The elements of franchise agreement contracts can vary, depending on the franchisor. However, most franchise agreements cover specific core topics because either federal law requires them or the parties expect them.
Failing to understand these terms can lead to conflicts and even business litigation. Whether you are evaluating a franchise relationship or trying to determine if your franchisor has violated your contractual rights, a franchise attorney can review and assess your franchise agreement terms.
What Is Included in a Franchise Agreement?
A franchise agreement outlines the terms and conditions for supplying products or services under someone else’s brand. Retail stores, fast food restaurants, tax preparers, hair salons, fitness centers, and many other businesses are operated as franchises.
Franchise opportunities vary widely based on the business relationship. Some franchisors exercise tight control over franchisees and impose high financial obligations on them. Conversely, other franchisees have more freedom to create and benefit financially.
Before entering into a binding contract with a franchisor, franchisees must carefully review the franchise agreement’s terms.
A franchise agreement governs the business relationship between the franchisor and franchisee. The information included in a franchise agreement serves the following purposes:
- Creating the legal relationship between the parties
- Defining the franchisee’s legal and financial obligations, including the initial franchise fee
- Explaining the franchisor’s support services and ongoing obligations, such as marketing support
- Setting the franchisor’s expectations and mandates on the franchisee, such as quality control
Franchise ownership is much more restrictive than creating an original concept. Thus, having a successful franchise often depends on the agreement’s terms and the franchisee’s ability to meet them.
Core Franchise Agreement Terms and Structure Under Franchise Law
The Federal Trade Commission (FTC) has a franchise rule that governs the legal and financial performance representations that franchisors must provide to prospective franchisees. These disclosures help franchisees evaluate franchise opportunities. The franchise rule also prohibits certain unfair or deceptive practices.
What is included in a franchise agreement under federal law? Under the FTC’s regulations, a franchise relationship is created by a legal contract with the following characteristics:
- It creates a continuing commercial relationship
- It gives the franchisee the right to operate a business using the franchisor’s trademark
- It empowers the franchisor to exert authority over the franchisee’s operations and procedures
- It obligates the franchisee to pay the franchisor for the franchise
Not all franchise agreements are limited to these four standard franchise agreement sections. In fact, most franchisors go far beyond these core issues to address franchise contract details, such as suppliers and vendors, marketing, customer service standards, and even location.
Initial Fees, Royalties, and Financial Obligations of a Franchised Business
The information included in a franchise agreement must include the financial terms. In most cases, the franchisee must pay two types of fees.
First, the franchisee usually pays an initial franchise fee. This fee represents the cost of obtaining the franchise. Some franchisors allow franchisees to pay their initial franchise fee over time. In these relationships, the franchise agreement may include financing terms.
Second, the franchisee must pay royalties. These ongoing royalty payments represent the cost of maintaining the relationship with the franchisor. The royalties may be fixed, such as $10,000 per month, or variable, such as 8% of the franchisee’s gross sales.
Whether you are a franchisor or franchisee, look for franchise agreement clauses that address both upfront and ongoing financial obligations as you prepare or review your agreement.
Business Model Operational Requirements and Business Controls for the Franchise System
The franchise agreement outlines the standard operating procedures for the franchisee. For example, a franchisor might dictate the franchisee’s location and open hours based on other franchise locations in the area.
Additionally, the franchisor will often set performance and service standards, since poor-quality products or services could harm the franchisor’s reputation. For example, a restaurant franchisee may be required to purchase ingredients from the franchisor or approved suppliers.
The franchisor will usually impose reporting requirements, such as weekly, quarterly, and annual financial statements. The franchisor may also have the right to audit the franchisee’s financials.
A franchise agreement will often set minimum performance standards. These quotas will ensure the franchisee develops the market instead of coasting on the franchisor’s advertising. In most cases, the franchisee may be required to make advertising fund contributions to support regional or national marketing.
Some franchisors provide support services to help franchisees meet their obligations. Many franchise agreements require new franchisees to attend initial training programs to learn the company’s standards.
Intellectual Property and Branding Rights
One of the major parts of a franchise agreement is the intellectual property license. A franchise agreement outlines the intellectual property rights licensed, including the following:
- Logos
- Business name
- Names of products and services
- Slogans
- Recipes and formulas
- Processes
- Trade secrets
The goal of a franchise legal agreement is to provide branded goods and services that meet the franchisor’s quality standards. Stated differently, the franchisor grants the franchisee the right to provide the franchisor’s products and services, but requires that they meet certain standards.
These expectations guarantee that the products or services are consistent, ensuring customer satisfaction and protecting brand reputation. For example, a Big Mac at one location should look and taste the same as a Big Mac from every other location. If it does not, the franchisor will receive customer complaints and its reputation will suffer.
The information included in a franchise agreement will usually describe the franchisor’s proprietary rights and explain how to use them within the business. This explanation may define approved advertising methods and brand usage.
Additionally, one of the key provisions of a franchise agreement gives the franchisor the right to inspect the franchisee’s services, goods, and advertising to verify that they comply with the franchise agreement requirements.
Franchise Disclosure Document, Legal Terms, and Risk Provisions
Federal regulations require franchisors to provide a franchise disclosure document (FDD). This document includes a complete history of the franchise so the franchisee can evaluate the risks and rewards, such as the following:
- Financial performance representations
- Special licenses franchisees may need
- Legal requirements for franchisees
- Background on company officers and executives
- Litigation history, including any lawsuits between the franchisor and its franchisees
- All fees
- Any bankruptcies
- Territorial restrictions on customers, suppliers, and marketing efforts
- Advertising and training support
- Growth and turnover of franchisees
The FDD is not a franchise agreement. Instead, it is prepared by the franchisor for people interested in buying a franchise. The franchise disclosure is strictly informational so that the franchisee understands how the franchisor deals with its franchises. In short, it is not a binding contract.
However, the franchise disclosure information includes copies of all current franchise agreements. The franchisee can review the FDD carefully for a franchise agreement breakdown, including the boilerplate terms. These franchise contract components can prove significant in any dispute.
For example, typical franchise agreement language will include the termination clauses explaining how the franchisor can cancel the franchise. It will also explain how the franchisee can withdraw from the franchise or transfer it to someone else.
These terms will often include non-disclosure and non-competition clauses. These terms help the franchisor protect its proprietary information from current and former franchisees.
Should a dispute arise, the contents of a franchise agreement will include the dispute resolution procedures. In many cases, the franchise agreement outlines a mediation and arbitration process so the parties can avoid filing lawsuits.
Both parties will still have legal representation during a mediation or arbitration. However, these processes are often quicker than a lawsuit. Moreover, the mediator or arbitrator is often an expert in franchising, allowing the parties to have their case handled by someone with subject matter knowledge.
Franchise Risk Management
Investing in a franchise can be a risky move. FTC regulations and the proposed franchise agreement may include provisions to manage risk to both parties. First and foremost, the franchisor must provide the FDD at least 14 days before franchisees are required to sign any agreements or pay any franchise fees.
The FDD must include the franchise agreement so prospective franchisees can have it reviewed by a lawyer before committing to it. Although most franchisors will not negotiate the terms, a lawyer can identify possible risks and advise the potential franchisee about whether the deal is worthwhile.
Moreover, the FDD provides enough information for the franchisee and their legal team to perform due diligence on the franchisor. They can contact current and former franchisees and review any legal disputes with the franchisor.
This review can also include a financial review that analyzes the known costs and potential revenues the franchisee could earn.
Contact Vestige Law to Discuss Your Franchise Agreement
Franchising can be lucrative because franchisees receive the benefit of the franchisor’s brand building. Moreover, franchisors avoid the day-to-day risks of running multiple locations in diverse markets.
A strong franchise agreement can benefit both parties by setting expectations and performance standards for both parties. Even when disputes arise, a sound contract can provide the parties with a process for resolving them or terminating their relationship.
Whether you are a current or prospective franchisee or franchisor, we can help with your franchise agreement. Contact us to schedule a consultation with an experienced business lawyer to discuss how to create a franchising relationship.
