“Trust but verify.” That phrase is most associated with the Cold War era, but it also makes practical sense in the modern world for a variety of reasons, including if you are considering buying a franchise. Prospective franchisees need to be able to count on the franchisor’s brand, expertise, training and support to help them succeed.
From the franchisor’s point of view, a franchisor seeks reputable people who they can trust to represent and grow their brand. But with so much at stake for both parties, the legal requirements are extensive and complex. As a prospective franchisee with a substantial investment on the line, it is crucial that you understand the franchise agreement before you sign on the dotted line.
Legal considerations for franchisees
Before signing off on a franchise agreement, it is critical to consult with an experienced franchise law attorney who can provide a sophisticated review of all the documents. But it is essential to have an understanding of what those documents entail as well as your rights and legal protections. Here are terms and documents you should know before investing:
FTC Franchise Rule
The Federal Trade Commission established the Franchise Rule in 1979 and amended it in 2006, effective in 2008, which requires franchisors to disclose critical information about themselves and their company to prospective franchisees. The document containing this information is called the Franchise Disclosure Document (FDD). The FDD outlines 23 categories of the franchise’s operation, including:
- The franchisor’s financial statement
- Earnings claims
- Required fees for franchisees
- Litigation and bankruptcy history
- The term of the franchise agreement
- Investment requirements for franchisees
- Obligations of the franchisor to the franchisee
- Obligations of the franchisee to the franchisor
Franchisors must also disclose certain information about their officers and other franchisees, and the FDD must be updated yearly within 120 days of the franchisor’s financial year-end. The FTC instituted the Franchise Rule to protect all parties from deceptive practices, such as fraud or misrepresentations in inducing a prospective franchisee to invest. The FDD is required to be written in “Plain English” and not legalese.
The franchise agreement
Franchise agreements are legally binding documents outlining the conditions and terms for the franchisee and franchisor. The agreement stipulates how the franchisee is expected to run the business and what help they can expect from the franchisor. Franchise agreements generally contain these elements:
- An overview of the franchisor-franchisee relationship, including the parties involved, the ownership of intellectual property and the franchisee’s obligations to meet brand standards
- The length of the relationship
- Requirements to upgrade the business’s location
- Initial and continuing fees required by the franchisor
- The franchise’s assigned territory and whether it is an exclusive or protected area
- Site selection and development support provided by the franchisor
- Initial training and ongoing support
- How franchisees can use trademarks, patents, manuals and other intellectual property
- The franchisee’s advertising obligations
- Minimum insurance requirements for franchisee during the agreement’s term
- Record-keeping requirements
- Franchisor’s right to audit the franchisee’s books
Franchise agreements are not boilerplate documents. Since each franchise depends upon its brand promise, these agreements are typically unique and complex. In many cases, they are contracts of adhesion, meaning the terms are typically heavily weighted in favor of the franchisor and franchisors are usually not open to changing them. In an established franchise, the uniformity of the system starts with the franchise agreement.
Franchisors must give prospective franchisees a minimum of 14 calendar days to review the FDD. An additional seven calendar days are required to allow the franchisee to review the completed franchise agreement. These two timelines can overlap if there have not been negotiated changes to the franchise agreement.
By this point, you have done extensive research into the franchise and whether it checks all the boxes regarding the type of business you want to invest in and the potential for success. But do not let the excitement of operating your own business overwhelm caution and diligence.
Once you receive these documents, it is essential to have a lawyer skilled in franchise law review them to identify potential red flags. Having a knowledgeable lawyer is a critical last step in the process and can save you from experiencing substantial personal, financial and legal headaches in the future.
Are franchise agreements negotiable?
It depends. Most successful franchises rely on a consistent and sustained duplication of their brand’s procedures and policies. Most established franchises with hundreds or thousands of franchisees are very unlikely to change the agreement.
On the other hand, newer franchises may be more willing to negotiate changes to the franchise agreement. Prospective franchisees for emerging brands are taking a significant investment risk compared to buying an established brand and should be able to expect franchisors to offer more leeway when negotiating contracts. Likewise, you may also have more leverage if you want to buy multiple franchises.
One important thing to remember is to keep your requests reasonable. Franchise agreements are not like other types of business contracts and do not get redlined and negotiated with hundreds of revisions. Do not expect a franchisor to lower fees or change their products or services. After all, they are trying to build a brand and making piecemeal changes to franchisees affects brand consistency, which is a core principle for success.
Understand exit requirements before you sign
The excitement of attaining the American dream of owning your own business, especially if you are a first-time business owner, can sometimes make people forget to look into the future to a time when it might be necessary to sell the franchise. Most franchisors have specific rules for selling an existing franchise.
Under the best circumstances, franchisors offer some flexibility. But you must understand precisely what the agreement stipulates, so you are not caught off-guard if you need to sell the franchise for financial or other reasons. It is also vital to understand the potential tax consequences related to the sale.
Seek specialized legal guidance
The franchise attorneys at Lanard and Associates have represented franchisees for more than 25 years. The franchise agreement is a very important and long-term contract that is not easily understood. It is important to have a full legal review of the documents to ensure that you have a clear understanding of what your obligations are to the franchisor and what to expect from the franchisor. We review critical details of franchise-related documents, such as:
- Franchise agreements
- Multi-unit development agreements
Knowledgeable franchise lawyers also verify that trademarks are federally-registered, valid and live. In some cases, we negotiate franchise agreements on behalf of our clients to protect them legally and financially. Trust is a cornerstone of the franchisor-franchisee relationship, but legal protections are essential for your personal and professional well-being.