Presentation on theme: "Vancouver Franchise Show"— Presentation transcript:
1Vancouver Franchise Show Legal Aspects of Purchasing a FranchiseSeptember 23, 2012
2Presenter Eric Mollema BProc LLM 20 years legal experience 15 years of franchising experience20 years of business experienceShort bio
3YOU MUST KNOW WHAT YOU ARE GETTING INTO FranchisingYOU MUST KNOW WHAT YOU ARE GETTING INTOFranchising is the practice of using another Company’s successful business model to your own benefit; orFranchising is:A form of business organization (franchised business)in which a Company that already has a successful product or service (the franchisor)enters into a continuing contractual relationship (franchise agreement)with other businesses (franchisees)operating under the franchisor's trade name (license)and usually with the franchisor's guidance (training)in exchange for a fee. (royalty)You have to pay monthly royalties – that is what franchising is aboutYou cannot say “What is the franchisor doing for me?” when you are using its setup
4Franchise Legislation BC is different…Franchise Legislation inAlbertaManitobaOntarioNew BrunswickPrince Edward IslandActs focus on the protection of the Franchisee through disclosureOther provinces? For information purposes only!USA - Franchising commands 43% of total retail sales and service dollars
5Legal Process Disclosure Non Disclosure Agreement Franchise ApplicationFranchise AgreementPre-purchase Investigations – 12 things to look out for:Compatibility of Franchisor & FranchiseeNot too much competitionGood locationRisk of the ventureLarge enough territorySufficient working capitalReasonable initial franchise feeOther fees & costsSufficient trainingSuccess of other franchiseesIs there a satisfactory exit strategyProfitabilityMost legal problems stem from insufficient pre-investigation
6Disclosure What must be disclosed Material information about the franchise networkFranchisor informationFinancial informationFinancial statementsOperational informationRights & Obligations of Franchisor and FranchiseeCurrent & past franchiseesAll arrangements regarding the relationshipThe prospective franchisee must be able to make a 100% informed decision95-97% of all franchises are still in business after 5 years
7Franchise AgreementEach franchise network has a very specific franchise agreementNo two franchise agreements are the sameFranchise agreements are based on common franchise principles and will “look the same”.However BEWARE, they are not!There is no such thing as a “standard franchise agreement”
8Franchise AgreementPartiesGrantTermFeesCostsPaymentFranchisee AcknowledgementsExclusivityFranchisor ObligationsPerformance requirementsStore location & Lease agreementsLeasehold improvementsOperation of the Franchised BusinessTerritoryCopyrightManual & Confidentiality62.2% of all new USA businesses fail within 6 years
9Franchise Agreement 1 in 12 establishments is a franchise Advertising MarksAccounting, Records, Reports, Audits and InspectionsInsuranceRestrictive covenants and trade secretsStart-up packageSale, assignment and transferControl of the FranchiseSecurity for PaymentFrustration of the AgreementSubstitutionDeath or IncapacityTerminationGuarantor’s covenantsGeneralSchedules1 in 12 establishments is a franchise
10Who is the purchaser What are the requirements of the Franchisor If an incorporated company is requiredWho will the directors be?Who will the shareholders be?Name reservationIncorporation of the companyArticles of IncorporationOptimal Share StructureAccountant inputShareholders AgreementLoan AgreementsSecurity documentsEmployment AgreementsRegistrations & Records OfficeStart-up copyrightsA new franchise opens every 8 minutes of every business day
11Other legal matters Lease Lease agreement Employees Letters of AppointmentEmployment agreementsBusiness licensesAn average franchise employs between 8 – 14 staff
12Tips of the day Do not go it alone! Ask an expert! It is part of the investment in your franchise!Learn as much about franchising as you can.(Read the hand-out: “Buying a Franchise is like getting married”)Ask questions (Questions to ask your franchisor)USA franchise sales total over 1 Trillion per year
14Franchise Agreement Parties Franchisor Franchisee Indemnitor The person who owns the franchise network and who sells the franchises.FranchiseeYou – the person who is interested in buying a franchised business from the franchisor.Indemnitoror Surety or Guarantor or Principle Co-debtorThis is the person who stands in for the franchisee should something goes wrong. This usually refers to the debts of the franchisee to the franchisor, but in some cases can be extended to include acting in a certain manner in the place of the franchisee.Usually this is the applicant personally who stands in for the franchisee (his incorporated company)
15Franchise Agreement Grant The rights granted usually are: The franchisor grants certain rights to the franchisee which are described here.The rights granted usually are:Right to operate a franchised business – exclusive or non exclusiveLicensed rights to use the franchisor’s marks, system, etc.Right to a territoryFranchisee’s limited rights to access National or Regional contractsCircumstances where under the rights may be suspendedMinimum performance requirement o retain rights
16Franchise Agreement Term Initial term Renewal period Effective date This referrers to the contract term which is also the period for which the franchise is awarded.You do not “buy” a franchise and have the rights “forever”Initial termThis is the first term of the agreement – usually between 3 to 5 years.Renewal periodThis is any further periods, after the Initial Term, for which the agreement is resigned or renewed.Effective dateThe date when the agreement becomes effective.This may differ from the signature date.
17Franchise Agreement Fees Initial Franchise Fee Royalty Fee This is the up front amount that must be paid to receive the right to the franchise for the first time.It usually has a non-refundable portion (administration fee) and a refundable portion which is only payable if the franchise application is successful.No fees of any kind should be paid directly to the franchisor before 14 days have elapsed from the date of disclosure.Royalty FeeThis is a recurring monthly fee that the franchisee must pay to the franchisor.Usually based on monthly sales or turnover.Advertising FeeThis is a fee or a portion of the franchisee’s income that is paid to the franchisor to do advertising on the behalf of all the franchisees collectively.This is over and above the royalty payment.Renewal FeeThis is a fee paid to the franchisor for the privilege of renewing the franchise agreement for a further period.This can be made up in various ways.Relocation FeeWhen a franchisee relocates its franchise, this fee is payable to the franchisor to compensate it for its efforts to assist you.
18Franchise Agreement Costs Build out or setup Initial stock This is the cost, in addition to the initial franchise fee, payable to the franchisor for the setup of the franchise. This is usually for signs, branding, shelves, etc. (everything that is going to be used in the franchise that is not stock)Initial stockThis is the cost, in addition to the initial franchise fee and the build out or setup costs, payable to the franchisor to enable it to purchase your startup inventoryCost of incorporationThe legal cost of having the franchise entity incorporated.Usually payable directly to the lawyer.
19Franchise Agreement Payment When? Where? How? Default Interest Tax What happens in the case of defaultInterestWhat interest rate is payable on arrears paymentsTaxWho pays whatNo-setoffFranchisee not allowed to do deductions on the royaltiesApplication of paymentsHow are the payments of the franchisee to be applied. Interest, then penalties, then fees?
20Franchise Agreement Franchisee Acknowledgements General Confirms the Franchisor’s investment in the systemThat goodwill and customer association with marks have been establishedFranchisee must operate franchisee in conformation with the systemFranchisor must have some control over the franchiseIndependent investigationConfirmation that the franchisee investigated the business opportunity independentlyTrading nameConfirms the trading entities and that the franchisee has no right theretoTrading entityConfirms in what entity the franchise must be operated.This is usually in an incorporated companySuccess of the businessConfirms that the franchisee does not quarantine the success of the businessFurther businessesEstablishes the franchisor’s right to open other related or unrelated businesses or initiativesUniformity of agreementsConfirms the right of the franchisor to request that the franchisee resign a further franchise agreement.This is to ensure that all the franchisees have the same agreement and are thus treated equally in law.
21Franchise Agreement Exclusivity Franchisee must deal with the Franchisor exclusivelyFranchisor’s rights outside of this exclusive arrangementReferrers t National and Regional Contracts, Internet Marketing and E-Commerce.
22Franchise Agreement Franchisor Obligations Supply the franchise model Site selection assistanceOperations manualTrainingOperating assistanceStart-up packageMarketingInspections & EvaluationsDelegation of services by the franchisorOther programs and business modelsNotification of legal proceedingsCompliance with Governmental requirementsPricing
23Franchise Agreement Performance requirements This section sets out what is expected from the franchiseeWhat is required of the franchiseeThis usually focuses on the areas that are critical for the franchisee to succeed and can include: sales, operations, financial, target dates, etc.What is the minimum performance that is acceptable to the franchisorThis is the minimum targets, set by the franchisor.Normally, if the franchisee does not reach these set targets, there will be consequences, i.e. fines, lost of certain rights and even loss of the franchise opportunity.
24Franchise Agreement Store location & Lease agreements Approved locationThis section describes and regulates all aspects with relating to the location from which the franchised business will operate. It describes the process which will be followed to obtain this location and what each party’s involvement in the process will be. Usually the franchisor must approved the location in writing.Lease of premisesThis section sets out the arrangements required by the franchisor in relation to the lease of the approved location. Specifically it handles with the arrangement relating to head leases, subleases, assignment of leases, etc.Any additional provisionsAny additional arrangements are noted here. This section usually deals with renewals of the lease, consent of the landlord to the operation of the franchised business from the location, prohibits subleasing, modifications, upgrades, etc.RelocationAll arrangements relating to the relocation of the franchised business is noted here. This usually relates to notice, approval, etc.Furnishing lease to franchisorThe franchisor usually requires a copy of the lease for safekeeping.
25Franchise Agreement Leasehold improvements Obligation to construct When a suitable location has been agreed on, it must be changed to comply with the requirements of the franchisor.Subject to what is agreed, this can be done by the franchisor or the franchisee.If it is the franchisor’s responsibility, the cost is usually include in the amounts paid to the franchisor.If it is the franchisee’s responsibility, the franchisor must supply the specifications.Obligation to constructThe franchisee must do the required changes.Governmental approvalsThe necessary requirements relating to the changes must be obtained from the relevant authorities, i.e. plans, approvals, permits, etc.Use of qualified architect and engineerTo limit liability to everyone, only qualified professionals may be used.Use of qualified contractorTo limit liability to everyone, only qualified contractors may be used.Construction of improvementsConstruction must be done as prescribed by the franchisorSecuring approvalThe franchisor must approve the final productTimeframeRegulates when the construction must start and be finished.Construction insuranceNormal construction insurance must be in place during the construction phase.
26Franchise Agreement Operation of the Franchised Business Duties and obligations of the franchiseeThis section describes in detail the duties an obligations of the franchisee in relation to the franchised business.System modificationsThe franchisor has the right to modify its system and the franchisee must implement such changes.InternetAll arrangements relating to the franchisor’s online systems, websites, social media presence, etc.Franchise gatheringsPurchase and Sale of ProductsDiscounts, Rebates and BonusesTransfer of fundsContact mechanismsUse of the approved locationStandardsEmployee policy
27Franchise Agreement Territory Location of the store Allocated area Describes the extent of the franchisees area of operation and the type of rights he has thereto.Location of the storeLocation from which the franchised business will operate.Allocated areaDescribes in words the allocated area;Geographically – the are know as the municipal district of Maple Ridge.Radius – a radius of 10 kilometers from the approved locationExclusive useDescribes the specific area that the franchisee will have exclusive use of, if any.Non exclusive useDescribes the specific area that the franchisee will have non-exclusive use of, if anyMapThe map of the area is usually attached as a schedule to the franchise agreement.It is common practice to use electronic geographical representations such as Google Maps.
28Franchise Agreement Copyright cop·y·right [kɒpi-raɪt] [kop-ee-rahyt]noun 1. the exclusive right to make copies, license, and otherwise exploit a literary, musical, or artistic work, whether printed, audio, video, etc.: works granted such right by law are protected for the lifetime of the author or creator and for a period of 50 years after his or her death.Description of the franchisor’s copyrights and the arrangements relating thereto.This usually pertains to the franchisor’s manuals and system documents.
29Franchise Agreement Manual & Confidentiality Compliance with the manualThe franchisee is expected to comply with the content of the manual. Breach may be seen as breach of the franchise agreement leading to a contractual default.Non-disclosureThe content of the manuals are subject to non-disclosure arrangementsManual the property of the franchisorThe franchisor stays the owner of the manuals. The franchisee only has the right of use thereof.Keeping the manual confidentialThe franchisee may not disclose the content of the manual to third parties.Keeping the manual currentThe franchisee is obliged to keep the manual current.Irreparable harm from disclosure of confidential informationDisclosure of the content of the manual to third parties may lead to harm to the system and damages to the franchisor and its franchises. This section gives the franchisor extended legal rights which it can enforce against the franchisee in case of breach.Individuals associated with the franchiseeNot only the franchisee is bound by this section. Usually all shareholders, directors, employees and immediate family are included.Translation of the manualRegulates the language and alternativesApplicabilityRegulated to whom this section is applicable.SurvivalThe content of this section usually survives the termination of the agreement and the franchisee stays bound thereby for an agreed period.
30Franchise Agreement Advertising Local advertising Regional advertising Advertising done directly to the benefit of the franchised business. May be done by the franchisee or the franchisor.Regional advertisingAdvertising done by the franchisor or the regional franchisees together.National advertisingThe franchisor’s national advertising initiativesAdvertising fundsAdvertising levies (agreed deductions for the exclusive use for advertising) is usually paid into a separate account which is referred to as the advertising fund. This section sets out arrangements relating to this fund.Opening promotionFranchisees are usually expected to have an opening promotion.Internet, e-commerce and electronic advertisingArrangements relating to the rights of the franchisor and the franchisee in this regard.Advertised price deviationSome franchisor’s allow franchisees to have their own special promotions. This section regulates the extent to which the franchisee may deviate from prescribed pricing models during these promotions.Franchisee developmentsThis section regulates franchisee initiatives that may be adopted by the franchisor.Franchisee Advisory CommitteeArrangements regulating franchisee input through the FAC in relation to advertising.
31Franchise Agreement Marks Protection No permanent interest This sets out the protection agreed to in relation to the franchisor’s trademarks and patents.No permanent interestThe franchisee only obtains a right to use the trademarks and patents of the franchisor.Franchisee’s obligations with respect to the marksWhat the franchise may r may not do in relation to the trademarks and patentsInfringement or changeWhat happens if there are trademark or patent infringements.
32Franchise AgreementAccounting, Records, Reports, Audits and InspectionsBookkeeping, accounting and recordsPrescriptions relating to bookkeeping, accounting methods and the keeping of recordsReports and financial informationWhat reports are required by the franchisor at what stages and what financial and other information these report must contain.Inspection and audit of books and recordsThe franchisors right to inspect and audit the books and financial record of the franchisee.Auditor’s report to be finalThe report of the auditor of the financial situation of the franchisee to the franchisor is considered to be the correct version.
33Franchise Agreement Insurance Types of insurance Policies Copies The types of insurance required by the franchisor is listed and described. This usually includes content insurance, fire insurance, general and specific liability insurance, key man insurance etc.PoliciesSets out the requirements the franchisor insists must be included in the policy. This usually relates to acceptability of the insurer, insured amount, beneficiary, renewal, etc.CopiesThe franchisor may insist on having a copy of the latest insurance policy on file.Placement of Insurance by the FranchisorOn default of the franchisee, the franchisor may insure on the franchisee’s behalf.
34Franchise Agreement Restrictive covenants and trade secrets These are the non-compete arrangementsCompetition during the terms of the agreementArrangements applicable while the franchise agreement is still in forceCompetition after termination of the agreementArrangements applicable to the franchisee after the franchise agreement is terminatedThese arrangements are usually applicable for an agreed period in an agreed area.Acknowledgement of a corporate franchiseeAs the franchisee may be a incorporated company which was erected for the specific purpose of housing the franchised business, it may not continue after termination. The franchisor will want to enforce the content of this clause against everyone involved in the franchised business, especially the key individuals. These individuals are bound personally by the content of this section.ApplicabilityThe people to whom this section is applicable is set out herein.
35Franchise Agreement Start-up package Initial branding This refers to the items included in the initial franchise fee or other amounts that is supplied by the franchisor to the franchisee before opening of the franchised business. This may be anything! Usually it refers to corporate clothing, signs, business cards and letterheads, promotional items, etc.Initial stock and materialThis refers to the initial stock in trade that the franchisee requires to open the business.
36Franchise Agreement Sale, assignment and transfer This refers to the sale of the business or the shares of the business, whatever the case may be, and the arrangements that the parties agree to.Assignment by the franchiseeThe franchisee agrees to certain conditions that will be applicable when its sells its shares. This usually deals with the suitability of the purchaser as a franchisee and the obligation of the purchaser to qualify as a franchisee.Right of first refusalFranchisors usually reserve a right of first refusal to purchase the franchised business. These arrangements are noted in this section.Sale of shares or other interest in the franchiseeIf the franchisee is a corporation or a partnership, the arrangements are slightly different and are noted here.Assignment by franchisorThe franchisor will not be bound by any agreement for sale and purchase if it is not done according to this section and cannot be forced to assign any rights to the purchaser.
37Franchise Agreement Control of the Franchise This section described the franchisor’s rules relating to who may, and may not, control of the franchised business and franchisee.The franchisor may reserve a right to take control of the franchised business in certain circumstancesExamples: Death or Incapacity of the franchisee, uncontrolled loss situation, default, etc.
38Franchise Agreement Security for Payment Arrangements ensuring the payment of any outstanding amounts to the franchisor is agreed to in this section.This usually takes the form of the franchisee’s assignment of his rights to the business’s stock, debtors, etc. to the franchisor as security.
39Franchise Agreement Frustration of the Agreement Frustration of the agreement refers to actions by the franchisee that has the effect that the franchisor cannot enforce the agreement, such as:Unauthorized sale of the franchisees shares;Insolvency of the franchiseeDeath of the franchiseeThis section regulates the rights of the franchisor in such cases and the obligations of the franchisee
40Franchise Agreement Substitution Either party may do what is required by the other in cases where that party cannot, or will not, act as is required by the franchise agreement.This usually give the franchisor the right to sign documents on behalf of the franchisee.
41Franchise Agreement Death or Incapacity This section deals with what happens on the event of the franchisee’s death or permanent incapacity.It also sets out what permanent incapacity is deemed to be.
42Franchise Agreement Termination Events of termination Events that are considered as ending the relationship between the franchisor and the franchisee. These usually include: non payment of fees, failure to complete initial training, franchisee in breach of a term of the franchise agreement, failure to observe rules, not open for business, etc.Effect of terminationWhat happens when he agreement is terminated. This section regulates the process that is followed after termination which usually includes; ceasing to use the franchisor’s marks, stop doing business as a franchisee, return manuals, etc.Rights of the FranchisorWhat rights does the franchisor have? Usually to buy the stock of the franchisee.Exercise of the Franchisor’s rightsFurther rights; sett-off of owed amounts against money due, transfer of permits and business licenses,Additional remediesDescribes any additional remedies that the franchisor may insist on.Survival of covenantsStates which sections of the franchise agreement survive the termination of the agreement.Failure to act not to affect rightsStates that the franchisor’s failure to act does not effect or negate its rights in terms of the franchise agreement.
43Franchise Agreement Guarantor’s covenants Guarantee and Indemnity A guarantor is a person who stands in for the financial, and sometimes other obligations of the franchisee.This is usually the natural persons involved in a corporate franchise but may be a third party in the case of a natural person franchisee.Guarantee and IndemnityThis section defines the extent to which the guarantor is guaranteeing. This usually relates to payments and amounts owed. It can however refer to specific actions such as managing the franchised business, etc.The guarantor also indemnifies the franchisor against any liability relating to the franchise,; losses, claims, etc..Waiver of right to proceedThe franchisor may act against the guarantor directly.Any dealings binding on GuarantorAny actions between the franchisee and the franchisor is binding on the guarantor, if he was part thereof or not.Settlement binding on GuarantorAny settlement reached between the franchisor and the franchisee is binding on the guarantor, of he was part of the negotiations or not.Bankruptcy of the franchiseeThe guarantor stays liable even if the franchisee is bankrupt.Guarantor’s covenants bindingThe successors of the guarantor are bound by the terms of the agreement even if he passes away, etc.Guarantor to be boundConfirms that it is the intent of the guarantor to be bound by the franchise agreement.
44Franchise Agreement General provisions Amendment & prior agreements Entire agreementIndemnification of the franchisorRight to injunctive reliefLegal feesNo liabilityLegal relationshipJoint and severableSeverability of the agreementNoticeHeadings & section numbersApplicable lawsTime of the essenceWaiver of obligationsFranchisee and Guarantor defined, use of pronounLawful attorneyDefault cumulativeFurther assurancesBinding agreementWhen agreement is binding on the FranchiseeRights of the Franchisor are cumulativeForce MajeureCounterpartsEnglish languageGood faithGood nameSignature clausesThink before you sign!This is your absolute last chance.
45Franchise Agreement Schedules Definitions & General Interpretation Contract InformationFranchisor’s Protected MarksTerritory MapStart-up PackageCompany ResolutionConfirmation of New Shareholder, Director or ManagerDisclosure of Franchisee’s Interest in Other EntitiesHead Lease ArrangementsConditional Assignment of LeaseOption and Shop LeasePersonal GuaranteeAssignment of Franchise AgreementRenewal AgreementFranchise Renewal Promissory NoteAuthority to ActSoftware Support and Maintenance Agreement
46Disclosure Topics covered Advertising Attachments Public Figures Background InformationBusiness SummaryComputer SoftwareContinuing FeesCosts of Establishing the FranchiseDirectors and Officers InformationEstimated Initial InvestmentFinancial Performance RepresentationsFinancial StatementsFinancingFranchisee's ObligationsFranchisor’s ObligationsFurther CostsLegal MattersNon-disclosureObligation to Participate in the Operation of the Franchised BusinessOutlets and Franchisee InformationPatents, Copyright and Proprietary InformationPrior Business ExperiencePublic FiguresRebates and DiscountsReceiptRenewal, Termination and TransferRestrictions on Sources of Products and ServicesRestrictions on what the Franchisee may SellStart-up PackageTerritoryTime To OpenTrademarksTraining