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Understanding the Franchise Contract

Source: U.S. Small Business Administration

The franchise contract, like the Uniform Franchise Offering Circular (UFOC), is a very important document. The contract is probably the most important document in the transaction process. It is a legal commitment which is binding on both the franchisor and franchisee. In the franchise contract, the franchisor's promises must be presented to the franchisee in writing and subjected to careful scrutiny. During this stage of the buy/sell process, the franchisee must have competent legal advice regarding the meaning and effect of the contract.

When reviewing the contract, you and your attorney, will need to determine if it confirms what you have been told. If you find improprieties in the contract at this point, you may decide to withdraw from the transaction before committing your time, energy and money to an agreement that may not be beneficial for you. If, however, you choose to continue with the process, you may be able to negotiate favorable terms, but remember by signing the contract, you are legally bound by the provisions of the agreement.

The franchise contract consists of two main parts: 1) the purchase agreement and 2) the franchise or license agreement. For convenience, occasionally the franchise transaction is split into two stages. When this happens, some franchise companies have two contracts, one for each stage, rather than a single contract. While it isn't necessary to have two contracts, it can be the better method where there is a comprehensive equipment and initial services package.

The purchase agreement of the contract covers:

  • the franchise package
  • the price
  • the services to be provided.

The franchise or license agreement covers:

  • the rights granted to the franchisee
  • the obligations undertaken by the franchisor
  • the obligations imposed upon the franchisee
  • trade restrictions imposed upon the franchisee
  • assignment/death of franchisee
  • termination provisions.

A brief explanation of each agreement follows.

PURCHASE AGREEMENT

1. The franchise package. Consists of an equipment or inventory list. This list must contain all the items the franchisee has been told to expect. Some franchise companies regard this list as being confidential and stipulate in the contract that it must be so treated.

2. The price. The price and the manner of payment will be specified. This may be cash on signature, although rare. More often a deposit is required on signature with payment of the balance to follow on delivery of the equipment or at other stages of the transaction.

3. The services to be provided. This section outlines or lists the franchisor's responsibilities to the franchisee. Those services the franchisor is required to provide the franchisee before he or she is ready to open for business are called the initial services. Those services the franchisor provides periodically are called continuous services. A more detailed explanation of the services provided by the franchisor are included in the next section on the license agreement.

FRANCHISE OR LICENSE AGREEMENT

1. The rights granted to the franchisee. The franchisee will be given the right as it applies to particular circumstances. As a franchisee there are certain rights that are extended to you.

Your rights include:

  • use of trademarks, trade names and patents of the franchisor.
  • use of the brand image and the design and décor of the premises developed by the franchisor.
  • use of the franchisor's secret methods.
  • use of the franchisor's copyright materials.
  • use of recipes, formulae, specifications and processes and methods of manufacture developed by the franchisor.
  • conducting the franchised business upon or from the agreed premises strictly in accordance with the franchisor's methods and subject to the franchisor's directions.
  • guidelines established by the franchisor regarding exclusive territorial rights.
  • rights to obtain suppliers from nominated suppliers at special prices.

2. The obligation undertaken by the franchisor. This item in the contract tells prospective franchisees what the franchisor will do for them both before and after start-up. That is why this item frequently refers to specific contractual obligations detailed in the franchise agreement, which is attached to the UFOC.

3. The obligations imposed upon the franchisee. Certain obligations are required of you by the franchisor. These obligations include:

  • to carry on the business franchised and no other business upon the approved and nominated premises.
  • to observe certain minimum operating hours.
  • to pay a franchise fee.
  • to follow the accounting system laid down by the franchisor.
  • not to advertise without prior approval of the advertisements by the franchisor.
  • to use and display such point of sale advertising materials as the franchisor stipulates.
  • to maintain the premises in good, clean and sanitary condition and to redecorate when required to do so by the franchisor.
  • to maintain the widest possible insurance coverage.
  • to permit the franchisor's staff to enter the premises to inspect and see if the franchisor's standards are being maintained.
  • to purchase goods or products from the franchisor or his designated suppliers.
  • to train your staff in the franchisor's methods to ensure that they are neatly and appropriately clothed.
  • not to assign the franchise contract without the franchisor's consent.

4. Trade restrictions. The restrictions imposed upon a franchisee may prohibit him or her from carrying on a similar business except under franchise from the franchisor, taking staff away from other franchisees, carrying on a similar business in close proximity to other franchised businesses within that chain, and continuing, after termination of the franchise contract, to use any of the franchisor's trade names, secrets, and so forth.

5. Assignment/death of the franchisee. The franchisee should ensure that in the event of death his/her personal representative or dependent will be able to keep the business going until one of them can qualify as a franchisee, and that arrangements can be made to keep the business going until a suitable assignee can be found at a proper price.

6. Termination provisions. The termination of a franchise is an event heavily regulated by the franchise laws of 17 states. Franchise relationship laws in many states specify the conditions under which a franchisor may terminate or refuse to renew the franchise, imposing a standard of "good cause," "reasonable cause" or "just cause" as defined by those laws. Minimum advance notice usually has an opportunity to cure the default and avoid terminations; notice ranges from five days to 90 days. Many states also specify circumstances under which the standard notice and cure requirements need not be met.

In view of the close working relationship that must exist between the franchisee and franchisor all provisions must be stated clearly in the contract. In this transaction, no small print should exist. Make sure, if possible, the franchise contract contains provisions that are favorable for both you and the franchisor.


Understanding the Franchise Contract reprinted from and courtesy of the U.S. Small Business Administration (from the SBA's Workbook entitled "Is Franchising for Me?")

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