Vancouver Franchise Show Legal Aspects of Purchasing a Franchise September 23, 2012

Presenter Eric Mollema BProc LLM 20 years legal experience 15 years of franchising experience 20 years of business experience Short bio

YOU MUST KNOW WHAT YOU ARE GETTING INTO Franchising YOU MUST KNOW WHAT YOU ARE GETTING INTO Franchising is the practice of using another Company’s successful business model to your own benefit; or Franchising 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 about You cannot say “What is the franchisor doing for me?” when you are using its setup

Franchise Legislation BC is different… Franchise Legislation in Alberta Manitoba Ontario New Brunswick Prince Edward Island Acts focus on the protection of the Franchisee through disclosure Other provinces? For information purposes only! USA - Franchising commands 43% of total retail sales and service dollars

Legal Process Disclosure Non Disclosure Agreement Franchise Application Franchise Agreement Pre-purchase Investigations – 12 things to look out for: Compatibility of Franchisor & Franchisee Not too much competition Good location Risk of the venture Large enough territory Sufficient working capital Reasonable initial franchise fee Other fees & costs Sufficient training Success of other franchisees Is there a satisfactory exit strategy Profitability Most legal problems stem from insufficient pre-investigation

Disclosure What must be disclosed Material information about the franchise network Franchisor information Financial information Financial statements Operational information Rights & Obligations of Franchisor and Franchisee Current & past franchisees All arrangements regarding the relationship The prospective franchisee must be able to make a 100% informed decision 95-97% of all franchises are still in business after 5 years

Franchise Agreement Each franchise network has a very specific franchise agreement No two franchise agreements are the same Franchise 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”

Franchise Agreement Parties Grant Term Fees Costs Payment Franchisee Acknowledgements Exclusivity Franchisor Obligations Performance requirements Store location & Lease agreements Leasehold improvements Operation of the Franchised Business Territory Copyright Manual & Confidentiality 62.2% of all new USA businesses fail within 6 years

Franchise Agreement 1 in 12 establishments is a franchise Advertising Marks Accounting, Records, Reports, Audits and Inspections Insurance Restrictive covenants and trade secrets Start-up package Sale, assignment and transfer Control of the Franchise Security for Payment Frustration of the Agreement Substitution Death or Incapacity Termination Guarantor’s covenants General Schedules 1 in 12 establishments is a franchise

Who is the purchaser What are the requirements of the Franchisor If an incorporated company is required Who will the directors be? Who will the shareholders be? Name reservation Incorporation of the company Articles of Incorporation Optimal Share Structure Accountant input Shareholders Agreement Loan Agreements Security documents Employment Agreements Registrations & Records Office Start-up copyrights A new franchise opens every 8 minutes of every business day

Other legal matters Lease Lease agreement Employees Letters of Appointment Employment agreements Business licenses An average franchise employs between 8 – 14 staff

Tips 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

“Thank You” Any questions? emollema@beckerlawyers.ca – www.beckerlawyers.ca

Franchise Agreement Parties Franchisor Franchisee Indemnitor The person who owns the franchise network and who sells the franchises. Franchisee You – the person who is interested in buying a franchised business from the franchisor. Indemnitor or Surety or Guarantor or Principle Co-debtor This 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)

Franchise 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 exclusive Licensed rights to use the franchisor’s marks, system, etc. Right to a territory Franchisee’s limited rights to access National or Regional contracts Circumstances where under the rights may be suspended Minimum performance requirement o retain rights

Franchise 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 term This is the first term of the agreement – usually between 3 to 5 years. Renewal period This is any further periods, after the Initial Term, for which the agreement is resigned or renewed. Effective date The date when the agreement becomes effective. This may differ from the signature date.

Franchise 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 Fee This is a recurring monthly fee that the franchisee must pay to the franchisor. Usually based on monthly sales or turnover. Advertising Fee This 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 Fee This 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 Fee When a franchisee relocates its franchise, this fee is payable to the franchisor to compensate it for its efforts to assist you.

Franchise 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 stock This 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 inventory Cost of incorporation The legal cost of having the franchise entity incorporated. Usually payable directly to the lawyer.

Franchise Agreement Payment When? Where? How? Default Interest Tax What happens in the case of default Interest What interest rate is payable on arrears payments Tax Who pays what No-setoff Franchisee not allowed to do deductions on the royalties Application of payments How are the payments of the franchisee to be applied. Interest, then penalties, then fees?

Franchise Agreement Franchisee Acknowledgements General Confirms the Franchisor’s investment in the system That goodwill and customer association with marks have been established Franchisee must operate franchisee in conformation with the system Franchisor must have some control over the franchise Independent investigation Confirmation that the franchisee investigated the business opportunity independently Trading name Confirms the trading entities and that the franchisee has no right thereto Trading entity Confirms in what entity the franchise must be operated. This is usually in an incorporated company Success of the business Confirms that the franchisee does not quarantine the success of the business Further businesses Establishes the franchisor’s right to open other related or unrelated businesses or initiatives Uniformity of agreements Confirms 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.

Franchise Agreement Exclusivity Franchisee must deal with the Franchisor exclusively Franchisor’s rights outside of this exclusive arrangement Referrers t National and Regional Contracts, Internet Marketing and E-Commerce.

Franchise Agreement Franchisor Obligations Supply the franchise model Site selection assistance Operations manual Training Operating assistance Start-up package Marketing Inspections & Evaluations Delegation of services by the franchisor Other programs and business models Notification of legal proceedings Compliance with Governmental requirements Pricing

Franchise Agreement Performance requirements This section sets out what is expected from the franchisee What is required of the franchisee This 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 franchisor This 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.

Franchise Agreement Store location & Lease agreements Approved location This 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 premises This 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 provisions Any 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. Relocation All arrangements relating to the relocation of the franchised business is noted here. This usually relates to notice, approval, etc. Furnishing lease to franchisor The franchisor usually requires a copy of the lease for safekeeping.

Franchise 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 construct The franchisee must do the required changes. Governmental approvals The necessary requirements relating to the changes must be obtained from the relevant authorities, i.e. plans, approvals, permits, etc. Use of qualified architect and engineer To limit liability to everyone, only qualified professionals may be used. Use of qualified contractor To limit liability to everyone, only qualified contractors may be used. Construction of improvements Construction must be done as prescribed by the franchisor Securing approval The franchisor must approve the final product Timeframe Regulates when the construction must start and be finished. Construction insurance Normal construction insurance must be in place during the construction phase.

Franchise Agreement Operation of the Franchised Business Duties and obligations of the franchisee This section describes in detail the duties an obligations of the franchisee in relation to the franchised business. System modifications The franchisor has the right to modify its system and the franchisee must implement such changes. Internet All arrangements relating to the franchisor’s online systems, websites, social media presence, etc. Franchise gatherings Purchase and Sale of Products Discounts, Rebates and Bonuses Transfer of funds Contact mechanisms Use of the approved location Standards Employee policy

Franchise 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 store Location from which the franchised business will operate. Allocated area Describes 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 location Exclusive use Describes the specific area that the franchisee will have exclusive use of, if any. Non exclusive use Describes the specific area that the franchisee will have non-exclusive use of, if any Map The 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.

Franchise 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.

Franchise Agreement Manual & Confidentiality Compliance with the manual The 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-disclosure The content of the manuals are subject to non-disclosure arrangements Manual the property of the franchisor The franchisor stays the owner of the manuals. The franchisee only has the right of use thereof. Keeping the manual confidential The franchisee may not disclose the content of the manual to third parties. Keeping the manual current The franchisee is obliged to keep the manual current. Irreparable harm from disclosure of confidential information Disclosure 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 franchisee Not only the franchisee is bound by this section. Usually all shareholders, directors, employees and immediate family are included. Translation of the manual Regulates the language and alternatives Applicability Regulated to whom this section is applicable. Survival The content of this section usually survives the termination of the agreement and the franchisee stays bound thereby for an agreed period.

Franchise 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 advertising Advertising done by the franchisor or the regional franchisees together. National advertising The franchisor’s national advertising initiatives Advertising funds Advertising 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 promotion Franchisees are usually expected to have an opening promotion. Internet, e-commerce and electronic advertising Arrangements relating to the rights of the franchisor and the franchisee in this regard. Advertised price deviation Some 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 developments This section regulates franchisee initiatives that may be adopted by the franchisor. Franchisee Advisory Committee Arrangements regulating franchisee input through the FAC in relation to advertising.

Franchise Agreement Marks Protection No permanent interest This sets out the protection agreed to in relation to the franchisor’s trademarks and patents. No permanent interest The franchisee only obtains a right to use the trademarks and patents of the franchisor. Franchisee’s obligations with respect to the marks What the franchise may r may not do in relation to the trademarks and patents Infringement or change What happens if there are trademark or patent infringements.

Franchise Agreement Accounting, Records, Reports, Audits and Inspections Bookkeeping, accounting and records Prescriptions relating to bookkeeping, accounting methods and the keeping of records Reports and financial information What 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 records The franchisors right to inspect and audit the books and financial record of the franchisee. Auditor’s report to be final The report of the auditor of the financial situation of the franchisee to the franchisor is considered to be the correct version.

Franchise 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. Policies Sets 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. Copies The franchisor may insist on having a copy of the latest insurance policy on file. Placement of Insurance by the Franchisor On default of the franchisee, the franchisor may insure on the franchisee’s behalf.

Franchise Agreement Restrictive covenants and trade secrets These are the non-compete arrangements Competition during the terms of the agreement Arrangements applicable while the franchise agreement is still in force Competition after termination of the agreement Arrangements applicable to the franchisee after the franchise agreement is terminated These arrangements are usually applicable for an agreed period in an agreed area. Acknowledgement of a corporate franchisee As 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. Applicability The people to whom this section is applicable is set out herein.

Franchise 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 material This refers to the initial stock in trade that the franchisee requires to open the business.

Franchise 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 franchisee The 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 refusal Franchisors 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 franchisee If the franchisee is a corporation or a partnership, the arrangements are slightly different and are noted here. Assignment by franchisor The 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.

Franchise 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 circumstances Examples: Death or Incapacity of the franchisee, uncontrolled loss situation, default, etc.

Franchise 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.

Franchise 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 franchisee Death of the franchisee This section regulates the rights of the franchisor in such cases and the obligations of the franchisee

Franchise 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.

Franchise 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.

Franchise 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 termination What 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 Franchisor What rights does the franchisor have? Usually to buy the stock of the franchisee. Exercise of the Franchisor’s rights Further rights; sett-off of owed amounts against money due, transfer of permits and business licenses, Additional remedies Describes any additional remedies that the franchisor may insist on. Survival of covenants States which sections of the franchise agreement survive the termination of the agreement. Failure to act not to affect rights States that the franchisor’s failure to act does not effect or negate its rights in terms of the franchise agreement.

Franchise 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 Indemnity This 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 proceed The franchisor may act against the guarantor directly. Any dealings binding on Guarantor Any actions between the franchisee and the franchisor is binding on the guarantor, if he was part thereof or not. Settlement binding on Guarantor Any 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 franchisee The guarantor stays liable even if the franchisee is bankrupt. Guarantor’s covenants binding The successors of the guarantor are bound by the terms of the agreement even if he passes away, etc. Guarantor to be bound Confirms that it is the intent of the guarantor to be bound by the franchise agreement.

Franchise Agreement General provisions Amendment & prior agreements Entire agreement Indemnification of the franchisor Right to injunctive relief Legal fees No liability Legal relationship Joint and severable Severability of the agreement Notice Headings & section numbers Applicable laws Time of the essence Waiver of obligations Franchisee and Guarantor defined, use of pronoun Lawful attorney Default cumulative Further assurances Binding agreement When agreement is binding on the Franchisee Rights of the Franchisor are cumulative Force Majeure Counterparts English language Good faith Good name Signature clauses Think before you sign! This is your absolute last chance.

Franchise Agreement Schedules Definitions & General Interpretation Contract Information Franchisor’s Protected Marks Territory Map Start-up Package Company Resolution Confirmation of New Shareholder, Director or Manager Disclosure of Franchisee’s Interest in Other Entities Head Lease Arrangements Conditional Assignment of Lease Option and Shop Lease Personal Guarantee Assignment of Franchise Agreement Renewal Agreement Franchise Renewal Promissory Note Authority to Act Software Support and Maintenance Agreement

Disclosure Topics covered Advertising Attachments Public Figures Background Information Business Summary Computer Software Continuing Fees Costs of Establishing the Franchise Directors and Officers Information Estimated Initial Investment Financial Performance Representations Financial Statements Financing Franchisee's Obligations Franchisor’s Obligations Further Costs Legal Matters Non-disclosure Obligation to Participate in the Operation of the Franchised Business Outlets and Franchisee Information Patents, Copyright and Proprietary Information Prior Business Experience Public Figures Rebates and Discounts Receipt Renewal, Termination and Transfer Restrictions on Sources of Products and Services Restrictions on what the Franchisee may Sell Start-up Package Territory Time To Open Trademarks Training