gross turnover. Other terms that may be used for royalties are service fees or management fees.
The term used in many franchise agreements to refer to the continuing fees payable to the franchisor, usually monthly, for the right to use the business system and intellectual property rights of the franchisor, including the brand, and to benefit from the services and support the franchisor provides to its franchisees generally. Such continuing fees are sometimes alternatively described as royalties.
A franchisor may decide that it wishes to invest in its operations in new territories. It may therefore look to set up a new company with the developer, master franchisee or unit franchisee in that territory. The parties will enter into a subordinated equity agreement that will govern how the new company is to operate. The new company – which will be partly funded by the franchisor – will then be granted either master franchise rights (via a master franchise agreement), development rights (via a development agreement) or unit franchise rights (via a franchise agreement) by the franchisor.
The system represents the franchisor’s methods for conducting the franchised business. The system encompasses the franchisor’s knowhow and the business format. The operational elements of the system should be set out in the operations manual.
The term of a franchise agreement, or a master franchise or development agreement, is the period of time, usually a specific number of years, for which the franchisee can operate the franchise business. If the franchisee wishes to continue after the term expires, a renewal of the franchise agreement will be needed.
Termination describes the scenario where the franchise agreement, and therefore the relationship between a franchisor and its franchisee, comes to an end. Termination may arise in a number of scenarios including: (i) where the franchise agreement has reached the end of its contractual term (also referred to as expiration); (ii) in scenarios where the parties mutually agree to end it early; or (iii) in circumstances where one party has broken its contractual obligations in a way that allows the other party to end the franchise agreement. It is recommended that the grounds for termination, including any opportunity to remedy, are expressly detailed in the franchise agreement.
The specific geographical area, whether a city, region or country, within which the franchisee is granted the right to operate. Often, but not always, a franchisee will be given exclusive rights to a territory, meaning no other franchisee of the business will operate there in competition.