What is a Franchise Agreement?

 

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What is a Franchise Agreement?

 

A franchise agreement is an agreement between the franchisor and the franchisee which grants the franchisee the right to operate the franchise business and sets out the commercial terms agreed by the parties. 

If you are buying a franchise business you will need to enter into a franchise agreement.

Franchise agreements are regulated in Australia by the Franchising Code of Coduct (the Franchising Code).

 

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What is a Franchise Agreement under the Franchising Code?

 

The Franchising Code uses 4 criteria to determine whether an agreement is a franchise agreement.

Even if an agreement is called a licence agreement or a sub-contractor agreement, if the agreement meets the 4 criteria it will be deemed to be a franchise agreement and the obligations set out in the Franchising Code will apply.

 

1 - there is an agreement between the parties.

An agreement between the parties does not need to be in writing. The agreement can be verbal or it can be implied.

 

2 - a right has been granted to operate a business of offering, supplying or distributing goods in Australia under a system or marketing plan which must be followed.

It is likely that there is a system or marketing plan if some or all of the following apply

  • there are suggestions for retail prices to be charged for products or services;
  • there are products that must be produced;
  • there are recipes that must be followed;
  • there are specific methods for providing services;
  • there is a detailed advertising programme;
  • there are restrictions on the sale of products.

 

3 - the operation of the business will be substantially or materially associated with a trade mark, advertising or commercial symbol owned or specified by the franchisor.

One of the main rights that a franchisee is given by the franchisor is the right to use the franchisor's brand, name and logo.

 

4 - amounts have been or will be paid to the franchisor or an associate of the franchisor under the agreement.

Payments include royalty payments, up front licence fees, advertising payments, commissions and training fees.

 

Licensing v Franchising-1

 

 

What terms are standard in a Franchise Agreement?

 

Some of the main terms that are commonly found in a franchise agreement include:

 

 

Rights granted to the Franchisee

Under a franchise agreement, the franchisee is normally granted the right (licence) to use the franchisor's:

The licence is typically limited to a territory or site and may be exclusive or non-exclusive within that territory or site.

If the licence is non-exclusive, the franchisor may operate or grant franchises to other franchisees to operate in the territory.

If the licence is exclusive, the franchisor will not operate or grant franchises to other franchisees to operate in the territory. However, the franchisor is likely to reserve rights, for example the right to sell goods and services online.

 

Franchisor's Obligations

The franchise agreement will set out what is required by the franchisor, for example

  • what training is to be provided,
  • what advertising and promotion is to be undertaken,
  • what support is to be given.

 

Franchisee's Obligations

The franchise agreement will also set out what is required by the franchisee, for example

  • the services to be provided,
  • the methods to be used,
  • the manuals to be followed,
  • the standards to be maintained, and
  • the way that the business is to be promoted.

The franchise agreement should be read together with the operations manual. The operations manual usually sets out the detail involved in operating the franchise business.

Most franchise agreements provide that the franchisee must comply with the operations manual. If the franchisee does not comply with the operations manual that will be considered a breach of the franchise agreement.

 

Payment Provisions

The payment provisions in a franchise agreement include initial and ongoing fees, such as

  • the initial franchise fee,
  • the initial training fee,
  • fixed lead fee,
  • licence fee royalties,
  • POS or software fees, and
  • advertising contributions.

The initial franchise fee and the initial training fee are usually payble on the signing of the franchise agreement. The amount of the initial fee will vary considerably depending on the type of franchise being offered.

Royalties are ongoing fees paid by the franchisee to the franchisor for the use of the brand and intellectual property. Royalties vary but are generally between 4% and 6% of gross turnover for retail franchises and 6% and 10% of gross turnover for service franchises. A royalty can also be a fixed fee.

Advertising fees are ongoing fees paid by the franchisee to the franchisor for group advertising and related expenses. Advertising contributions vary but are generally between 2% and 4% of gross turnover. An advertising contribution can also be a fixed fee.

Advertising fees must be paid into a separate marketing fund.

 

Term and Termination

A franchise agreement will set out:

  • how long the franchise relationship will last (the term),
  • how it will come to an end,
  • whether the franchise agreement can be renewed by the franchisee, and
  • what happens on termination.

If the franchise agreement includes an option to renew or extend, it will also set out the time frames in which a franchisee must advise the franchisor that the franchisee wishes to renew the franchise agreement.

The franchise agreement may contain obligations which the franchisee must comply with in order the renew the franchise agreement, including an obligation to pay a renewal fee.

 

Site

If the franchise business is to be operated from a site, the franchise agreement will contain terms applicable to the site or premises.

The franchisor will generally have to approve the location of the site, although the franchisor will not necessarily choose the site itself.

The franchisor may enter into the lease itself and then licence the franchisee to use the premises, or the franchisee may enter into the lease directly with the landlord. If the franchisee enters into the lease directly with the landlord, the franchisor will generally require the lease to contain provisions which allow the franchisor to "step-in" to the lease.

The look of the site will need to be consistent with the franchisor's brand image and the franchise agreement will contain terms about the construction or fit-out of the site. 

 

Restrictions

The restrictions contained in a franchise agreement include things such as

  • restrictions with suppliers,
  • prohibitions against operating a competing business, and
  • restrictions on the recruitment of employees after termination.

The franchise agreement will generally require the franchisee to buy all of their products and services from the franchisor or from a supplier nominated by the franchisor.

The franchisor may receive a rebate for the purchase of goods or services from a nominated supplier. Rebates are disclosed in the disclosure document, although they are not necessarily shared with franchisees.

If a franchisee wishes to purchase products or services from alternate suppliers, the franchisor will generally need to approve the alternate supplier and the franchise agreement will set out the approval process.

 

Resale Rights

The franchise agreement will set out the method by which a franchisee may sell the franchise business. Some franchise systems allow their franchisees to sell the franchise business, while other franchise systems write in buy back or right of first refusal clauses.

If the franchisee sells the franchise business to a third party it is likely that the franchisee will have to obtain the consent of the franchisor and will have to pay a transfer fee to the franchisor.

While the franchisor cannot unreasonably withhold consent to the transfer of a franchise agreement, the franchisor may withhold consent in the circumstances set out in clause 25 of the Franchising Code of Conduct, including if the transferee does not meet the selection criteria of the franchisor.

 

Disclaimer

The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.

 

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