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What is a Franchise Agreement?
A Franchise Agreement is a contract whereby a franchisee buys the right to run the business of the franchisor at a designated location/market. It is legally binding and details the expectation of the franchisors from the franchisee.
The Franchise Agreement delineates the respective rights and obligations of the franchisor and franchisee in the franchise arrangement.
Under a Franchise Agreement, the franchisor’s obligations would be training and providing assistance, while those of the franchisee will be focused on the operation of the business e.g., the use of intellectual property rights.
Some examples and popular names of businesses that use franchise agreements are:
- Fast food and chain restaurants such as KFC, Starbucks, Mcdonald’s, and Pizza hut.
- Convenience stores such as 7-Eleven, Walmart, and Target.
- Travel and hospitality chains like Marriot International, Hilton Hotels, and resorts.
- Freight Service Providers like UPS, and DHL.
Why is a Franchise Agreement important?
A Franchise Agreement is an instrument for getting legal approval of doing business on the basis of the franchisor’s business model by using the franchisor’s brand name and goodwill. This is a very popular business model because it has already been tested and running successfully so there is a minimum risk while operating such kind of business if done correctly. It helps both franchisor and franchisee to protect their legal right.
While drafting this agreement, all the things related to payment, renewal, training & management, and transfer of ownership has already been discussed and written down in the agreement which will help both parties to settle down the disputes if arise in the future. While the agreement is mainly designed to protect the intellectual property (IP) of the franchisor, it is equally important to ensure consistency in the brand when it comes to operation by the licensees.
How does a Franchise Agreement work?
A Franchise Agreement works out if there is mutual understanding between the franchisor and franchisee throughout the business. Some of the important things to include in the agreement are:
Terms and conditions of the agreement: this includes the basic terms and conditions on which both franchisor and franchisee have agreed to do the business. This includes specified locations with exclusivity rights, advertising commitments, conditions for renewal, termination policies arbitration clauses, insurance, and indemnification clauses.
Duration of the franchise agreement: the duration or time frame of the franchise has been written down on the agreement, this also includes the process or possibility of extending the duration.
Training and support: while starting a franchise business one of the main concerns for the franchisee is training and support from the franchisor. A franchisor is responsible for providing all the training and support while starting the business as it helps to develop a proper system for the business.
Use of goodwill and brand name: This includes the use of the franchisee’s intellectual property rights, trademarks, and goodwill. It will specify how it can be used. A franchisee will also be required to maintain records and provide regular reports of the financial and operational activities. The franchisor also holds the right to request more information such as tax returns in order to audit the franchisee’s records. The franchisor reserves the right to inspect the physical premises to ensure that the facility is well maintained. They can additionally request renovations as required.
Fees and payment: There is an initial fee and a continuing royalty or fees and payments a franchisee must agree to pay a franchisor. The recurring payment is usually on a percentage basis of the total sales.
A Franchise Agreement details the franchisee/franchisor relationship, including detailed information such as proprietary statements. It also covers site maintenance and upgrades requirements.
What are the three types of franchise agreements?
There are three types of franchise agreements:
Master Franchise Agreement: This agreement grants a master franchisee who is also known as a sub franchisor the ability to approve franchises to others dealers in a specific geographical location.
Area Development Agreement: Also called an “area director agreement” or “area franchise agreement,” this agreement grants the sub franchisor similar rights and capacity, but with comparatively less responsibility and rewards.
The representative, here usually does not hold the power to grant or sign franchise agreements. Still, they have the right to help with the marketing process of the franchise and provide assistance to franchisees on the franchisor’s behalf, within a particular area.
Area Representative: This is an option agreement where one agrees to open and operate a certain number of franchised businesses in a specific area. A separate fee has to be paid to obtain exclusive rights to create more units in the area.
Issues with Franchise Agreement
Franchising allows a brand to consistently grow by having a sustainable replication of a brand’s image. However, an agreement for the same is quite complex to prepare. Franchises while being in line with a company’s brand guidelines should have uniqueness too but there is a very thin line of balance for this and so, the lines between consistent branding and expressing uniqueness can get quite blurry. Legally speaking, this can be a huge dealbreaker. For example, Mcdonald’s has a huge global franchise spread across continents and each stands out as the McDonalds-fast-food brand itself. However, the menu of the fast-food chain varies greatly according to the location in order to fit in with the local taste.
A Franchise Agreement needs to be flexible enough to cater to this kind of uniqueness but at the same time should have the values of the brand as its core. This must be one of the biggest issues while drafting a Franchise Agreement.
Can a Franchisor negotiate a franchise agreement?
Most franchise agreements are in favor of the franchisor. However, franchisees can try to negotiate a few changes to make it more favorable for them if the agreement has not yet been signed. Even in such cases, a franchisor does not have to agree to the changes if they do not want to. In case the agreement has already been signed, the franchisee can be held to follow the terms.
Can a Franchisor terminate a franchise agreement?
Normally when a franchisor finds a breach of contract, they have to inform franchisees and provide them a reasonable time to sort things out. If things were not sorted out properly according to the terms and conditions mentioned in the agreement then a franchisor can terminate a franchise agreement.
A Franchise Agreement is well detailed and quite elaborate as well as lengthy. A successful franchise business requires a well-drafted franchise agreement and effort from both franchisor and franchisee. While a franchisor is responsible for establishing business systems, providing the use of trademark, providing training and support on the other hand a franchisee should pay franchise fees and manage the franchise location.
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