A franchise is a business model where a party (the “Franchisor”) provides another party (the “Franchisee”) with a licence to operate the Franchisor’s business using the Franchisor’s branding and operating systems. In return for such a licence, the Franchisee is typically required to pay certain sums to the Franchisor.
Franchises are commonplace and could form a mutually beneficial arrangement for both the Franchisor and the Franchisee:
● The Franchisor obtains revenue from the Franchisee as it receives certain sums from the Franchisee. Besides, a franchise arrangement may facilitate a Franchisor’s market penetration efforts in new territories.
● The Franchisee may obtain sales revenue from customers through the operation of the franchised outlet.
A franchise agreement sets out the terms with respect to a franchise arrangement, and lends enforceability to the parties’ respective rights and obligations.
In this article, we examine 5 key issues to look out for in a franchise agreement.
Issue 1: Franchisor and Franchisee obligations
A franchise agreement would typically set out a whole host of obligations with respect to both the Franchisor and the Franchisee.
Depending on the complexity of the franchise arrangement and the Franchisor’s business model, the obligations of both parties could potentially be wide-ranging, and it is key for parties to scrutinise their respective obligations.
Broadly, the Franchisor’s obligations may include:
● Obligation to provide the Franchisee with a licence to operate its business using its branding and operating systems
● Obligation to provide the Franchisee’s staff with training in relation to its operating systems and business model.
● Obligation to provide Franchisee with consultations and advice with respect to the business model.
● Obligation to provide the Franchisee with updates with respect to its operating systems.
Broadly, the Franchisee’s obligations may include:
● Obligation to comply with the Franchisor’s operating manual and standards.
● Obligation to take all steps necessary to ensure that the Franchisor’s intellectual property (“IP”) is not exposed to third party infringements.
● Obligation to obtain supplies only from suppliers designated by the Franchisor.
● Obligation not to operate any other businesses at the franchised premises.
It is important to pay attention to all of these obligations, no matter how long the list may be, as a breach of any of these obligations may potentially result in grave consequences, including termination and/or an obligation to compensate the innocent party.
Issue 2: Marketing
Apart from general obligations with respect to the operation of the business, a Franchisee may also be required to undertake certain marketing obligations, in order to aid the Franchisor’s market penetration efforts.
Typical marketing obligations may include:
● Obligation to set aside a fixed amount of money for marketing efforts in the region
● Obligation to market the business through channels specified by the Franchisor (e.g. internet, newspaper etc)
● Obligation to use marketing material prescribed by the Franchisor
● Obligation to obtain translated versions of the Franchisor’s marketing material, for use in the relevant jurisdiction
Issue 3: Intellectual Property Rights (“IPR”)
Intellectual Property (“IP”) is generally defined to mean “creations of the mind” – these include inventions, literary and artistic works, and symbols/names/images used in commerce.
A Franchisor’s business model, operating systems and branding are likely to be extremely IP-intensive.
Indeed, it is likely to be the Franchisor’s IP that makes the franchise so valuable in the first place, and a Franchisor is likely to seek stiff protection in respect of its IP in order to maintain a competitive advantage over its rivals and preserve the value in its franchise.
In this regard, a franchise agreement may contain very granular provisions with respect to the Franchisor’s IP. Things to look out for in IP provisions contained in a franchise agreement may include:
● Who own the rights in relation to improvements to the Franchisor’s IP that the Franchisee may develop over the course of the franchise arrangement?
● What steps must the Franchisee undertake (if any) where it suspects that there has an infringement of the Franchisor’s IP rights?
● Is the Franchisee required to assist the Franchisor in making any registrations with respect to the Franchisor’s IP in the relevant jurisdiction?
● What steps is the Franchisee required to undertake in the event that it is required to register the IP on the Franchisor’s behalf in the relevant jurisdiction?
Issue 4: Audit
A Franchisor may also seek extensive audit rights on a Franchisee, in order to ensure that standards are upheld and that its branding is not tarnished.
Issues to pay attention to with respect to audit provisions include:
● What exactly is the Franchisor allowed to audit (e.g. all financial statements of the Franchisee)?
● How often is the Franchisor allowed to exercise such audit rights?
● What are the consequences of the Franchisee failing an audit?
● How bears the costs of audits?
Issue 5: Liability
There are 3 general categories of liability provisions, namely “no liability” clauses, “limited liability’ clauses and “unlimited liability” clauses. These clauses are commonly found ion franchise agreements.
As their respective names suggest, “no liability” clauses set out the scenarios where a party has no liability under the agreement, “limited liability” clauses set out caps on a party’s contractual liability, and “unlimited liability” clauses set out scenarios where a party’s contractual liability is unlimited.
“No liability” scenarios would typically cover loss scenarios that are unforeseeable and/or remote in nature (e.g. various forms of indirect loss, such as loss of profit).
“Unlimited liability” scenarios would cover scenarios where a party’s contractual liability ought to be unlimited. These typically relate to losses arising from conduct that is extremely egregious (e.g. gross negligence, wilful misconduct etc).
The caps set out in “limited liability” clauses could take reference from various values – e.g. the purchase price of the goods and/or services, the amount spent on goods and/or services over the past ‘x’ number of quarters, etc.
It is important to scrutinise these liability provisions – a failure to do so could mean sky-high potential liabilities that could cripple tour business, or a failure to obtain recourse for egregious conduct by the counterparty.
We hope that this article has been helpful to you as a start-up trying to make headway in the exciting, yet uncertain, world of commerce.
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*The above content does not constitute, nor is it offered as, legal advice of any kind. GLS Solutions Pte Ltd is not a law firm and any support provided pursuant to this entity is not regulated legal advice or legal opinion.