The Power Dynamic Between Two Parties: Everything You Ever Wanted to Know About Franchise Agreements

Individuals looking to purchase a branch of an existing business might find they must sign a franchise agreement. This binding contract outlines the terms and conditions for the franchise as dictated by the franchisor. Each franchise must adhere to all terms and conditions or risk losing its license. The power dynamic between the two parties differs from that seen with most contracting relationships, and the franchisee must understand this. This agreement governs every aspect of the franchisee’s business and the role of the franchisor.

The franchisee has little room, if any, for negotiation, which is why they must understand the components of the contract before signing any documents. This helps in preventing the parties from becoming involved in a lawsuit over a failure of either party to live up to these terms and conditions. However, individuals must know what a franchise is, the terms of a standard franchise agreement, and any requirements before signing the agreement. This helps to ensure there is no question the franchisee is making the right choice.

What Constitutes a Franchise Agreement?

Individuals must understand what makes up a franchise agreement to ensure the document they are signing legally qualifies as this type of contract. The Federal Trade Commission (FTC) has established a definition of a franchise, referred to as the FTC Franchise Rule, to clear up any confusion about which businesses fall into the category. According to this rule, a business must meet three general requirements to be considered an official franchise.

A franchisor brand and franchisee’s business must be substantially associated and share a common brand. The franchisor maintains control over how franchisees use its brand in business operations or provides meaningful help in this area.
Each franchisee remains an independent contractor rather than a joint employer. As a result, the franchisor controls brand standards but doesn’t receive say in the franchisee’s human resources or daily business operations. As long as they adhere to the brand standards requirements, these areas fall under the control of the franchisee.

The franchisee pays a fee for the right to operate a franchise under the franchisor’s trademark. This fee may be a one-time payment when the relationship is established or an ongoing fee, although there are certain exemptions both parties must know of.

States may also establish laws regarding the definition of a franchise. The agreement serves as a license that dictates the rights and obligations of each party and protects the intellectual property of the franchisor. Furthermore, it ensures consistency among the franchises. However, the agreement allows for some flexibility to ensure the franchisor can adapt to changing times and remain competitive. Nevertheless, the agreement allows each franchisee to manage its independently owned business daily while adhering to the brand standards. This remains a key component of a franchise agreement.

Standard Franchise Agreement Terms

Franchisees agree to adhere to certain requirements and regulations in exchange for benefiting from a provider business model. The franchise agreement outlines each provision the franchisee agrees to, and a thorough understanding of the provisions ensures a smooth partnership between the franchisee and franchisor. What are some things a person might expect to see in a franchise agreement?

Grant

When a person or entity enters a franchise agreement, they receive limited use of the brand’s trademark images. This includes slogans, logos, images, and more. Furthermore, the franchisee receives the right to use the franchisor’s operating procedures as outlined in the agreement. This permission is referred to as a grant but does not allow the franchisee to use these items freely. The agreement must clearly state any expectations and limitations. For instance, a tire company operating as a franchisee may be given permission to advertise on social networks using the brand logo and images, but cannot create custom hats and sell them to advertise their specific location.

Fees

When the two parties enter a franchise agreement, the franchisee typically pays an initial fee. A continuing fee is then remitted on a predetermined schedule to maintain the agreement. In addition, the agreement often includes multiple side fees. For instance, each franchisee contributes to an advertising or brand fund the franchisor uses for brand marketing purposes and other purposes defined in the contract. Potential franchisees need to review this information carefully to ensure they understand what they are responsible for when it comes to additional fees.

Territory

If the franchisee will open a brick-and-mortar location, they need to know their territory within a specified geographical area. Multiple locations of the same franchise in proximity to one another could hurt the revenue for each location. The franchisor should prevent this by clearly defining territory limits for each franchisee. Some franchise agreements lack this information, as the franchise agreement contains no information concerning exclusive or protected territories. However, the territory specifics need to be defined. Furthermore, franchisors must deal with the reservation of their rights inside each franchisee’s territory. This includes internet sales and alternative distribution sites.

Signage plays a role in territory rights. For example, certain restaurants today have a location inside a shopping mall and another in the parking lot. They cater to different clientele, as the location inside the mall hopes to lure hungry shoppers. The exterior location hopes to attract those driving by and individuals who wish to pick up food without leaving their car. The franchise agreement should outline where each location can place signs.

Time Limit

Most franchise agreements come with an end date and information about renewal rights. Not only will the document list the length of the relationship, but the agreement should include information about the rights of a franchisee successor to enter a new agreement and location upgrade requirements. Detailed information such as this helps to minimize disputes in the future, as both parties know what they are agreeing to before they sign the document.

Training and Support

Franchisors usually provide new franchisees with training and support, from site selection to quality control. They do so to ensure the brand remains properly represented at all times during the agreement. The level of support varies by the franchisor and the documents should outline this.

Proprietary Data

Intellectual property and proprietary data remain the most valuable assets of a company. Franchisees receive access to this information temporarily. However, the franchise agreement should outline exactly how the franchisee may disseminate confidential data and trade secrets. Furthermore, this information must be state specific to avoid any issues.
For example, a franchisee may not share customer information, standard operating procedures, or other sensitive data with people outside of the franchise. Doing so violates the franchise agreement and may lead to the franchisee losing their license without reimbursement.

Criticism

A franchisee might find they are unhappy with certain portions of the franchise agreement. However, under many agreements, the franchisee remains prohibited from sharing these criticisms. In addition, the agreement should outline what happens in the event of a breach. In certain cases, the franchisor receives the right to end the agreement without reimbursing the franchisee.

Times have changed and many companies now take a political stance. This could lead to criticism of this stance rather than the brand. To avoid this, a franchise agreement might state franchisees cannot make major investments or campaign donations without receiving permission from the franchisor. This information appears in the franchise agreement.

Indemnification

Most franchise agreements contain an indemnification covenant. If the franchisee acts negligently or commits some wrongdoing that harms the franchisor, the franchisee becomes responsible for any losses related to their actions. The franchisee must know of all expectations and ensure they remain in adherence with all safety regulations regarding the operation of their business.

For instance, a franchisee may sell food that has passed its expiration date. Doing so leads to customers becoming ill and suing the company for damages. The franchisee must reimburse the franchisor for any losses experienced because of this behavior. A franchise owner might wish to invest in indemnity insurance to protect themselves in the event of a problem.

Right to First Refusal

A franchisee might find they wish to sell or transfer the business. Before doing so, they must alert the franchisor. At this time, the franchisor may exercise their right of first refusal. If the franchisor declines to do so, the franchise owner may sell or transfer their interest.

Termination of the Agreement

All franchise agreements come with a termination clause that details how either party can end the contractual relationship. This clause shares key terms regarding the timing of the notice, procedures each party must follow, and how they will handle damages from an early termination.

Non-Compete Clause

Franchise agreements often come with a non-compete clause. This clause prohibits the franchisee from opening a similar business for a specified period after dissolving the franchise agreement. In addition, it may state a distance the franchisee may open a new business upon dissolution of the franchise agreement. Each state establishes the level of restriction permitted in a non-compete clause.

As with any legal document, each person must carefully review a franchise agreement before either party signs. Consult with a business attorney to review the documents, as this added step ensures they answer any questions before the franchisee enters the agreement. The cost of the consultation is minimal compared to the legal fees each party will accumulate if a problem arises. Working with an attorney to review the agreement reduces the risk of this happening.