Franchising · 1 October 2015

Understanding the niche elements of franchise law

Gordon Drakes has some key information for possible franchisees
Gordon Drakes has some key information for possible franchisees

Gordon Drakes is a senior associate at Fieldfisher, ranked last year by legal guide Chambers UK as the top law firm in franchising. He answers some of the most common questions posed by prospective franchisees and outlines the right way to approach signing up to start a franchise.

(1) Is there any specific franchise legislation in the UK?

There is no franchise-specific legislation in the UK. However, the general principles of contract law apply to franchise agreements. The Unfair Contract Terms Act 1977 applies to exclusions and limitations of liability in standard form business to business contracts (business format franchise agreements usually fall into this category). UK and European competition law also applies to franchise agreements, and in particular to terms which deal with online rights, exclusive territories, retail price maintenance and non-competition restrictions.

The British Franchise Association (BFA) is a trade body which promotes ethical franchising in the UK. Its franchisor members (and their franchise agreements) are required to adhere to the BFA’s Code of Ethics as a condition of membership.

(2) I’ve been asked to pay a deposit before I’ve become a franchisee. Is this normal?

It is common to be asked to pay a deposit before you become a franchisee. The deposit can be a useful way of signalling to the franchisor that you are serious about their business and becoming a franchisee. The franchisor will incur costs in dealing with each applicant, so the deposit will act as a deterrent to those applicants who are not serious.

However, be wary of what you are getting in return for the deposit. Does the deposit secure you an exclusive negotiation period in respect of a particular territory? On what terms, if any, will the deposit be returned to you if you do not proceed with the transaction? Typically, if you become a franchisee, the deposit will be deducted from any upfront fee. If you do not become a franchisee, it should be returned to you, less the franchisor’s reasonably incurred costs.

What’s the purpose of a franchise agreement and what does it cover?

The franchise agreement is the principal agreement which governs your relationship with your franchisor. It sits alongside the operations manual and the business plan – all three documents together form the foundation of your business, so it is essential that you understand the terms of the franchise agreement, otherwise you will not have a strong foundation on which to build a business.

A franchise agreement includes a licence of the franchisor’s key intellectual property, such as the trademark, copyright in materials, any proprietary software and its knowhow (or “business format”), which is set out in the manual. In addition, the franchisor is providing initial and ongoing support and training, and also some centralised services.

There will be a long list of the franchisee’s obligations to follow the business format and comply with guidelines regarding the use of the intellectual property. The franchise agreement will also set out the key financial obligations and what happens when the relationship comes to an end.

Should it be reviewed by a professional solicitor?

Absolutely! If you are going to buy a house, you would get a survey to ensure that the structure of the house and its foundations are sound. The same principle applies here – and investing in a franchise may cost a similar amount or more.

Franchising is a niche area of the law and it is important that you use a solicitor who is experienced in franchising, otherwise they will not be able to advise you comprehensively. You should consider using a solicitor who is an affiliate member of the BFA and also look at the legal directories (Legal 500 and Chambers UK), which rank law firms by sector (franchising being one such sector) on the basis of client feedback.

Are the agreement terms negotiable?

Typically, the terms are non-negotiable for business format franchise agreements, as a franchisor needs to maintain a uniform network and be fair to all of its franchisees. That being said, it may be that you can negotiate certain commercial terms, such as fees, or particular waivers, which would usually be set out in a side letter.

The scope of negotiation depends in part on the maturity or the franchise network, the strength of and demand for the brand, and the type of business opportunity.

Why then is it important to have it reviewed before signing?

Even if the terms are non-negotiable, you should understand what they are before you sign up to them. If you are investing a significant amount of capital (and potentially using your house as security), you should understand what you are getting in return, how long you are tied in for and what happens if you want to sell up or terminate. Forewarned is forearmed.

What happens if I break the terms of the agreement?

The franchisor will have the right to require you to remedy the breach (if it is remediable), and if it is not remedied in time (or the breach is irremediable), the franchisor will have the right to terminate the agreement and/or sue you for damages. It may also have other remedies at its disposal, such as re-drawing your territorial boundaries or withdrawing your exclusive rights.

On termination, you will typically be required to sell the assets in your business to the franchisor and you will not be able to operate a competing business for at least 6-12 months post-termination.
It is therefore essential that you comply with the terms of the franchise agreement, follow the manual and maintain a good commercial relationship with your franchisor.

What if I think the franchisor has broken them?

You should raise the issue with the franchisor, but it that fails to resolve the situation, you should consult your franchise agreement and your solicitor. Typically, a franchisee will have very limited or no contractual rights to terminate, but a franchisee could sue for damages for breach of contract.

If the breach is so fundamental that you are effectively prevented from operating your business, you could rely on the common law principle of “repudiatory breach”, which would allow you to either stay as a franchisee but sue for damages; or terminate the agreement and sue for damages (and you would be free from all of your restrictive covenants). This right is available to you, regardless of what the contract says. However, this is a very narrow right and must be applied carefully to the facts, so it is essential that you obtain legal advice before taking action.

If the issue is system-wide, consider approaching your franchisor as part of a group of franchisees (but be wary of your confidentiality obligations under each franchise agreement), or instructing a solicitor to advise you as a group. Groups of franchisees will have a stronger bargaining position with the franchisor and will have more resources to spend on the necessary legal advice and support.

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ABOUT THE EXPERT

Paul Stafford is the British Franchise Association’s PR manager, which allows him ample opportunity to indulge in two of his passions: writing and business. A background in various SMEs led Stafford to the franchise sector in 2012 and a role which sees him work closely with businesses of all sizes and sectors, from international giants to kitchen table startups.

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