The legal aspects of franchising are wide-ranging although there is no specific franchising legislation in the UK. Instead, a franchise agreement will use commercial contract law as well as intellectual property rights and IP licensing, employment, competition, and dispute resolution law. As a result, franchise agreements can become long and often complex documents to ensure the correct protections are in place to protect the franchisor's brand.
In this guide, we take a look at the legal documents and considerations to successfully franchise your business. And, if you're ready to take the next step in creating and selling a franchise, our team of franchising law experts can provide the right legal support to help you reach your goals.
Contents:
Legal documents needed to franchise your business
When you franchise your business, you will need a variety of legal documents including:
- A non-disclosure agreement – if you don’t want a franchisee to disclose commercial information provided during the franchise negotiations to third parties you will need a non-disclosure agreement. As a franchisee is investing in your franchise, and getting commercial lending, it isn’t surprising that they, their accountants, and lenders, will want to pore over your management accounts and forecasts. For more information on non-disclosure agreements have a read of Non-disclosure agreements: protect confidential business information.
- An exclusivity agreement - when entering negotiations with a franchisee, you may ask the franchisee to enter an exclusivity agreement to prevent the franchisee from entering talks with another franchisor during the exclusivity period
- A franchise agreement – this could be a franchise purchase agreement, a master franchise agreement, or a franchise development agreement depending on your chosen franchise model. For additional reading on models, take a look at our guide to making your business a franchise
- A lease or sub-lease or licence - if you lease or own the premises where the franchisee will operate the business then you will need the franchisee to sign a commercial property agreement
- An intellectual property agreement - a separate licence granting the franchisee the right to use your IP may be necessary
The franchise agreement is the backbone of the relationship between the franchisor and the franchisee. It provides important protections and requires the franchisee to exercise the rights granted in accordance with the conditions imposed by the agreement. The franchise agreement should be supplemented by a franchise manual with the franchisee under a contractual obligation to meet the standards detailed in the manual. The manual protects both the franchisor and the franchisee’s fellow franchisees who will want every franchisee to maintain consistently high standards.
Selling a franchise
From a commercial solicitor’s perspective selling a franchise is similar to selling a business; your buyer will want to undertake due diligence and their lawyers will want to negotiate on aspects of the deal. However, unlike a business sale, you will have an ongoing business and contractual relationship with your franchisee. You are not their employer or business partner or competitor, more of a CEO, with the precise details of your powers and responsibilities and their obligations contained in the franchise agreement.
Selling a franchise doesn’t just involve reviewing your business and collating sufficient financial information to provide to potential franchisees to enable them to undertake due diligence inquiries. The franchise sales process also involves selling your ability to provide overall franchise direction to the franchisee’s business. Selecting the right franchisee is just as important as selling a franchise as a franchise opportunity given the nature of your ongoing business relationship. You need to consider whether the prospective franchisee has the aptitude to run a franchise.
Franchising lawyers recommend that your franchise paperwork is in order before you commence the franchise sales process. For example:
- Writing your franchise manual and testing it during the pilot franchise period
- Getting your franchise agreement drawn up so it is ready for negotiation with potential franchisees
- Checking franchise marketing and due diligence material because if they contain errors or omissions this could amount to misrepresentation. The franchisee could take action for compensation or they might be entitled to terminate the agreement
- If commercial premises are part of the franchise deal make sure you understand what is required; such as the landlord’s consent to a sub-lease
- Registering trademarks and design rights
- Joining a franchise organisation, such as the British Franchise Association (BFA) (other professional associations are available in the UK). The BFA is a self-regulatory body and member franchisors are obliged to follow codes and procedures, such as a code of ethical conduct and disciplinary, complaints, and appeal procedures. Alternatives include committing to comply with the European Code of Ethics for Franchising or joining the International Franchise Association (IFA). The IFA is a self-regulatory body similar to the BFA as it requires franchisors to comply with the IFA code
The franchise agreement
The franchise agreement governs your relationship with your franchisees and provides both franchisor and franchisee with protection. Important protective clauses in the franchise agreement include:
- Franchise standards – the standards you expect your franchisees to meet will be too detailed to include in the agreement but the agreement should refer to the franchise operation manual and give you the right to update the manual. Detailed standards protect franchisees as much as the franchisor as the selection of one rogue non-compliant franchisee can affect the reputation and brand of the entire franchise network
- Payments – whether it is the initial franchise fee, regular monthly payments, or training and advertising fees, it is important to have a clear payment schedule and, if necessary, audit and inspection rights. Read more on making money from franchising.
- Use of trademarks and other Intellectual Property (IP) – you will need to have protected your IP through registration (such as your trademark) and you may need your franchisee to sign a separate IP agreement. It is important that the franchise documentation restricts the franchisee’s use of trademarks and other IP to use in the course of the franchise business and only for the duration of the franchise agreement. If you are new to IP and your rights you may find our article Intellectual Property FAQs a good starting point to understanding IP rights
- Restrictive covenants – use of restrictive covenants can prevent the franchisee from soliciting your customers and suppliers, competing with your business after the end of the franchise agreement, and exploiting confidential information. Care needs to be taken on the scope and extent of restrictive covenants as a covenant will not be enforceable unless it is reasonable in scope and necessary to protect your legitimate interest. Generally, it will be necessary to limit the scope of restrictive covenants to apply to a limited period after termination of the agreement, and within a specified geographical territory, to ensure the restrictive covenant is enforceable. Recent case law has established that in the case of franchising one size does not fit all – you should consider the scope of the restrictive covenants on a case by case basis as each franchise is granted. For a more in-depth look at restrictive covenants take a look at our article on Using Restrictive Covenants in commercial contracts
- Step-in rights - you may want to include a step-in right clause to allow you to give written notice to the franchisee to assume responsibility for the management of the franchisee’s franchise. Such a right should be limited to specific circumstances and termination grounds
- A right of first refusal – this will entitle you to be offered the first opportunity or first refusal to buy back the franchise business before the franchisee offers to sell the business on the open market to a third party. This clause can be complemented by a provision that allows you to buy any goods, equipment, plant, and fixtures that the franchisee posses at the point of termination or expiry of the franchise agreement
- A right of approval – this gives you a right of veto so a franchisee can only sell the franchisee to an approved buyer who has been vetted by you. This is important so that you control who operates the franchise in the future. Such rights are limited in scope because a franchisor must be reasonable when considering whether to grant consent and approval for a sale. If a franchisor unreasonably withholds consent or approval, the franchisee may take action for breach of contract which could lead to the payment of damages, in addition to the court sanctioning the sale to the proposed substitute franchisee
- Termination of the agreement – as a franchisor your ultimate sanction is to terminate the franchise agreement to protect your interests or the interests of the entire franchise network. Termination triggers should be spelled out in a comprehensive termination clause to minimise the risk of franchise disputes. Termination reasons could include persistent failure to comply with the franchise manual or to pay agreed fees or a breach of the agreed use of IP. In the case of non-payment of fees, you may grant a grace period, during which interest will apply on the delayed payment. If the payment is not made within the grace period, you reserve the right to terminate the agreement. Termination rights are generally wide ranging and one sided to protect you as the franchisor. It is unusual for a franchisee to be allowed to terminate the franchise agreement during the term of the agreement
Grounds for a franchisor to terminate a franchise agreement
To terminate a franchise agreement early you need the grounds to do so otherwise you will be in breach of the agreement. It is therefore best to carefully consider the termination provisions in your franchise agreement. Potential reasons why a franchisor may want to terminate a franchise early include:
- Persistent complaints against the franchisee
- Franchisee’s inability to repay its creditors
- Change of control of the franchisee
- Material breach of the franchise agreement by the franchisee
- Failure to pay under the franchise agreement
If you terminate the agreement when you don’t have the grounds to do so a franchisee could start commercial litigation for breach of contract. It is sensible to include dispute resolution clauses in the agreement so there is an agreed dispute resolution mechanism to minimise the risk of court proceedings.
For additional reading on franchise disputes take a look at our article Franchise disputes: common causes and exit strategies.
Is a franchisor liable for the actions of its franchisees?
In the UK, a franchisor is not usually liable for the actions of a franchisee because a franchisee is not an employee of the franchisor. It is sensible to include clauses in the franchise agreement to confirm there is no employment relationship between the franchisor and the franchisee and to limit your liability as a franchisor. You may also want to include provisions about requirements for the franchisee to take out insurance cover in case they are the subject of complaints and litigation as the insurance cover may help to protect the franchise brand.
Can a franchisor sue a franchisee?
A franchisee can be sued by a franchisor for breach of contract if they don’t comply with the franchise agreement. That’s why it is important that the agreement clearly defines the obligations of the franchisee and what amounts to a material breach of contract. Common reasons a franchisor may wish to take action against the franchisee include failure to:
- Maintain franchise standards to the detriment of the brand
- Pay franchise fees
- Comply with advertising obligations within the franchise territory
For minor breaches, a franchisor may be entitled to compensatory damages to put you in the position you would have been in had the breach not occurred. Dispute resolution is often the best solution for minor breaches if the franchisor and franchisee are going to have to continue to work together.
International franchising
Your business may not be suitable for regional UK franchises but it may be entirely suitable for an international franchise network by country or continent. Alternatively, you may have reached the limits of your UK franchise growth opportunities and want to expand your franchise network overseas.
If you are contemplating an international franchise, it is essential to get specialist franchise law advice in each territory that you are looking to enter as your franchise will potentially be subject to local franchise legislation or regulation which can affect how you operate the franchise; how you recruit franchisees and the rights of both parties on termination of the agreement.
For additional reading take a look at our article FAQs: the basics of franchising your business
