LOCAL ADVERTISING FUND

Under the local advertising fund requirement, a good agreement will provide that franchisor’s corporate units will also contribute on the same basis as franchised outlets.  A thornier area is whether the franchisees’ contribution to shopping centre advertising funds should be deducted from the franchisee’s requirement for local advertising.  Given that landlord advertising programs are universally recognized failures, franchisors (and often franchisees) will prefer or need to expend additional monies for proper local advertising.  Unfortunately, until landlords are persuaded to back down or at least reduce the contributions required of franchisee tenants, it may not be economically possible for the franchisee to bear these duplicate charges.  Accordingly, a setoff should be allowed.

ASSIGNMENT

While most franchise agreements strictly control their assignability, some agreements attempt to prevent assignments entirely or make them subject to the sole and unfettered discretion of the franchisor.  Such provisions except in some very few franchise systems should be amended to provide for consent which will not to be unreasonably withheld, subject to certain reasonable business tests.

Many franchise agreements define the word “assignment” extremely broadly so as to cover any and all conceivable changes of ownership.  While such total control may be desirable the franchisor.  The following exclusions from the definition of assignment will save a lot of time in franchisor/franchisee negotiations that invariably result in concessions being made by the franchisor anyway:

(a)        Shares transfers among existing shareholders;

(b)        Partnership interest transfers among existing partners (which are transferred by right of survivorship or pursuant to a Partnership Agreement);

(c)        Gifts to a Trust or by Will or other inheritance for the benefit of the transferor or members of his immediate family.  In cases of such assignments the Franchisor may make the transfer conditional on the transferees successfully completing the Franchisor’s training program. In such a case, the Franchise Agreement should also provide that the franchisor may manage the franchisees business on behalf of the franchise in the absence of capable next of kin.  The sale of the business should occur over a period of three to six months.

Of course any of the exempted transferees must first sign the necessary confidentiality, non-competition and guarantee provisions (if any), which are required by the Franchise Agreement.

DEFAULT AND TERMINATION

A typical Franchise Agreement will contain upwards of twenty clauses articulating events of default which give the franchisor the right to terminate the Franchise Agreement.  Noted below are some examples of the more contentious provisions, with “step down” provisions highlighted in black:

(a)        if the Franchisee shall breach any other of the material terms or conditions, as determined by the Franchisor, acting reasonably, of this agreement or any other agreement or undertaking entered into pursuant hereto and such breach shall continue for a period of twenty (20) days after written notice thereof has been given to the Franchisee;

(b)        if the Franchisee shall fail to observe or perform any of the rules, bulletins, directives or other notices set forth in the Manual, which in the opinion of the Franchisor, acting reasonably, are material and any such failure to observe or perform same shall continue for a period of ten (10) days after written notice thereof has been given by the Franchisee;

(c)        if the Franchisee makes or purports to make a general assignment for the benefit of creditors and/or is convicted of a criminal offence, which offences substantially impair the goodwill of the Marks or the licences under which business operates;

(d)       if the Franchisee or any agent or representative of the Franchisee knowingly: (i) fails repeatedly to submit any report required to be furnished to the Franchisor pursuant hereto; or (ii) understates Gross Sales by more than three (3%) percent on more than three (3) occasions or if the Franchisor determines such understatement from an audit; (iii) if the Franchisee materially distorts any other material information pertaining to the Franchised Business, or fails to maintain its records in a manner which permits a determination of Gross Sales, unless the Franchisee proves to the satisfaction of the Franchisor that it had no knowledge of such distortion;

(e)        subject to the provisions of Article 15 hereof, if the Franchisee shall die or otherwise become permanently incapacitated and the Franchisee’s spouse, adult child or other immediate member of the Franchisee’s family acceptable to the Franchisor, acting reasonably, does not desire to continue to operate the Franchised Business as provided in accordance with the provisions of the said Article 15 or if the Franchisee shall not have a spouse or adult child.

TRADEMARKS -INTELLECTUAL PROPERTY RIGHTS

The Franchise Agreement should always contain a strong statement acknowledged by the franchisee that the trademarks and the tradenames being licensed, as well as any proprietary trade secrets, are the exclusive property of the franchisor and that the franchisee and its employees will protect the trademarks and trade secrets licensed thereunder against misuse and disclosure.  In this regard the confidential operations manual should always be on an “on loan” basis.  The Franchise Agreement should clearly state that the manual is to be returned to the franchisor on termination for any reason whatsoever without copies being made.

One area of contention that is often encountered in start-up situations arises from the fact that it may take up to eighteen months from the date of submission of a trademark application before registration is granted.  The franchisor may want the right to mandate a change of identity if the tradename/trademark has to be changed.  Assuming that the franchisee will want to proceed with such a franchise, the franchisor should, as a minimum, provide that the franchisor will bear the expense of re-identifying the premises.

NON-COMPETITION

There are two aspects to the issue of non-competition, one involving in-term competition and the second one dealing with post term competition.

With respect to in-term competition, if the Franchise Agreement requires full time and attention of the franchisee or its principals, then the in-term competition clause should not present any problem for the franchisee.  If on the other hand, the franchise system is such that investors would be included in the class of franchisees or prospective franchisees, then an in-term non-competition clause may not be appropriate and to the extent that it is appropriate, may only be so with respect to the business of the franchisor narrowly defined.  The type of covenant obtained or sought to be obtained should reflect the narrow business interest of the concept and should be arrived at in close consultation with the franchisor.

With respect to post-termination non-competition clauses, the law is relatively clear that some form of restriction is enforceable provided such clauses are very carefully drafted.   Franchisors however must be cautious as to the scope of protection that they seek through such clauses for if the protection sought is too broad, then the entire clause may be struck down.

MISCELLANEOUS PROVISIONS

As with any well drafted business agreement intended to govern a long term relationship, a Franchise Agreement should include applicable law, entire agreement, severability and independent relationship clauses.  There should also be a form of notice provision as well as to independent investigation and independent legal advice clauses.  Franchisors who do not insist on their franchisees obtaining independent legal advice do so at their peril.  Furthermore, Franchisor’s counsel acting for both parties place themselves in serious jeopardy.

CONCLUSION

As with any agreement, the drafter has to be as clear, precise and thorough as possible.  With lengthier agreements it is also essential that the document be organized in a logical fashion and that the be internally consistent.  In addition to all of the above, in preparing a Franchise Agreement, the drafter must also be well acquainted with and have a solid understanding of the inner workings of the system to be franchised if he/she is to successfully translate that understanding into the organic document that it should be.