What is a Franchise Agreement?

A franchise is a business model where one party provides another with a license to operate their business using the Franchisor’s branding and operating systems. The following article will explore some of the key points within a franchise agreement.

Understanding the relationship between the franchisor and franchisee 

Franchises are a commonly occurring business structure and are built upon forming a mutually beneficial business agreement between ‘Franchisor’ and ‘Franchisee’.

•  The Franchisor obtains revenue from the Franchisee as business operations proceed. The franchise arrangement may facilitate a Franchisor’s market penetration efforts in new territories
• The Franchisee may obtain sales revenue from customers through the operation of the franchised outlet

Franchisor and Franchisee obligations

A franchise agreement would typically dictate a set of obligations with respect to both the Franchisor and the Franchisee.

Depending on the complexity of the franchise arrangement and the Franchisor’s business model, the obligations of both parties could potentially be wide-ranging, and it is crucial for both parties to scrutinise their respective obligations.

Franchisor’s obligations 

• to provide the Franchisee with a licence to operate its business using its branding and operating systems
• to provide the Franchisee’s staff with training in relation to its operating systems and business model
• to provide the Franchisee with consultations and advice
• to provide the Franchisee with updates and modifications regarding its operating systems

Franchisee’s obligations 

• to comply with the Franchisor’s operating manual and standards
• to take all the steps necessary in ensuring the Franchisor’s intellectual property (IP) is not exposed to third-party infringements
• to obtain supplies strictly from suppliers designated by the Franchisor
• to refrain from operating any other businesses at the franchised premises

 A breach of any of these obligations may potentially result in the termination of the franchise agreement.

Marketing in franchising 

Apart from general obligations with respect to the operation of the business, a Franchisee may also be required to undertake certain marketing obligations, in order to advance the Franchisor’s market penetration efforts.

Marketing obligations within a franchise environment

• to set aside a fixed amount of money for marketing efforts in the region
• to market the business through channels specified by the Franchisor (e.g. internet, newspaper etc)
• to use marketing material prescribed by the Franchisor
• to obtain translated versions of the Franchisor’s marketing material for use in the relevant jurisdiction

Intellectual Property Rights (“IPR”) in franchise environments 

Intellectual Property (IP) is generally defined to mean “creations of the mind” – these include inventions, literary and artistic works, and exclusive symbols, names or images used in commerce.

A Franchisor’s business model, operating systems and branding are likely to be extremely IP-intensive and the Franchisor is therefore likely to seek rigorous protection for their IP in order to maintain a competitive advantage over its rivals and preserve the value in its franchise.

The Franchisor may also seek to obtain confidentiality agreements to be reviewed and signed by both the Franchisee and all employees working under the Franchisor’s business name.

Things to look out for in IP provisions within a franchise agreement

• Who owns the rights with regard to improvements or modifications made to the Franchisor’s IP?
• What steps must the Franchisee undertake (if any) where it suspects that there has been an infringement of the Franchisor’s IP rights?
• Is the Franchisee required to assist the Franchisor in making any registrations with respect to the Franchisor’s IP in the relevant jurisdiction?
• What steps is the Franchisee required to undertake in the event that it is required to register the IP on the Franchisor’s behalf in the relevant jurisdiction?

Audit

A Franchisor may seek extensive auditing rights, in order to ensure that standards are upheld and that its branding is not tarnished. Matters to pay attention to with respect to audit provisions include:

• What is the Franchisor allowed to audit?
• How often is the Franchisor allowed to exercise such auditing rights?
• What are the consequences of the Franchisee failing an audit?
• Who bears the cost of audits?

Franchise liability

There are three general categories of liability provisions, namely “no liability” clauses, “limited liability’ clauses and “unlimited liability” clauses. These clauses are commonly found in franchise agreements.

As their respective names suggest, “no liability” clauses set out the scenarios where a party has no liability under the agreement, “limited liability” clauses set out limits on a party’s contractual liability, and “unlimited liability” clauses set out scenarios where a party’s contractual liability is unlimited.

“No liability” scenarios would typically cover loss scenarios that are unforeseeable and/or remote in nature (e.g. various forms of indirect loss, such as loss of profit).

“Unlimited liability” scenarios would cover scenarios where a party’s contractual liability ought to be unlimited. These typically relate to losses arising from conduct that is extremely egregious such as gross negligence or willful misconduct.

The limits set out in “limited liability” clauses could take reference from various values such as the purchase price of the goods and/or services, the amount spent on goods and/or services over the number of quarters, etc.

Failure to be aware of these terms could result in potential liabilities that could cripple a business, or the failure to obtain recourse for egregious conduct by the counterparty.

Negotiating an agreement

When it comes to signing a contract as a Franchisee, it’s likely the franchise will be utilizing contract templates making the franchise agreement non-negotiable.

Prospective Franchisees should always ask about contract negotiation and seek as much clarification as needed, with the help of a legal professional.

When it comes to franchising agreements, it can seem overwhelming at first as they can be extremely complex agreements. However, the franchise model is well understood by seasoned legal advisors. 

What next?

When it comes to legal basics, it can seem overwhelming at first. But, it doesn’t have to be. GLS offers a host of free Startup resources to help set you on your way. You can also browse our list of over 200 Legal Templates and Tools, to choose the products your Startup needs at each critical stage of business.

We also offer a wide range of subscription based Legal Support Plans created specifically for Startups who want a 360 degree service in creating their own virtual legal dept.

*The above content does not constitute, nor is it offered as, legal advice of any kind. GLS Solutions Pte Ltd is not a law firm and any support provided pursuant to this entity is not regulated legal advice or legal opinion.