Questions

Every franchisee, before purchasing a franchise, receives from the franchisor a Federal Disclosure Document (“FDD”), which includes the franchise agreement that will eventually be executed by the franchisor and franchisee. This article contains five questions every franchisee should ask when reviewing a franchise agreement.

1. Minimum Royalty Fees. Does the franchise agreement require the payment by the franchisee of minimum monthly or yearly royalty fees, regardless of the amount of actual revenue the franchisee generates? 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 fell short of the minimum royalty fee called for in the franchise agreement. This is certainly a fact that all franchisees must be aware of prior to execution of the franchise agreement.
2. Termination by Franchisee. Does the franchise agreement allow the franchisee to terminate the agreement without cause, or upon a material breach of the agreement by the franchisor? A franchisee’s right to terminate the franchise agreement is arguably the most important right granted to a franchisee, since a franchisee may be able to terminate an agreement if its business gets into financial trouble or if the franchisor fails to comply with its obligations under the franchise agreement. The right to terminate will also permit a distressed franchisee to avoid the fees and other obligations owed to the franchisor before disaster strikes.
3. Post-Termination Non-Competition Covenant. Does the franchise agreement contain a post-termination covenant not-to-compete, and if so, is it reasonable? A post-termination covenant not-to-compete is the franchisor’s attempt to prohibit a franchisee from competing with the franchisor during the period immediately following termination or expiration of the franchise agreement. Courts across the country have held that in order to be enforceable, a non-competition covenant must be reasonable in scope and duration. In other words, a non-compete that prohibits competition for 10 years, or across the entire United States, will most likely be held unreasonable and therefore unenforceable. A franchisee must pay careful attention to the language of a non-compete prior to signing.
4. Dispute Resolution. Carefully review the franchise agreement to determine exactly how and where disputes with the franchisor must be resolved. With regard to how, some franchise agreements call for arbitration, others litigation, and some a mix of both procedures. With regard to where, most franchise agreements call for dispute resolution in the home jurisdiction of the franchisor. Some but not all state laws allow the franchisee to sue or arbitrate in its home state, regardless of what the franchise agreement says. Because of the added expense a franchisee must bear in the event of a dispute being held in a place other than the franchisee’s home state, a franchisee whose state does not add such a protection must be aware of this fact and possibly add language allowing the franchisee to sue or arbitrate in its home state.
5. Territory. Some franchise agreements grant a franchisee an “exclusive” territory. This means that the franchisee is protected from competition from other franchisees and the franchisor as well inside this exclusive territory. Most franchisees view a protected territory as a must, believing that such market protection will allow the franchisee’s business to flourish. With that in mind, read the “Territory” section carefully in order to determine exactly what is being granted. Can the franchisor compete with the franchisee in the territory? Are there development or sales quotas that must be met in order to retain exclusive territory status? Can supermarkets or other wholesalers compete with the franchisee? These and other questions must be answered to gain a complete understanding of the issue.

Interested in Learning More? Have  Questions?

Contact Raymond McKenzie at 301-330-6790 or ray@mckenzie-legal.com