L. Seth Stadfeld 781-444-4883
L. Seth Stadfeld 781-444-4883
franchise-counsel.com

Representing Franchisees

THE BUSINESS LAWYER

REPRESENTING PROSPECTIVE FRANCHISEES

By Elizabeth D. Sigety and L. Seth Stadfeld
__________________________________________

Introduction

Most attorneys with any knowledge of franchising recognize that a franchisor cannot even take baby steps towards starting its business without engaging the services of an experienced franchise attorney. But what about the prospective franchisee? When talking to potential franchisees, a lawyer may hear, "Well, I am told the franchise agreement is not negotiable, so why should I need a lawyer?"; or "The franchisor says I don't really need a lawyer until I start my business or negotiate my lease. What can you do for me now?" This article is meant to answer these questions. An experienced franchise attorney can provide a number of advantages to a prospective franchisee considering an investment in a franchised business and launching that business. A franchise attorney can educate the new franchisee on the rights and responsibilities of being a member of a franchise system and can offer advice about the franchisee's rights under franchise laws and regulations. The attorney can give insight into the business of franchising and, upon learning the prospective franchisee's circumstances, can offer constructive comments and clarifications for negotiation and discussion with the franchisor. Aside from all the other legal needs that any business, franchised or not, has, a franchise lawyer can help the potential new business owner to take a first giant step into the world of franchising.

Business Considerations

Because franchise relationships are not for everyone and there is no guarantee of success, prospective franchisees must evaluate carefully a variety of business considerations wholly apart from legally mandated disclosures. They must assess the relative benefits, drawbacks and alternatives to each opportunity.

Consider the following basic business concerns: (i) the industry under consideration and prospects for short and long term industry growth; (ii) whether the particular business can be taught easily to others; (iii) whether experience is necessary; (iv) whether geographic factors may affect the probabilities for success; (v) the time commitment necessary to operate the business successfully; (vi) the capital investment necessary to establish and maintain the business and the individual prospect's financial capacity to handle it; (vii) the actual experience (financial and personal) of existing franchisees as well as the franchisor's track record in such a business; (viii) the legal rights/obligations of the parties in the relationship; and (ix) whether the prospect will be compatible with the franchise business, including the capacity to balance entrepreneurial zeal with the necessity of following the franchisor's system of business operation. Indeed, often actually working in the franchise business before investing makes sense.

Once one has decided on a particular industry or type of opportunity, the next step is to evaluate available offers, franchised and non-franchised, in the field. In addition to legally required disclosure documents for a franchise opportunity, typically a seller provides prospects with marketing literature that describes the company and its opportunity. At best, these materials are a starting point for careful evaluation. While informative, often they accentuate the positive and omit the negative. Some suffer from hype and distortion. At worst, they contain fraudulent statements and/or deceptive omissions. The astute franchise prospect must take time to investigate all available legal and objective sources, including existing and former franchise owners, to fully assess the pros and cons of an opportunity. When doing so, the following key business factors should be addressed.

Financial Performance Representations . Clearly, a prospect's most important question is: "What kind of money can I make if I buy this franchise?" Of course, one should ask existing franchisees about their experience in this area. Frequently, however, their answers may not be informative or reliable. What is more, franchisors need not provide this information as a matter of law. But a prospect should proceed very cautiously, if at all, if a franchisor does not include a helpful financial performance representation in its Franchise Disclosure Document (FDD) under circumstances where it ought to have responsive information in its files. It may be that the reason for nondisclosure is that its franchisees are not doing well and a disclosure making this plain will have an adverse effect on its ability to sell franchises. When one is looking to buy a non-franchised business, detailed information on sales, expenses and profit/loss is always available. The situation should not be different if a franchise purchase is under consideration. Prospects should avoid distracting salesmanship and act accordingly.

Franchisor's Financial Health . Typically, three years of audited franchisor financial statements are provided in the FDD so that prospects can evaluate its financial condition and historical performance. It may be wise to have an accountant review them. Can the franchisor pay its debts as they come due? Must it sell franchises to meet its obligations (a bad sign) or does it otherwise have sufficient cash flow to operate via franchise royalties, product sales or similar sources? Does it have sufficient net worth so that it will be there over the long term of a franchise agreement? If sued, can it pay a substantial judgment? Finally, study the notes to the statements because often they contain statements about the franchisor, its affiliates and its business that have not been filtered through counsel.

Franchisor Personnel . Evaluate the franchisor's staff to determine if it has the expertise,

experience and capacity to provide meaningful support and guidance to franchisees. Is their experience in the actual business of the type to be franchised (such as running a restaurant) or is it in unrelated areas or just franchising itself? Particularly where the franchise involved does not have a well-known trademark, it is the actual know-how in operating the franchised business that should be most important to prospective franchisees. Financially weak franchisors may allocate their scare resources in other areas, such as franchise sales and accounting. Each opportunity should be carefully scrutinized to see if there is sufficient qualified personnel to train, service and supervise franchisees adequately. Finally, as with the franchisor organization, any material adverse litigation history or bankruptcy history involving franchisor personnel should be thoroughly investigated and taken seriously.

Training and Support . Because most prospects don't have experience in the franchise business, they depend greatly on the franchisor's initial training as well as ongoing training and assistance during the relationship. The quality of franchise training programs varies greatly. Similarly, some franchisors regularly visit their franchisees to evaluate and help them in their businesses while others do not. In addition to evaluating a franchisor's capacity to support franchisees by assessing its financial condition and the ability and capacity of available personnel, prospects should investigate extensively with existing franchisees to discern if they are satisfied in this area.

Site Selection Guidance . For franchise businesses where location is important, prospects should learn if the franchisor provides (or requires) sophisticated site analysis or merely provides comparatively perfunctory approval of sites selected by inexperienced franchisees. Is the site sufficiently accessible? Is there adequate parking? Is it attractive demographically? Because site analysis often calls for sophisticated tools and skills, some franchisors will not allow prospects to do it. Thus, a franchisor's undertakings and talents in this area should be seriously considered.

Trademark and Advertising . The strength of the principal mark under which the franchise will operate is crucially important. It should be distinctive, legally protectable against use by unauthorized third parties and the subject of customer good will in the marketplace. In point of fact, the great majority of franchises do not offer trademarks with substantial good will, particularly in the locality where most franchisees will set up shop. Also, the prospect must determine the kinds and extent of advertising (national, regional, local) that is provided by the franchise system and undertaken by franchisees. Advertising (for the brand's products/services - not for the solicitation of franchise sales) has been described as the "life blood" of a franchise system. While franchisees typically are assessed fees for advertising programs administered by the franchisor, such payments do not always translate into promotions that drive sales in their markets.

Source Restrictions . Whether for the establishment or ongoing operation of the franchise business, many franchisors make their franchisees purchase or lease goods, services, equipment or real estate from them, their affiliates or designated suppliers in which they have a financial interest. This may be done for quality control purposes or to offer franchisees necessary items on the most attractive terms available. Conversely, however, some franchisors treat their franchisees as "profit centers" and make a tidy mark-up on these transactions. Also, some receive rebates or comparable benefits from suppliers to franchisees that increase the cost of these items to franchisees. Accordingly, prospects should investigate carefully any source restrictions to understand the financial ramifications and to learn if they will have any freedom to deal with alternative suppliers.

Territorial and Competitive Considerations . Although not appropriate for every business, typically franchisees want protection from market saturation. While interbrand competition is understandable, intrabrand competition from encroaching units in their own system can be a serious problem. They seek the franchisor's promise by contract to grant them an exclusive territory in which it will not establish competing system units. Some franchisors agree to this while others do not. And even when they do, typically they reserve rights to compete against their franchisees in other ways. They may establish competing businesses under different trademarks or sell competing goods or services through other distribution channels, such as retail outlets or via the internet. Prospects must assess the franchise offering carefully as well as specific markets under consideration, to fully understand their rights and risks in this area.

Legal Considerations

The Franchise Disclosure Document

When a prospect is considering the purchase of a franchised business, the most easily obtainable information is contained in the FDD, which must be given to a prospective franchisee 14 days (or in some states 10 business days) before the franchisee pays for the franchise or signs an agreement. The information contained in the FDD is precisely prescribed by the Federal Trade Commission and must contain all of the information required by the FTC Franchise Rule. Though the prospective franchisee should not rest his/her investigation of a franchised business solely on review of the FDD, the information in the FDD addresses most of the topics discussed above and is the most important document for the prospect to review during due diligence.

Among others, the following items must be included in the FDD: cost figures for the establishment and operation of the business (which include the initial franchise fee, royalties, and advertising fees), the type of assistance that the franchisor may offer to the franchisee (such as training and site selection), contractual provisions (including rights and obligations involving termination, renewal and transfer of the franchise), important financial information (including financial statements of the franchisor), litigation and bankruptcy history of the franchisor and its management personnel, and historical statistics on the franchise system (including number of units open, terminations, non-renewals and transfers). Also, the FDD must describe the territory's exclusivity, or lack thereof. This section in the FDD and the franchise agreement should be analyzed carefully, as discussed previously in this article.

As for forward-looking financial information, it is important for the attorney and potential franchisee to understand that any financial performance representations or projections about the franchised business presented by the franchisor to the franchisee outside of the FDD may well be illegal. If properly instructed, franchise salespersons will be very careful to avoid giving such information other than that contained in the FDD. Figures written on cocktail napkins have been the subject of successful lawsuits against franchisors. Such financial information must be contained in the FDD in the financial performance representation section or not be disclosed at all. When considering franchises that do not give a financial performance representation in the FDD, the potential franchisee must be thorough in interviewing current and past franchisees, as they may discuss the financial aspects of their businesses. The FDD must contain lists of franchisees, both current and past. Contacting these franchisees, both those recommended by the franchisor and others randomly selected from these lists, is an important part of the due diligence that a prospective franchisee should undertake prior to making an investment decision.

The Franchise Agreement

Just as one's house rests on a foundation, a franchised business rests on the franchise agreement. A form of the franchise agreement is contained in the FDD. Franchise agreements are prepared in the best interests of the franchisor, and there are good reasons for this. They contain many franchisor rights and corresponding franchisee obligations in order to achieve a uniform identity among outlets in a franchise system. This benefits both the franchisor and the franchisees and strengthens many aspects of the franchise relationship, such as use by franchisees of the franchisor's trademarks and standards for goods and services offered by franchisees under them.

Especially in states where franchisees have no statutory or other legal rights, the foundation of the franchisee's business will be shaky and weak if built upon many provisions contained in the typical franchise contract. Accordingly, franchisee counsel must fully explain to the prospect/client that s/he will be in a very vulnerable position if s/he signs the contract as initially offered. Negotiating certain rights in order to firm up the foundation for the franchised business is good practice. Generally, if a franchisee does not negotiate even a modicum of rights at the start, s/he will not gain them during the relationship. It is far better for a franchisee to enter the relationship relying on rights and sound information, than on hope and trust in the franchisor that it will do the right thing in a critical situation.

In the franchise sales process, a prospect often may hear from the franchisor that it does not really enforce certain provisions of the franchise agreement in practice and conducts business in a different way - sometimes blaming the provisions on its legal counsel's insistence. It may refer the prospective franchisee to other operators in the system for proof of current practice. The attorney should question why the agreement does not reflect the practices of the franchisor and request amendment or clarification. Remember, frequently franchise systems are sold and the purchaser may decide to enforce the agreement.

This does not mean that many, or even most, franchisors will not operate in good faith. But it is simply unwise, from the franchisee's perspective, to make a substantial investment and to sign on to substantial contract obligations with "fingers crossed" and little else. Some franchisors will negotiate. Others will not. Sometimes, developed systems are more resistant to making amendments than newer systems. Often, amendments are granted more easily when special circumstances relating to a specific franchisee recommend changes due to a particular business situation. But, whatever system is being reviewed or whatever the circumstances, the prospective franchisee has absolutely nothing to lose and everything to gain by conducting a thorough review of the franchise agreement and requesting desired revisions.

For example, provisions that should be considered and addressed are:

  • Do the termination provisions permit a sufficient period of time in which to cure defaults? Does the franchisor have the power to terminate the franchisee for relatively minor infractions?
  • Are there any limits on future increases in fees or expenses, whether on the royalty, advertising fee or other expenses, or on expenses franchisees may incur relating to major system changes?
  • Is the assistance and training contractually required by the franchisor sufficient to educate the franchisee and enable him/her to commence the business? Is there adequate post-training consultation and support, including on-site assistance?
  • Are the dispute resolution provisions one-sided? Are there adverse remedial restrictions such as onerous liquidated damages provisions?

It is important for the prospect to understand the ramifications of the personal guarantee, which is required by most franchise systems. The risks associated with these guarantees must be evaluated, particularly in connection with indemnification provisions and liquidated damages provisions. Sometimes, these can be negotiated. Also, if the franchise agreement contains a minimum royalty and does not allow the franchisee to terminate the agreement, franchisees with minimal or no operations can find themselves owing these minimum royalties to the franchisor, and having personal liability for them.

Finally, a prospect must be made aware of the adverse effect that the non-compete provisions of the franchise agreement may have on his or her ability to conduct business if the agreement is terminated. If a franchisee was in the same or a similar business prior to purchasing the franchise, a broadly crafted non-compete provision may prevent him or her from continuing in that business after a termination of the franchise. Similarly, many franchise agreements contain a post-term collateral lease assignment to the franchisor and/or option of the franchisor to purchase certain assets of a franchisee. Such provisions permit the franchisor to succeed to the franchisee's business with little or no compensation to the franchisee. These provisions can have a devastating effect in many instances. They should be examined and negotiated to allow the franchisee enough security to continue in his or her profession if the franchised business is not successful.

Conclusion

Prospective franchisees must exercise diligence and care in evaluating and investigating franchise opportunities. Many business and legal factors must be considered as illustrated above. Franchisees should not let themselves be persuaded into making quick decisions that could have disastrous long-term effects. Rather, they should invest the time and resources necessary to evaluate competing opportunities thoroughly.

Competent counsel is essential to this mission, both to evaluate each offering and represent the prospect in negotiations with the franchisor should the opportunity present itself. For most clients, the decision to buy a franchise and establish a franchised business is monumental, much like the decision to purchase one's home. A comprehensive investigation and analysis must be done, and guidance obtained, before a franchisee signs the contract and pays the fee. Counsel for the franchisor is typically able and experienced in franchise law. Prospective franchisees deserve comparable expertise. Accordingly, their lawyers should educate themselves sufficiently in franchise law matters or direct the prospect to an attorney who is knowledgeable in the area.

THE BUSINESS LAWYER

REPRESENTING PROSPECTIVE FRANCHISEES

By Elizabeth D. Sigety and L. Seth Stadfeld

__________________________________________

Introduction

Most attorneys with any knowledge of franchising recognize that a franchisor cannot even take baby steps towards starting its business without engaging the services of an experienced franchise attorney. But what about the prospective franchisee? When talking to potential franchisees, a lawyer may hear, "Well, I am told the franchise agreement is not negotiable, so why should I need a lawyer?"; or "The franchisor says I don't really need a lawyer until I start my business or negotiate my lease. What can you do for me now?" This article is meant to answer these questions. An experienced franchise attorney can provide a number of advantages to a prospective franchisee considering an investment in a franchised business and launching that business. A franchise attorney can educate the new franchisee on the rights and responsibilities of being a member of a franchise system and can offer advice about the franchisee's rights under franchise laws and regulations. The attorney can give insight into the business of franchising and, upon learning the prospective franchisee's circumstances, can offer constructive comments and clarifications for negotiation and discussion with the franchisor. Aside from all the other legal needs that any business, franchised or not, has, a franchise lawyer can help the potential new business owner to take a first giant step into the world of franchising.

Business Considerations

Because franchise relationships are not for everyone and there is no guarantee of success, prospective franchisees must evaluate carefully a variety of business considerations wholly apart from legally mandated disclosures. They must assess the relative benefits, drawbacks and alternatives to each opportunity.

Consider the following basic business concerns: (i) the industry under consideration and prospects for short and long term industry growth; (ii) whether the particular business can be taught easily to others; (iii) whether experience is necessary; (iv) whether geographic factors may affect the probabilities for success; (v) the time commitment necessary to operate the business successfully; (vi) the capital investment necessary to establish and maintain the business and the individual prospect's financial capacity to handle it; (vii) the actual experience (financial and personal) of existing franchisees as well as the franchisor's track record in such a business; (viii) the legal rights/obligations of the parties in the relationship; and (ix) whether the prospect will be compatible with the franchise business, including the capacity to balance entrepreneurial zeal with the necessity of following the franchisor's system of business operation. Indeed, often actually working in the franchise business before investing makes sense.

Once one has decided on a particular industry or type of opportunity, the next step is to evaluate available offers, franchised and non-franchised, in the field. In addition to legally required disclosure documents for a franchise opportunity, typically a seller provides prospects with marketing literature that describes the company and its opportunity. At best, these materials are a starting point for careful evaluation. While informative, often they accentuate the positive and omit the negative. Some suffer from hype and distortion. At worst, they contain fraudulent statements and/or deceptive omissions. The astute franchise prospect must take time to investigate all available legal and objective sources, including existing and former franchise owners, to fully assess the pros and cons of an opportunity. When doing so, the following key business factors should be addressed.

Financial Performance Representations . Clearly, a prospect's most important question is: "What kind of money can I make if I buy this franchise?" Of course, one should ask existing franchisees about their experience in this area. Frequently, however, their answers may not be informative or reliable. What is more, franchisors need not provide this information as a matter of law. But a prospect should proceed very cautiously, if at all, if a franchisor does not include a helpful financial performance representation in its Franchise Disclosure Document (FDD) under circumstances where it ought to have responsive information in its files. It may be that the reason for nondisclosure is that its franchisees are not doing well and a disclosure making this plain will have an adverse effect on its ability to sell franchises. When one is looking to buy a non-franchised business, detailed information on sales, expenses and profit/loss is always available. The situation should not be different if a franchise purchase is under consideration. Prospects should avoid distracting salesmanship and act accordingly.

Franchisor's Financial Health . Typically, three years of audited franchisor financial statements are provided in the FDD so that prospects can evaluate its financial condition and historical performance. It may be wise to have an accountant review them. Can the franchisor pay its debts as they come due? Must it sell franchises to meet its obligations (a bad sign) or does it otherwise have sufficient cash flow to operate via franchise royalties, product sales or similar sources? Does it have sufficient net worth so that it will be there over the long term of a franchise agreement? If sued, can it pay a substantial judgment? Finally, study the notes to the statements because often they contain statements about the franchisor, its affiliates and its business that have not been filtered through counsel.

Franchisor Personnel . Evaluate the franchisor's staff to determine if it has the expertise, experience and capacity to provide meaningful support and guidance to franchisees. Is their experience in the actual business of the type to be franchised (such as running a restaurant) or is it in unrelated areas or just franchising itself? Particularly where the franchise involved does not have a well-known trademark, it is the actual know-how in operating the franchised business that should be most important to prospective franchisees. Financially weak franchisors may allocate their scare resources in other areas, such as franchise sales and accounting. Each opportunity should be carefully scrutinized to see if there is sufficient qualified personnel to train, service and supervise franchisees adequately. Finally, as with the franchisor organization, any material adverse litigation history or bankruptcy history involving franchisor personnel should be thoroughly investigated and taken seriously.

Training and Support . Because most prospects don't have experience in the franchise business, they depend greatly on the franchisor's initial training as well as ongoing training and assistance during the relationship. The quality of franchise training programs varies greatly. Similarly, some franchisors regularly visit their franchisees to evaluate and help them in their businesses while others do not. In addition to evaluating a franchisor's capacity to support franchisees by assessing its financial condition and the ability and capacity of available personnel, prospects should investigate extensively with existing franchisees to discern if they are satisfied in this area.

Site Selection Guidance . For franchise businesses where location is important, prospects should learn if the franchisor provides (or requires) sophisticated site analysis or merely provides comparatively perfunctory approval of sites selected by inexperienced franchisees. Is the site sufficiently accessible? Is there adequate parking? Is it attractive demographically? Because site analysis often calls for sophisticated tools and skills, some franchisors will not allow prospects to do it. Thus, a franchisor's undertakings and talents in this area should be seriously considered.

Trademark and Advertising . The strength of the principal mark under which the franchise will operate is crucially important. It should be distinctive, legally protectable against use by unauthorized third parties and the subject of customer good will in the marketplace. In point of fact, the great majority of franchises do not offer trademarks with substantial good will, particularly in the locality where most franchisees will set up shop. Also, the prospect must determine the kinds and extent of advertising (national, regional, local) that is provided by the franchise system and undertaken by franchisees. Advertising (for the brand's products/services - not for the solicitation of franchise sales) has been described as the "life blood" of a franchise system. While franchisees typically are assessed fees for advertising programs administered by the franchisor, such payments do not always translate into promotions that drive sales in their markets.

Source Restrictions . Whether for the establishment or ongoing operation of the franchise business, many franchisors make their franchisees purchase or lease goods, services, equipment or real estate from them, their affiliates or designated suppliers in which they have a financial interest. This may be done for quality control purposes or to offer franchisees necessary items on the most attractive terms available. Conversely, however, some franchisors treat their franchisees as "profit centers" and make a tidy mark-up on these transactions. Also, some receive rebates or comparable benefits from suppliers to franchisees that increase the cost of these items to franchisees. Accordingly, prospects should investigate carefully any source restrictions to understand the financial ramifications and to learn if they will have any freedom to deal with alternative suppliers.

Territorial and Competitive Considerations . Although not appropriate for every business, typically franchisees want protection from market saturation. While interbrand competition is understandable, intrabrand competition from encroaching units in their own system can be a serious problem. They seek the franchisor's promise by contract to grant them an exclusive territory in which it will not establish competing system units. Some franchisors agree to this while others do not. And even when they do, typically they reserve rights to compete against their franchisees in other ways. They may establish competing businesses under different trademarks or sell competing goods or services through other distribution channels, such as retail outlets or via the internet. Prospects must assess the franchise offering carefully as well as specific markets under consideration, to fully understand their rights and risks in this area.

Legal Considerations

The Franchise Disclosure Document
When a prospect is considering the purchase of a franchised business, the most easily obtainable information is contained in the FDD, which must be given to a prospective franchisee 14 days (or in some states 10 business days) before the franchisee pays for the franchise or signs an agreement. The information contained in the FDD is precisely prescribed by the Federal Trade Commission and must contain all of the information required by the FTC Franchise Rule. Though the prospective franchisee should not rest his/her investigation of a franchised business solely on review of the FDD, the information in the FDD addresses most of the topics discussed above and is the most important document for the prospect to review during due diligence.

Among others, the following items must be included in the FDD: cost figures for the establishment and operation of the business (which include the initial franchise fee, royalties, and advertising fees), the type of assistance that the franchisor may offer to the franchisee (such as training and site selection), contractual provisions (including rights and obligations involving termination, renewal and transfer of the franchise), important financial information (including financial statements of the franchisor), litigation and bankruptcy history of the franchisor and its management personnel, and historical statistics on the franchise system (including number of units open, terminations, non-renewals and transfers). Also, the FDD must describe the territory's exclusivity, or lack thereof. This section in the FDD and the franchise agreement should be analyzed carefully, as discussed previously in this article.

As for forward-looking financial information, it is important for the attorney and potential franchisee to understand that any financial performance representations or projections about the franchised business presented by the franchisor to the franchisee outside of the FDD may well be illegal. If properly instructed, franchise salespersons will be very careful to avoid giving such information other than that contained in the FDD. Figures written on cocktail napkins have been the subject of successful lawsuits against franchisors. Such financial information must be contained in the FDD in the financial performance representation section or not be disclosed at all. When considering franchises that do not give a financial performance representation in the FDD, the potential franchisee must be thorough in interviewing current and past franchisees, as they may discuss the financial aspects of their businesses. The FDD must contain lists of franchisees, both current and past. Contacting these franchisees, both those recommended by the franchisor and others randomly selected from these lists, is an important part of the due diligence that a prospective franchisee should undertake prior to making an investment decision.

The Franchise Agreement
Just as one's house rests on a foundation, a franchised business rests on the franchise agreement. A form of the franchise agreement is contained in the FDD. Franchise agreements are prepared in the best interests of the franchisor, and there are good reasons for this. They contain many franchisor rights and corresponding franchisee obligations in order to achieve a uniform identity among outlets in a franchise system. This benefits both the franchisor and the franchisees and strengthens many aspects of the franchise relationship, such as use by franchisees of the franchisor's trademarks and standards for goods and services offered by franchisees under them.

Especially in states where franchisees have no statutory or other legal rights, the foundation of the franchisee's business will be shaky and weak if built upon many provisions contained in the typical franchise contract. Accordingly, franchisee counsel must fully explain to the prospect/client that s/he will be in a very vulnerable position if s/he signs the contract as initially offered. Negotiating certain rights in order to firm up the foundation for the franchised business is good practice. Generally, if a franchisee does not negotiate even a modicum of rights at the start, s/he will not gain them during the relationship. It is far better for a franchisee to enter the relationship relying on rights and sound information, than on hope and trust in the franchisor that it will do the right thing in a critical situation.

In the franchise sales process, a prospect often may hear from the franchisor that it does not really enforce certain provisions of the franchise agreement in practice and conducts business in a different way - sometimes blaming the provisions on its legal counsel's insistence. It may refer the prospective franchisee to other operators in the system for proof of current practice. The attorney should question why the agreement does not reflect the practices of the franchisor and request amendment or clarification. Remember, frequently franchise systems are sold and the purchaser may decide to enforce the agreement.

This does not mean that many, or even most, franchisors will not operate in good faith. But it is simply unwise, from the franchisee's perspective, to make a substantial investment and to sign on to substantial contract obligations with "fingers crossed" and little else. Some franchisors will negotiate. Others will not. Sometimes, developed systems are more resistant to making amendments than newer systems. Often, amendments are granted more easily when special circumstances relating to a specific franchisee recommend changes due to a particular business situation. But, whatever system is being reviewed or whatever the circumstances, the prospective franchisee has absolutely nothing to lose and everything to gain by conducting a thorough review of the franchise agreement and requesting desired revisions.

For example, provisions that should be considered and addressed are:

  • Do the termination provisions permit a sufficient period of time in which to cure defaults? Does the franchisor have the power to terminate the franchisee for relatively minor infractions?
  • Are there any limits on future increases in fees or expenses, whether on the royalty, advertising fee or other expenses, or on expenses franchisees may incur relating to major system changes?
  • Is the assistance and training contractually required by the franchisor sufficient to educate the franchisee and enable him/her to commence the business? Is there adequate post-training consultation and support, including on-site assistance?
  • Are the dispute resolution provisions one-sided? Are there adverse remedial restrictions such as onerous liquidated damages provisions?

It is important for the prospect to understand the ramifications of the personal guarantee, which is required by most franchise systems. The risks associated with these guarantees must be evaluated, particularly in connection with indemnification provisions and liquidated damages provisions. Sometimes, these can be negotiated. Also, if the franchise agreement contains a minimum royalty and does not allow the franchisee to terminate the agreement, franchisees with minimal or no operations can find themselves owing these minimum royalties to the franchisor, and having personal liability for them.

Finally, a prospect must be made aware of the adverse effect that the non-compete provisions of the franchise agreement may have on his or her ability to conduct business if the agreement is terminated. If a franchisee was in the same or a similar business prior to purchasing the franchise, a broadly crafted non-compete provision may prevent him or her from continuing in that business after a termination of the franchise. Similarly, many franchise agreements contain a post-term collateral lease assignment to the franchisor and/or option of the franchisor to purchase certain assets of a franchisee. Such provisions permit the franchisor to succeed to the franchisee's business with little or no compensation to the franchisee. These provisions can have a devastating effect in many instances. They should be examined and negotiated to allow the franchisee enough security to continue in his or her profession if the franchised business is not successful.

Conclusion

Prospective franchisees must exercise diligence and care in evaluating and investigating franchise opportunities. Many business and legal factors must be considered as illustrated above. Franchisees should not let themselves be persuaded into making quick decisions that could have disastrous long-term effects. Rather, they should invest the time and resources necessary to evaluate competing opportunities thoroughly.

Competent counsel is essential to this mission, both to evaluate each offering and represent the prospect in negotiations with the franchisor should the opportunity present itself. For most clients, the decision to buy a franchise and establish a franchised business is monumental, much like the decision to purchase one's home. A comprehensive investigation and analysis must be done, and guidance obtained, before a franchisee signs the contract and pays the fee. Counsel for the franchisor is typically able and experienced in franchise law. Prospective franchisees deserve comparable expertise. Accordingly, their lawyers should educate themselves sufficiently in franchise law matters or direct the prospect to an attorney who is knowledgeable in the area.

Weston Patrick, P.A.
L. Seth Stadfeld, Member

19 Pamet Road, Yarmouth, MA 02673
3 Carlton St, Brookline, MA 02446
Tel: 781-444-4883
Fax: 617-742-5734
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