Planning on selling a franchise business requires attention and consideration of the franchisee’s obligations under the franchise agreement. In most cases the franchisee has an obligation to the franchisor in respect to the sale and exit from the franchise system. What are some of the obligations that a franchisee may need to be aware of?
In most cases selling a franchise business can be cumbersome and stressful at the best of times. The secret to the smooth transfer of a franchise business is to ensure that the franchisee has within ample time met or have a good grasp of their obligations both to the purchaser and franchisor. Obligations to the purchaser can be dealt with on another occasion which leaves us with the franchisee’s obligations to the franchisor.
The obligations are generally known as Pre and Post Termination Obligations.
Pre – Obligations
A good understanding of the franchise agreement would certainly alleviate any concerns that a franchisee should have in relation to their obligations to the franchisor. The following are pertinent but not exhaustive matters to be considered:
- Compliance of the franchise provisions prior to requesting the transfer/sale of the franchise business.
- The provision to offer the franchise business to the franchisor, generally known at the Right of First Refusal, prior to transferring or selling the business to a third party. In most but not all cases the franchisee must offer the franchise business back to the franchisor for an agreed amount, generally an amount which is being offered to the open market. The franchisee must ensure that it meets the strict provisions noted in the franchise agreement during this process.
- Ensure that the incoming franchisee or purchaser meets the criteria generally set out in the franchise. That is:
- the purchaser must be able to meet the financial obligations that the purchaser would have under the franchise agreement; or
- the purchaser must meet a reasonable requirement of the franchise agreement for the transfer of a franchise, including satisfactorily completing the franchisor’s own current standard training program for franchisees and being otherwise capable of operating the franchise as a franchisee; or
- the purchaser must meet the selection criteria of the franchisor; or
- the disclosure obligations under clause 12 of the Franchising Code of Conduct must be met; and
- the proposed purchaser must agree in writing to comply with the obligations of the franchisee under the franchise agreement.
The above points are in no way reflective of what must be satisfied for every franchisee and it would be prudent to ensure that the terms noted in the franchise agreement are satisfied.
- A Deed of Release and Termination or Deed of Surrender must be entered into with the franchisor. In most cases franchisors require this document to be signed to release the franchisor from any claims which may be made against the franchisor whilst the franchisee was conducting the franchise business. It is suggested that legal advice is obtained in respect to such a document.
Post – Obligations
Once the franchisee sells the business and is no longer a part of the franchise system and notwithstanding that the franchisee’s relationship with the franchisor may have come to an end, the franchisee may still have obligations to the franchisor. Some of these obligations include:
- The obligation to satisfy the post termination provisions of the franchise agreement. These include ensuring that you return all material in accordance with the franchise agreement to the franchisor or purchaser, that is, Operations Manuals, insignia, uniforms, business cards and stationery and the customer database.
- Satisfying the non-compete covenants of the franchise agreement. This may include the restriction to operate a competing business within a particular territory and during a particular period of time after transferring the franchise business or simply not to contact any customers of the franchise business for a period of time after the franchisee’s release from the franchise agreement.
- Permanently ceasing to use all of the confidential material and any other intellectual property and return to the franchisor or destroy (as directed by the franchisor) any and all such materials or materials featuring the same.
- Execute all such documents and do all such things as are necessary to transfer to the franchisor or its nominee any and all business names incorporating the Name and any words deceptively similar thereto and any other intellectual property belonging to the franchisor.
Franchisors do all things necessary to protect their brand and the franchise system and the release of a franchisee from its system is a fundamental aspect for the protection of their brand and franchise system. Just as the transaction for signing a franchisee up to operating a franchise business is important the release of the franchisee can be just as important.
To ensure the success of a smooth release the franchisee should be alert to all their obligations in both respects, whether it be those noted above or as stipulated in the franchise agreement.
“I’m entering into a franchise agreement for a retail business and the franchisor has advised that I must enter into a lease agreement with the landlord. What should I do and what should I look out for?
The Retail Leases Act (NSW) (the “Act”) and similar legislation in other states govern retail leases, granting valuable rights to you as a lessee and imposing various obligations on the lessor both before the lease is entered into and during the lease term.
Under the Act, the landlord must have a draft lease available for inspection before you are offered a lease. Each prospective lessee must be provided with a copy of the retail tenancy guide, explaining your rights as a lessee, when negotiations are entered into.
The landlord must also provide you with a Disclosure Statement at least seven days before you enter the lease or occupy the premises, summarising the lease terms and setting out additional information about the premises. Importantly the Disclosure Statement will provide an estimate and a break down of the Outgoings you must pay under the Lease. If the landlord fails to give you a Disclosure Statement within this time you may be able to terminate the lease at any time within the first six months. Additionally, if you find that the Disclosure Statement failed to mention important issues or if it was in some way defective, you may be entitled to seek compensation from the landlord.
Under the Act, the lease term including any option to renew must be for a minimum of five years unless a solicitor has issued a certificate under s16(3) of the Act. If there is no such certificate the lease term is automatically increased to five years. The Act also restricts the method of rent review in that the lease may not have terms preventing the rent from decreasing – for example if the method of rent review caused the rent to decrease below previous levels. The Lease also cannot prescribe that you pay the higher of two alternate methods of rent review.
In NSW the landlord cannot pass on to a lessee the costs of preparing the lease. There are certain exceptions to this, for example landlords may pass on the ‘reasonable’ legal costs for amending the lease at the lessee’s request, after the lessee has given the lessor a copy of the lessee’s disclosure statement.
As the lease is a legally binding contract which imposes upon the lessee significant obligations, the lessee must examine the document carefully, understand the terms and conditions and consult a lawyer for advice. Entering into a lease agreement that has unfavourable terms may have significant ramifications throughout the term of the lease, affecting the success of the franchise business.
Important things to look out for:
- The Permitted Use of the premises must correspond to the main use to which you intend to use the premises;
- Ensure the lease term and any options to renew coincide with the term of your franchise. For example it is unwise to enter into a three-year lease if you are entering into a five-year franchise agreement. In our experience, many shopping centre leases do not provide for an option to renew which poses problems at the end of the lease term;
- Check if the lease is assignable in the future as you may wish to sell your business before the lease term expires;
- Total payments under the lease. You should carefully consider whether your business will be able to afford the payments under the lease, both now and in the future;
- Consider the amount of rent payable and understand the timing and calculation of rent increases. You should also ascertain the amounts of any additional payments required such as insurance, maintenance, marketing fees, fit-out costs and outgoings or shared operating expenses as outlined in the Disclosure Statement;
- Ensure that all representations made to you by the landlord have been reflected in the terms of the lease.
Before you sign the lease you should finally check with the Franchisor to ensure that there is nothing in the lease terms which would contravene your obligations under the Franchise Agreement.
Baybridge Lawyers – Managing Partner
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