In late 2017, restaurant giant McDonald’s cancelled the franchising of 169 restaurants in north and east India. The reason given was that the franchisee, Connaught Plaza Restaurants Ltd (CPRL), had defaulted on its royalty payments and breached other obligations under the franchise agreement with McDonald’s.
The termination marked the end of a 25-year relationship and resulted in CPRL being given 15 days to stop using the McDonald’s management system and intellectual property (IP), which included its trademarks, designs, branding, operational and marketing practices, as well as its food recipes and ingredient specifications.
The termination triggered legal proceedings, appeals and a mountain of costs for both sides. The fact that the world’s most successful franchise can wind up in a costly dispute illustrates the practical business advantage of having a precisely drafted franchise agreement. As a document designed to protect both parties, the franchise agreement provides the foundation on which the franchise partnership is based.
The contents of a franchise agreement
A properly drafted franchise agreement is designed to be an all-encompassing document. It outlines the legal rights and obligations of the franchisor and franchisee and generally includes provisions for the following:
1. The rights being granted to the franchisor, such as:
a. step-in rights (i.e. rights that allow the franchisor to take over the franchisee’s business if performance is poor);
b. the franchisor’s right to grant other franchises;
c. the franchisor’s retention of the ownership rights in its IP; and
d. pre-emption rights if a franchisee wants to sell the business, which would give the franchisor a first right of refusal before other potential buyers.
2. The rights being granted to the franchisee, such as:
a. the licence to use the franchisor’s IP, but only for the purpose of operating the franchised business;
b. receiving training from the franchisor on its systems and processes;
c. the ability to sell the franchised business;
d. a possible right of renewal at the end of the initial franchise term.
3. Identification of the franchisor’s intellectual property rights (e.g. a schedule of trademarks, key recipes etc) which are being licensed to the franchisee. It is advisable for the franchisor to have its trademarks registered in each jurisdiction in which it operates.
4. The goods and/or services to be provided to the franchisee by the franchisor, g. a copy of the operational manual, training, marketing materials etc.;
5. Franchisor’s obligations, such as:
a. guidance on site acquisitions, design layouts, etc. for the business premises;
b. initial and ongoing training of staff and managers;
c. marketing support, and whether there is a collective marketing scheme for members of the franchise;
6. Franchisee’s obligations, such as:
a. Financial reporting to the franchisor;
b. Compliance with the franchisor’s management system and operational manual;
c. Restrictive covenants – for example, the franchisee not being allowed to run a competing business
7. Franchise fees:
a. Initial franchise premium payable by the franchisee;
b. Ongoing royalty fees for using the franchised brand;
c. Marketing and advertising fees;
d. Franchise transfer fees – the fee payable to the franchisor if the franchised business is sold;
8. Franchisor’s supply and the franchisee’s pricing of goods or services:
a. Franchisor’s supply: Franchisors like to ensure that the quality of the goods/services is universal across their franchise network. As such, they often require franchisees to purchase goods/stock from approved suppliers or the franchisor itself (i.e. where the franchisor controls the supply chain);
b. Franchisee’s pricing to customers: The pricing offered by a franchisee is usually based on guidelines set by the franchisor. It’s worth noting that UK and EU competition laws prohibit franchisors from fixing the pricing of goods and services, but the franchisor is allowed to provide a range of minimum and maximum prices;
9. Termination provisions for the franchise agreement between the two parties, for example, for non-payment of fees, insolvency, non-compliance with the franchisor’s system, etc.;
10. Exclusivity clause – the franchisee will often want assurance that no competing franchisees can set up in their defined territory;
11. Dispute resolution provisions; and
12. Sales targets and development plans for the franchised business.
Negotiating the franchise agreement
After conducting thorough due diligence, a prospective franchisee should not be afraid to negotiate certain terms. However, if a franchisor is overly willing to capitulate on key matters such as sales targets, marketing, training, systems and the like, alarm bells should sound. Excessive concessions to individual franchisees may indicate the franchisor may not be confident in its own brand and management systems.
It is important to note that the franchise agreement presented to a prospective franchisee will usually be the same as that given to other franchisees. Therefore, although it is unlikely that a franchisor will budge on terms related to the consistency of the franchise operation, there is room to negotiate on some things that could make a real difference to the franchisee. For example, a prospective franchisee could ask for additional support such as training and guidance following the opening of the business, extended payment terms regarding the initial franchise fee, and/or a right of first refusal if a franchise in a territory nearby comes up for sale.
A key factor in ensuring that a franchise agreement works for all parties is for each party to seek independent legal advice to ensure the short and long-term ramifications are understood. Whether you are a franchisor or franchisee, once you are legally bound by a franchise agreement, it is usually too late to have a change of heart.
“To open a shop is easy, to keep it open is an art”.
– Chinese Proverb
Please note that this article does not constitute legal advice, but as some initial information for those interested in the franchising process. Saracens Solicitors is a multi-service law firm based opposite Marble Arch on the North side of Hyde Park in London. For further information on any of the points in this article, please call our office on 020 3588 3500.