This article originally appeared in the materials of the Canadian Bar Association of Ontario 1999
There is a key decision which a lawyer has to make as part and parcel of the initial retainer to establish the legal basis for a franchise system; whether the proposed scheme meets the basic requirements of franchising. Any company considering franchising as a method of growth must satisfy the basic requirements for successful franchising. The key prerequisites to a good franchising company as are follows:
- A proven “system” must be in place before undertaking a franchising program. This means that there must be a prototype of a location which has been tested, refined and operated successfully with demonstrated profitability. If the franchised concept is to be successful, it must be capable of duplication elsewhere, without reference to either the specific location or the special attributes of its operators.
- A distinctive tradename and identity including trademark registration as well as a uniform trade appearance, signage and trade dress;
- Proven methods of operation and management which can be reduced to writing in a comprehensive operations manual, and which can be enforced through objective quality control standards.
- A capable and proven management team consisting of founders, senior officers, etc. as well as qualified consultants (where appropriate). These individuals must understand both the industry as well as the legal and business aspects of franchising as a method of expansion. Above all, however, the key management team must consist of people whose background and character is unimpeachable.
- A training program for franchisees sufficient to impart all the basic components of operating and managing the proposed franchise. In addition, the training program must be supplemented by updates dealing with specific problems or issues not covered by basic pre-takeover training. In this regard, the franchisor must have staff capable of teaching prospective franchisees how to operate the system. A temperamental chef, regardless of how renowned he might be, is unlikely to be a good teacher of prospective franchisees, if he constantly fights with his sous-chefs.
- If the proposed franchise concept is a business format, the franchisor must have developed consistent site selection criteria and architectural standards that can be secured affordably in a competitive real estate marketplace.
- The franchisor must have developed relationships with suppliers, lenders and real estate people, so as to be able to launch an effective franchise program.
- Each franchisor must create a typical franchisee profile taking into account the nature of the franchised business and the consequential requirements, both in terms of personal as well as financial investment by prospective franchisees. Failure to prepare appropriate criteria for franchisee selection will undoubtedly lead to costly litigation sooner rather than later. Possession of the minimum cash requirements should never be the primary consideration in evaluating a prospective franchisee.
- The prospective franchisor must have developed an effective accounting and reporting system. This is necessary as a management tool as well as to ensure that franchisees report and remit royalties and other dues accurately and faithfully as and when required under the system. If the prospective system involves the handling of a large variety of goods (i.e. a convenience store) a sophisticated inventory control/point of sales system is also a must.
- Finally, the franchisor must develop and have a comprehensive set of legal documents in place, which reflect the peculiar needs of the specific system as well as the dynamics and idiosyncrasies of each particular management team. Merely copying a competitor’s franchise documentation package is a certain formula for disaster, even if the franchisor copied is successful.
Any prospective franchisor who does not possess the above noted “basics” is unlikely to be successful. Accordingly, it is incumbent upon lawyers counselling such franchisors to so advise. There is absolutely nothing wrong with saying to a client that in your opinion they are not ready yet and they should come back to see you in six months, a year or two years, when they have developed the above noted prerequisites.
Assuming that the prospective franchisor has satisfied the prerequisites for a potentially successful franchising company, franchisor’s counsel will draft a franchise agreement. In doing so, it is critical to be aware of the fundamental difference between a franchise agreement versus other contracts. It is by now trite to say that the franchise concept is an organic one and therefore unlike most other contracts known lawyers. Each and every other contract is designed, (as much as language will permit) to stipulate the rights and duties and obligations of each party from day one through to the last day of the term, the franchise agreement by contrast is intended to permit changes to the basic relationship. This flexibility is necessary for a variety of reasons, most of which are probably beyond the contemplation of the parties at the time of the drafting of the franchise document. For an excellent discussion on this point I refer you to an article by Gillian K. Hadfield, “Problematic Relations: Franchising and the Law of Incomplete Contracts” (1990) 42 Stanford Law Review, 927.