Franchises should be mutually beneficial for franchisors and franchisees. The operative word is should because, without the right agreement in place, there is potential risk for both sides. The best way to ensure mutual success is with a professionally-crafted franchise agreement.
It is important to understand what a franchise agreement is, how to minimise risks when buying or selling a franchise, and to be aware of different types of franchise agreement provisions. Some general information about these matters is set out below.
What is a Franchising Agreement
A franchise is a particular type of business arrangement whereby the franchisor sells the rights to an existing business model (including its product/service and branding) to a franchisee. A franchise agreement outlines the rights and obligations of each party, the terms of the business arrangement (including the right to terminate the relationship) and the structure of the franchise.
With each franchise being unique, a franchise agreement is necessary (and legally required under the Franchising Code of Conduct) in order to clarify the nature of the relationship between franchisee and franchisor. This is generally included in the franchise disclosure document, in which the franchisor outlines elements like franchise costs and the details of other franchisees.
What is a Franchisor Disclosure Document and Key Facts Sheet?
As specified by the ACCC, Franchisors must provide a disclosure document prior to a Franchisee signing or renewing a franchise agreement. The franchise disclosure document is required to stipulate key elements of the proposed franchise agreement, such as details of the franchise’s directors, financial obligations of the franchisee (such as start-up costs and ongoing fees) and details of the length of the agreement and terms of contract termination.
The Franchisor must also provide a Key Facts Sheet which is a summary of the disclosure document information. The Key Facts Sheet is prepared by the franchisor and contains information regarding its financial history, legal disputes and anticipated costs to operate the franchise.
What is the Franchising Code of Conduct?
The Franchising Code of Conduct is a mandatory code that regulates franchisors and franchisees. The code outlines the rights and obligations of the parties and requires all business dealings to be conducted in good faith. The code does not specify how a franchise agreement should be structured which makes seeking legal advice an essential step before signing any agreement.
As of 2021, significant amendments have been made to the Franchising Code of Conduct. One major addition is the creation of the Franchise Disclosure Register, which requires franchisors to upload disclosure information to the register which can be viewed by the public.
How do Franchise Agreements Work?
Franchise agreements set out the terms and conditions of franchise relationships. Though this will generally be a written contract, the ACCC states that such agreements may also be ‘oral or implied’.
Essentially, franchise agreements work by one party (the franchisor) granting another party (the franchisee) the right to operate a business under certain conditions and typically using the franchisor’s branding and intellectual property. Because franchises are not like standard business sales, the franchisor retains certain rights, while the franchisee is subject to specific conditions when operating the franchise. The purpose of the franchise agreement is to specify and agree on these rights and conditions. Because of the complexity and potential risk involved, it is always advisable to seek professional legal advice when considering franchise agreements.
What Are Some Of The Main Franchise Agreement Provisions?
Franchisees should carefully consider the stated provisions of a franchise agreement, as these can ultimately determine the balance of risk and reward. Provisions include:
- Fees: Franchisees are generally required to pay an initial fee in purchasing the rights to operate the franchise, as well as any set-up costs.
- Royalties: Royalties are regular (generally monthly) payments from the franchisee to the franchisor. These are often a fixed percentage of revenue and cover elements like support, training and the ongoing use of intellectual property.
- Territory: Franchise agreements will often specify the territory within which a franchisee may operate, as well as the specific location of the franchise. It can also state whether the franchisee is granted exclusive rights to a territory.
- Restraints: A restraint of trade clause is usually included in agreements to prevent the franchisee from competing with the franchisor if the franchise agreement is terminated.
Franchise Due Diligence Prior to Entry Into a Franchise Agreement
It is important for a potential franchisee to understand the risks associated with entering into a franchise agreement and for due diligence to be conducted and specialist advice obtained.
Risks involved can include the level of market competition, the sustainability of the business model and the cost of initial investment. Other risks might be the financial stability of the franchisor, territory restrictions, restraint of trade clauses and regulatory compliance obligations.
Dealing with Franchise Disputes
Disputes happen. They can be caused by any number of issues, including franchisee performance, disagreement over fees and royalties, misconduct, or one party making false representations in the initial agreement.
There are many avenues to consider before legal proceedings if a franchisee and franchisor have a dispute. Dispute resolution provisions are often included in franchise agreements, while the Franchise Code of Conduct sets out its own process. The code states that both parties must act in good faith and work towards an agreeable outcome.
If a satisfactory outcome cannot be achieved, parties may elect to take their dispute to arbitration, mediation or Court.
Seek Legal Advice on Starting a Franchise
Whether you’re looking to purchase a franchise or sell franchise rights to a business, it is important to understand potential risks. The team at McMahon Fearnley act for franchisors and franchisees and have the experience and expertise to assist with all elements of the franchising process, including due diligence, preparing franchise agreements, reviewing franchise agreements, and franchise litigation and dispute resolution.
To learn more about how McMahon Fearnley can assist with your franchise requirements, get in touch today.