Need a Franchise Attorney? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com

or ray@mckenzie-legal.com

The practice of franchise law is a niche area when it comes to the representation of franchisors.  Franchise attorneys draft complicated, tedious Franchise Disclosure Documents that must comply with the Federal Trade Commission Revised Rule as well as certain state disclosure law.  It is the Federal Disclosure Document (“FDD”), which includes the franchise agreement that will eventually be executed by the franchisor and franchisee, that is disseminated by franchisors to prospective franchisees for review prior to the offer of sale of a franchised business in this country.  It is the drafting and filing of the FDD in franchise registration states across the country that relies upon the expertise of a franchise attorney.

There is no reason, however, for a competent business attorney familiar with basic contract law to feel overwhelmed at the idea of reviewing a franchise agreement and advising a prospective franchisee.  You will hear many business owners say they have reviewed a franchise agreement and feel like they have a “pretty good idea” about what is contained there.  However, attorneys have spent a lifetime being taught that the difference between having a “pretty good idea” and being absolutely, legally, sure, can be quite costly.  It is therefore up to the attorney to advise the client as to exactly what the franchise agreement states, which will allow the client to make a fully informed decision using the legal expertise you provide.  With that in mind, here are ten tips for the non-franchise attorney to keep in mind when reviewing a franchise agreement.

• Term. The term of a franchise agreement varies, as it depends almost entirely on a business judgment made by the franchisor when drafting the FDD and franchise agreement.  Some franchisors prefer shorter terms, so that franchisees are asked to execute new franchise agreements every few years.  Other franchisors prefer the stability of having their franchisees committed to longer franchise agreements, without having to undertake the risk that a franchisee will prefer to leave the franchise system rather than re-up with the franchisor.  Franchisees’ preference as to the length of a franchise agreement varies as well, with some franchisees preferring to enter into a short-term agreement in case the business does poorly or the franchisee is simply not sure that the business is one that he wants to be involved in long term.  Just as many franchisees, however, especially where a large capital investment is required, prefer the security and predictability of a longer term, which allows the franchisee to focus on growing the business without the underlying concern of franchise agreement renewal and expiration issues.  Bearing in mind the client’s stated business objectives and the franchise’s possible pitfalls, it is up to the attorney to advise the client as to what length of term best suits the client’s goals and needs, and negotiating such term into the franchise agreement.

• Fees. Many franchise agreements require the payment of an initial franchise fee.  This fee is an up-front fee due at the time the prospect purchases the franchise.  Some franchisors will offer to finance this fee over a period of time, while others require the lump sum payment to be made without making any financing available.  In addition to an initial franchise fee, franchisors usually require in the franchise agreement that the franchisee pay ongoing royalty and advertising fees to the franchisor during the term of the agreement.   Royalty and advertising fees are usually paid monthly, and can be a percentage of the business’s gross revenue, a flat fee, or a combination of the two.  One of the issues to watch for with regard to ongoing fees is whether the franchisor requires the franchisee to pay a minimum royalty fee either monthly or annually, without regard to the amount of actual revenue the franchisee generates.  Think of it as an alternative minimum tax for franchisees.  At the end of a month or year, a franchisee may have to write the franchisor a check to cover the minimum franchise fee if the royalty fee paid by the franchisee, based on a percentage of the franchisee’s revenue, fell short of the minimum royalty fee called for in the franchise agreement.  This is unquestionably an issue that an attorney must make sure to bring to the attention of a franchisee prior to executing a franchise agreement.

• Renewals/Subsequent Agreements. Pay careful attention to the language regarding renewals and subsequent agreements. The term “renewal” is a misnomer, since technically most franchisors do not allow the franchisee to simply renew the existing agreement as-is.    Rather, most franchisors grant existing franchisees the opportunity to enter into a “then-current” franchise agreement, provided the franchisee is in good standing.  The “then-current” agreement will naturally contain terms differing, in some respects materially, from the previous agreement offered by the franchisor.  This is the franchisor’s way of making sure that it does not get stuck with a stale agreement, whether it be in the fee structure or numerous other areas that the franchisor may wish to change over time.  Some items to pay specific attention to when reviewing subsequent agreements include: whether a renewal fee is called for; whether the right to execute subsequent agreements goes on indefinitely, or instead if only a set number of renewals are allowed; whether the agreement calls for execution of the franchisor’s then-current franchise agreement, which may include terms materially different from the existing agreement; whether there is a cap on how much the franchisor can raise fees in subsequent agreements; what is the term of the subsequent agreement; and, what, if any, improvements, changes, renovations, and upgrades are required of the franchisee prior to a subsequent agreement being offered by the franchisor.

Check back for more tips in Part 2 of this series.

Need a Franchise Attorney? Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com