1. 1 Gurmeet S Jakhu, Partner Hamilton Pratt Solicitors Birmingham United Kingdom Topic 5: Successful Franchising: Key Terms of a Franchising Agreement

2. 2 CONTENTS 1.An Introduction into Franchising 2.Pilot Testing 3.Franchise Agreements a.Introduction b.Guiding Principles c.Outline Agreement 4.Operations Manuals 5.Property Documents

3. 3 1.An Introduction into Franchising What is a franchise? Types of Franchises What are the alternatives to franchising

4. 4 What is a franchise? Business Format Franchising contains 4 essential elements –The Fr’sor allows the Fr’ee to use a name which is associated with the Fr’sor –The Fr’sor exercises continuing control over the Fr’ee –The Fr’sor provides assistance to the Fr’ee –The Fr’ee has periodically to make payments to the Fr’sor.

5. 5 Types of Franchises Two main types: 1.Product distribution franchises –licences TM & logo, Fr’ee not provided with entire system for running business. Product distribution Eg: soft drink distributors, car dealers and gas/petrol stations 2.Business format – replicate business format. Most common form of franchise –Fr’ee uses/replicates the complete method to conduct the business. Business format Eg: fast food, retail, restaurants, business services and lodging

6. 6 Alternatives to Franchising 1.Distributorships D purchases products in his own name Has no connection with Supplier/wholesaler Familiar with local markets Deals with more than one supplier/producer; No/limited support, training from the supplier/producer D free to operate business, maybe regulation relating to stock levels, turnover & advertising Cf: franchising Fr’ee pays an initial fee and continuing fees D pays a one off purchase price. Profit element to supplier is difference in manufacture/purchase costs and that which he sells at

7. 7 Alternatives to Franchising 2.Agency: 1.Agents do not purchase in their own name 2.Contracts directly by supplier and customer or agent on supplier’s behalf 3.Few restrictions t - relate to the agent’s powers to incur liabilities 4.Some Franchises have agency-principal relationship – eg: parcels delivery franchises customers contracts with Fr’sor but delivery/collection by Fr’ees. 3.Licensing 1.IP rights licensed to a manufacturer to enable manufacture to produce/sell 2.Pay for rights to use particular trademark 3.Supervise the use of the license - limited 4.Most FA contain a licence to use TM & Brand – however FA more heavily regulated

8. 8 Alternatives to Franchising 4.Acquisition/Setting up a Subsidiary; Straight acquisition of an existing business or establish a wholly owned subsidiary - provides maximum control 5.Joint Venture: 2 or more companies/firms agree establish a common enterprise in which they intend to participate jointly; Frequently international in nature Advantageous

9. 9 (2) Pilot Testing Why pilot test - Purpose –prove the financial viability –ensure Fr’sor able to transfer its know how and –Chance to refine the franchise process itself 2 way process for transferring know how and experience Enables Fr’sor to develop its Operations Manual

10. 10 (3) Franchise Agreement Introduction Care and skill required in drafting FA FA fundamental to success of franchise: –Negative impact –Reflect current custom and practice –Accurately reflect the way the Fr’sor operates the business –Protect from Fr’ee claims

11. 11 Franchise Agreements – Guiding Principles –Protect reputation of the Fr’sor; –“tough” –but to strike correct balance Achieved by: Balance Limit Discretion Selling Document No legal terminology and well presented

12. 12 Franchise Agreements - Guiding Principles Easily understood – otherwise slow down process Do not change FA for individual Fr’ees Variables – premises, equipment package, minimum performance, key people often set out in Schedule

13. 13 Outline Franchise Agreement No two FA are the same - are some basic provisions ‘Skeleton’ form of FA and notes in Handout Parties: Franchisor, Franchisee, Individuals –Natwest/BFA Survey: 36% Sole Traders; 22% Partnership & 41% Companies Corporate Fr’ee – New Co, no assets; desirable to obtain individual guarantee

14. 14 Outline Franchise Agreement Directors/major Shareholders: –restrictions on transfer of shares & –subject to Restrictive Covenants Recitals: –set out the background and could form part of factual background in which to construe contract Definitions: –essential that all terms used in FA are clearly set out.

15. 15 Outline Franchise Agreement Rights granted Exclusive FA: Fr’sor not appoint another Fr’ee in the Fr’ee’s territory; Danger for new Franchises. An exclusive/non-exclusive licence to : Operate Business within the Territory (from Premises) Use of trade names and trade marks Use Fr’sors copyright, material, know-how, knowledge Benefit from Marketing knowledge & experience of Fr’sor

16. 16 Outline Franchise Agreement Term –Usual initial term is 5 years –If less than 5 years unlikely to be a franchise –BFA’s code of Ethical Conduct: Extension and Interpretation and Art.5.4 of the European Code of Ethics term to be sufficiently long to pay back the Fr’ee initial investment

17. 17 Outline Franchise Agreement Franchise Fee (Initial Fee) –Fr’ee should not be trained until full fee has been paid off –Initial fee should not contain a profit element –Amount will depend on reputation of Fr’sor and profitability of his franchise –Fr’ee to pay Fr’sors legal costs – discourages attempts by Fr’ee’s legal advisors to negotiate the terms of the FA

18. 18 Outline Franchise Agreement Rights of Renewal –Essential to enable a Fr’ee to renew term –At the end of initial term – optional for Fr’ee –Renewal should be exercised without further payment –Not to be lost for trivial/minor breaches of FA

19. 19 Outline Franchise Agreement Renewal (contd) Fr’sor may introduce further requirements: A“re-vamp” clause & relocation clause –Must be necessary to revamp or move; costs effective –Demonstrate that the revamp resulted in better financial performance for other Fr’ees –Fr’sor to assist with sourcing finance Indiv/Fr’ee to give up all claims against Fr’sor –Enforceability issues in light of UCTA

20. 20 Outline Franchise Agreement Rights of Renewal & Minimum Performance clauses Which apply on renewal only are acceptable Appropriate if all franchise territories are comparable & some form of exclusivity has been granted

21. 21 Outline Franchise Agreement Fr’ors initial obligations – to provide advice on: –Finding premises & alterations to the premises –How to set up the franchise –Such equipment, stock etc as set out in the Schedule –PR launch –Initial training programme right not to enter into FA and reimburse costs –Operations Manual on loan to Fr’ee

22. 22 Outline Franchise Agreement Franchisor’s continuing obligations –Provide Fr’ee with know how, advice & guidance relating to the Business –Supply products to the Fr’ee –Supply stationery when required –At cost, train Fr’ee’s personnel –Organise an annual conference for Fr’ees –Try and set out Fr’sors obligations extensively

23. 23 Outline Franchise Agreement Franchisee’s Obligations –Refurbish & equip the Premises as required by Fr’sor –To use Fr’sor supplied stationery, invoices & products –Operate the Business in accordance with Operations Manual –Use only signs & packaging in connection with the Business as approved by the Fr’sor –Premises: Maintain to the highest standards and not to carry out any alterations without Fr’sor’s consent

24. 24 Outline Franchise Agreement Fr’ees Obligations (contd): Use best endeavours to promote & extend Business –Operate the Business during specified hours –Ensure that staff are well dressed clean and polite –Not employ a manager unless: been approved by the Fr’sor and completed Fr’sor’s training course –At the request of the Fr’sor provide potential Fr’ees with information as reasonably requested

25. 25 Outline Franchise Agreement Training –For Individuals – corporate Fr’ee (no charge) –For Fr’ee’s employees and subsequent managers (at cost) –Initial training often FOC but during term – at cost Continuing Fees –Management Fee 6-10% average of Turnover –In high turnover franchises can be paid weekly –Payment by Direct Debit –If Fr’ee purchase goods/services from Fr’sor, Fr’sor will have a mark up on such gods/services supplied

26. 26 Outline Franchise Agreement Accounting Records – Fr’ee shall: –Maintain record of gross turnover & submit to Fr’sor –Records needed to calculate Management Fee & Marketing Levy as specified in the Operations Manual –Maintain records to verify gross turnover for 6 years –Fr’sor’s right to enter the Premises to review –Supply to the Fr’sor copies of all VAT returns

27. 27 Outline Franchise Agreement Advertising/Promotions –Fr’ee to contribute to national advertising and marketing by way of a Marketing Levy (2-4%) –Marketing Levy received kept in a separate marketing account - audited annually –All advertising is to be approved by the Fr’sor –Fr’ee free to advertise on internet – as long as not active selling

28. 28 Outline Franchise Agreement Insurance –Uncertainty - Fr’sors liability for act of Fr’ee –Relate to conduct of the Business & as Fr’sor shall reasonably require (Ops Manual) –Fr’sor’s interest to be noted on policies &/or –Provide Fr’sor with copies of policies and evidence of payment of premiums

29. 29 Outline Franchise Agreement Trade Marks –Fr’sor has to warrant that it is able to licence the use the Trade Marks? If it has Registered TM – no problem If not no warranty should be contemplated –To bring a passing off action in relation to unregistered trade marks, the Fr’sor must be able to show that it has retained goodwill in them –Fr’ee to notify Fr’sor if it becomes of any unauthorised use

30. 30 Outline Franchise Agreement Improvements –Right during term to introduce amendments and improvements –Who is to pay for the new technology –Ensure not impose too high a financial burden on Fr’ee –Not require Fr’ee to make extensive improvements just before expiry of the initial term of FA

31. 31 Outline Franchise Agreement Manual –Deals with day to day operations –Power to amend the Manual during term If not, will be unable to introduce modifications or amendments to the system –Definitive copy of Manual to be retained –In event of conflict between the FA and the amended Manual, the FA would prevail

32. 32 Outline Franchise Agreement Telephones, fax & domain names –Main source of advertising will be directories hence control of numbers is important esp. on termination –Fr’ee only to use the telephone numbers which have been notified to the Fr’sor for the Business –Consider: Fr’sor to subscribe to the number or Request Fr’ee to sign undated mandate which is exercisable on termination (transferring numbers/names to Fr’sor)

33. 33 Outline Franchise Agreement Sale of Business –Fr’ee’s right to transfer subject to Fr’sor’s consent –The Fr’sor shall consent to a transfer provided that: The purchaser meets Fr’sor’s min. standards –To include business experience and financial resources Payment of investigation and training cost There are no subsisting breaches of the FA

34. 34 Outline Franchise Agreement Sale of Business (contd.) –Option to match offer made to the Fr’ee –Fr’sor may require payment of a “finder’s fee” –Other matters may be taken into consideration such as aptitude for the business, references, etc Must ensure that tests are not too subjective otherwise the Fr’sor would effectively have a right of veto

35. 35 Outline Franchise Agreement Non-Competition During the term of the franchise neither Fr’ee nor the Individuals will: Carry on any other business Entice employees from the Fr’sor or other Fr’ees Use or disclose confidential information for any purpose other than a purpose set out in FA Staffing –Senior employees of Fr’ee not to make use of Fr’sor’s confidential information –Consider use of Side Letter/Deed of Confidentiality hence will be subject to restrictive covenants and obligations of confidentiality

36. 36 Outline Franchise Agreement Death of Individual –FA does not bind the Individual’s personal representatives –A manager for a period of 3 months, on payment of the Fr’sor’s then current costs and expenses –Within the 3 months period the Individual’s personal representatives or beneficiaries must either:- Qualify as a Fr’ee by training (same a for new incoming Fr’ee) or Notify the Fr’sor of their desire to sell the franchise failing which the Fr’sor may terminate the FA

37. 37 Outline Franchise Agreement Termination (1) –It is unusual for Fr’ees to be given an express right to terminate –If Fr’sor wishes to terminate because of Fr’ee’s breach, the Fr’ee should be given notice of any breach and reasonable time to remedy a default –The Fr’sor may terminate the FA if the Fr’ee: Fails to commence business within 3 months of execution of the FA

38. 38 Outline Franchise Agreement Termination (contd) 2: Breach of specific terms of the FA – list out those terms which amount to fundamental terms Persistently defaults in payment of any amounts due to Fr’sor Is found to have supplied materially false or misleading information in or supporting the franchise application

39. 39 Outline Franchise Agreement Terminations (contd) 3 Failure to rectify in specified period – breaches which can be remedied Goes into liquidation/bankruptcy or is insolvent Abandonment of business Serious criminal convictions Note: Consider inserting a liquidated Dm clause for sums payable by Fr’ee on termination – issues of enforceability.

40. 40 Outline Franchise Agreement Consequences of Termination Following termination of the FA the Fr’ee: Must cease use of the Fr’sor’s trade name and trade marks Not hold itself out as being a Fr’ee of the Fr’sor Pay all sums due Return all manuals, literature, promotional material etc Provide the Fr’sor with a list of all customers and potential customers of which it is aware – problematic due to ownership issues Not make use of or disclose confidential information relating to the system of the franchised business

41. 41 Outline Franchise Agreement Restrictive Covenants: Drafting Note: –Will only be enforceable if it is reasonable to protect legitimate interest of Fr’sor – ‘blue pencil’ test. –Make sure that RC does not simply prevent Fr’ee from carrying on business as Fr’sor –Need to ensure that Fr’ee does not compete with Fr’ee business and that of the Fr’sor

42. 42 Outline Franchise Agreement Fr’ee & Individual shall NOT: Compete with the former Fr’ee’s business/Fr’sor: –Expressed by reference to geographical limit and temporal (time) restrictions eg: 1 mile or 700 yards of the former premises or any other franchised or corporate owned premises For 6 or 12 months Solicit or entice customers of the former business –Actual or those who had expressed an interest Recruit former employees

43. 43 Outline Franchise Agreement Individual’s Guarantee –The Individuals shall indemnify the Fr’sor against any breaches of the FA by the Fr’ee Representations –the Fr’ee and the Individuals confirm that they have not relied on any representations or warranties from the Fr’sor in entering into this Agreement –Must be drafted with great care to ensure effectiveness of the clause in order to protect the Fr’sor from misrepresentation claims

44. 44 Outline Franchise Agreement Acknowledgement & Non Reliance Clause Not exclude liability for fraudulent misrepresentation eg: where Fr’sor made wholly unrealistic forecasts and representations Acknowledge that Fr’ee has not relied on any statements made by Fr’sor Remember UCTA and any similar legislation.

45. 45 4.Operations Manual 1.Introduction Brief summary of the franchise business What the franchisee will have to do What the franchisor will provide Details of the existing franchise network -The franchisor’s business philosophy 2.System A detailed description of the system and each of its elements

46. 46 Operations Manual 3.Operating Methods A list of what is required in the business should be set out and should include:- Equipment How the equipment is to be operated Equipment problems Stock requirements IT requirements (hardware and software) Vehicle requirements

47. 47 Operations Manual 4.Operation Instructions All matters relating to the operation of the business should be set out in detail and will include:- Standard procedures Financial records Financial reporting Payment of franchise fees

48. 48 Operations Manual General accounting, (VAT, PAYE and Income/Corporation tax) information on how to complete necessary forms Cash control and banking procedures How to deal with cheques, debit cards and credit cards Staff requirements Staff uniforms Advertising

49. 49 Operations Manual Staff training Procedure for disciplining staff Summary of employment legislation Breakdown of job description for staff Opening times Trading patterns Purchasing requirements and stock levels Pricing policies Insurance

50. 50 Operations Manual 5.Outlet Suggested location of store Store layout Display and merchandising techniques Cleanliness Complaints procedure

51. 51 Operations Manual 6.Standard Forms All standard documentation and forms required to be used in the business should be set out. This may include:- Business Names Act notices Accounting and financial forms Ordering forms Stationery Data Protection Act forms Contracts of employment

52. 52 Operations Manual 7.Legal Issues A summary of relevant legislation should be provided. 8.Franchisor's Directory A list of the franchisor's employees with their job descriptions and reporting structure Useful telephone numbers and contact details

53. 53 5.Property These could include: Lease (if the Fr’sor is the immediate LL – on termination just take over the premises) Deed of Option – upon termination, the Fr’sor has the option to take over occupation of the premises subject to LL consent