If you are thinking about buying a franchise, here are some things you should know about franchise agreements:
1. Most of a franchise agreement is likely non-negotiable
Generally speaking, franchisors have confidence in their brand and their system and want to keep contract administration and legal expense to a minimum. As a result, a franchise agreement is usually non-negotiable on substantive issues. A franchisor’s willingness to negotiate could actually be a warning sign that it lacks confidence in its system.
2. Exclusive territory
A franchise agreement should generally grant an exclusive territory. Depending on the nature of the business, this could be anywhere from a few blocks to a few kilometeres.
A franchisor will likely require you to purchase supplies through their approved suppliers. This means that there will be uniform quality standards and that customers can expect a similar experience at any given franchise. However, you should expect that franchisors will receive rebates or other benefits from its suppliers and that you will not be able to share in those benefits.
4. Remodeling and renovations
A franchisor typically has discretion to require you to remodel and renovate when it chooses. This means there is some assurance that other locations will have to freshen up from time to time. However, the expense can be significant and the timing can be inconvenient: it is not unheard of for a franchisor to require a franchisee to remodel just prior to selling a franchise, for example.
5. The entire agreement clause
A franchise agreement will likely have an entire agreement clause. This means that whatever you’ve been told about the franchise, no matter who told you, has no legal effect unless it is written into the franchise agreement. So if you have been promised something that is not reflected in the agreement, you should ensure that it is written into the agreement.
6. Applicable law
Under a franchise agreement, the laws of the franchisor’s home jurisdiction will typically govern. This presents two disadvantages to a franchisee. One is that in the event of a dispute, you may need to retain counsel in a faraway jurisdiction to bring your claim. The other is that a franchisor may choose to locate in a jurisdiction with laws more favourable to a franchisor than a franchisee.
Franchise agreements generally provide for arbitration as a dispute resolution mechanism. This means that you would have no right to take your franchisor to court in the event of a dispute. This could put you at a disadvantage for several reasons:
- Arbitration can be more expensive than going to court. Judges are paid by taxpayers, while arbitrators are paid by the parties – at a rate of hundreds of dollars per hour.
- The discovery process for an arbitration can be quite limited. This means that documents in the possession of the franchisor that could help build your case may to be inaccessible to you in an arbitration.
- Sometimes the threat of negative publicity from a lawsuit can be enough to force a settlement. However, arbitration is held behind closed doors and the outcome is confidential, so threatening arbitration is less likely to force the other party to settle.
8. Assignment / selling your franchise
The assignment clause can make a franchise difficult to sell. It usually allows the franchisor to withhold consent to a transfer unless certain requirements are met. Fees also may be payable, and they can be considerable – $10,000 or $15,000 for example. In some cases, the franchisor may even have a right of first refusal to buy back the franchise and deduct the value of the goodwill in doing so!
The non-compete clause means that you cannot learn the ropes at your franchise, sell the business and go off and start a competing business in the same industry. Generally speaking, a non-compete clause will keep you out of the industry for a period of several years after selling your franchise.
10. Withholding tax
If your franchisor is based outside Canada, then any royalties you pay to that franchisor will be subject to a withholding tax of 15%. If your franchisor is US based, then it should be able to claim a tax credit for this tax, so your agreement should state that you can deduct withholding tax from royalties.
If you would like assistance in reviewing a franchise agreement, we would be pleased to help.