A franchise agreement is a legally binding contract between the franchisor (the business or person issuing the franchise licence) and the franchisee (the business or person buying the franchise licence). The agreement allows the franchisee to carry on business using the franchisor’s brand and business systems. It also sets out the rules of the relationship that both franchisor and franchisee have agreed to, such as obligations, duties and responsibilities as well as the feasibility of the franchise.
When challenges arise, a franchise agreement plays a crucial role in addressing these problems or opportunities. However, the length of these contracts may make it easy to overlook important terms.
Here are some key terms for franchisees to look out for:
Financial Terms
First, it is vital to look out for the franchise purchase price and ongoing royalty payments. The purchase price is the upfront cost you need to pay the franchisor to operate the franchise, and this can range from $5,000 to $1,000,000 depending on the franchise. You also need to pay royalties, which are ongoing payments for the right to use the franchisor’s brand and business model. These ongoing payments cover fees such as for training, and stock and supplies. It is important to keep in mind these fees and review the fee provisions when committing to the business plan.
Marketing Fees
In addition to royalty fees, it is common for franchisees to be required to pay fees into a marketing fund operated by the franchisor. Marketing fees are used to pay for costs relating to marketing and advertising of a franchise network. Franchisees do not usually have a say on how the marketing fund is spent, and payment to the fund does not mean that your individual business will be promoted or advertised using money from the fund.
Franchisors or their fund administrator must abide by the rules in the Franchising Code of Conduct about how marketing money can be used, who pays into the fund, and reporting to franchisees how the money was collected and spent each financial year.
Exclusive Territories
A franchise agreement may include an exclusive territory clause which specifies where and how the franchisee can operate the business. An exclusive territory is a designated area where only one franchisee can conduct business. You should consider the location of your likely customer base and whether the number of customers in the location is enough to generate a profit.
Length of the Original Term
The original term is how long you are required to operate the business. It is useful to consider the pros and cons of shorter and longer terms. A shorter term means that there is more flexibility for you to exit the business if the business turns out to be unprofitable. However, you will need to pay renewal costs more often and there is more opportunity for the franchisor to change the terms of the agreement each time it is renewed, such as adding to franchise costs. On the other hand, a longer term provides ample opportunity for you to establish a successful business.
Termination
Termination refers to ending the agreement before the original term has ended. Typically, a franchisee has limited ways to terminate the agreement early and in some cases a termination clause may state that early termination by a franchisee is a breach of the agreement. If you want to terminate their agreement early, the Franchising Code of Conduct sets out a procedure for a franchisee to formally propose to the franchisor if they agree to terminate the agreement. This is not an automatic right for the franchisee to terminate the agreement.
Restraint of Trade
A restraint of trade clause prevents a franchisee from competing with the franchisor during the term of the agreement and after the agreement ends. A restraint of trade clause will not automatically apply or be enforceable, whether a franchisor can enforce the clause depends on how it is drafted. To be enforceable, the clause should do no more than is reasonably necessary to protect the legitimate business interests of the franchisor. Courts assess what is reasonable based on the activity that is being restrained, the area where activity is being restrained, and the period for which the activity is being restrained.
Therefore, it is likely that you cannot run the same or similar business in a similar location after you terminate or complete the franchise agreement as it would affect the profitability of the franchise in some way. It is crucial to consult a franchise lawyer before committing to a franchise agreement if you intend to open a similar business one day.
Dispute Resolution
The franchise agreement will include a dispute resolution clause. This reflects the dispute resolution procedure in the Franchising Code of Conduct. If you cannot resolve the issue, follow the process in the Code or franchise agreement to refer the matter for an alternative dispute resolution (ADR). ADR involves mediation, conciliation, or voluntary arbitration.
Key Points
These are just seven key points to pay attention to if you are planning to buy a franchise. It is helpful to ask a franchise lawyer to carefully review key terms of the franchise agreement so you can understand and consider all the conditions and requirements of the contract, such as ongoing financial terms, termination, and dispute resolution. Be clear about your business plan and what is needed in your contract, and be prepared to negotiate if it does not meet your business needs.
At OpenLegal, we provide expert legal services tailored to the needs of businesses, with a focus on franchise agreements and commercial law. Our team ensures your agreements are carefully reviewed and negotiated to protect your interests, covering key areas such as financial terms, marketing obligations, exclusive territories, termination provisions, and dispute resolution. We guide franchisors and franchisees through the complexities of the Franchising Code of Conduct and offer practical, business-focused advice to help you navigate challenges and achieve your goals with confidence.
Contact OpenLegal today at enquiries@openlegal.com.au or 1300 937 574 for a confidential consultation to discuss your situation and explore the best path forward.
Anneka Tan , Intern at OpenLegal
