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Key legal considerations for Franchisees – Part 1

Nov 9, 2021

As explained in this article, the Franchise Agreement contains all the principal terms upon which the franchise will be granted and governs the legal relationship between the franchisee (person taking the franchise) and the franchisor (the person granting the franchise).

There are numerous considerations that a franchisee should make when reviewing the Franchise Agreement. The key considerations for franchisees when reviewing a Franchise Agreement are summarised below.

 

1. Personal Guarantee

It is usual practice for an individual wishing to take a franchise to incorporate a new limited company to be the legal entity entitled to the franchise. If this is the case, a prudent franchisor will often require a personal guarantee of the obligations of the franchisee company from a director of the franchisee company (usually called the principal). This is because typically newly incorporated companies have few assets to meet a claim brought by the franchisor if there is a breach of the Franchise Agreement.

The personal guarantee will likely cover both the financial obligations and the performance obligations of the Franchisee. The practical implications of this is that the principal’s personal assets (house, shares in other companies, cash in the bank, etc) are at risk of being used to satisfy any judgment brought against the franchisee company. This can ultimately result in the principal becoming bankrupt. Whilst not unusual, the franchisee should ensure that appropriate financial and time limitations on the principal’s liability under the guarantee.

 

2. Franchisee Fees

A franchisee should ensure the agree fees are properly accounted for in the Franchise Agreement. By way of a broad, market position, the usual fees under a Franchise Agreement are:

  • Initial Fee
    An Initial Fee will usually be due upon signing of the franchise agreement. It should not contain a profit element for the franchisor. It is aimed only at reimbursing the franchisor’s costs in setting up and expanding the franchise. If franchisors were to make a significant profit on the initial fee, the emphasis of their business would be selling franchises rather than ensuring that franchises are profitable.

    Ultimately, the amount which can be charged by way of an initial fee will depend on the reputation of the franchisor, the profitability of its franchise, the term granted, whether it contains an exclusive area, and so on. The average amount is 5% to 10% for a successful franchise.

  • Service Fee
    The Service Fee is calculated as a percentage of the franchisee’s gross monthly receipts. and reimburses the franchisor for the cost of providing the continuing backup to the franchisee and provides the franchisor with its profit. The Service Fee is often set at around 8% of gross monthly receipts.
  • Advertising Levy
    The Advertising Levy is often set at around 2.5% of Gross Monthly Receipts.

 

3. Territory

A key benefit of having a franchise is to have an exclusive right to trade using the franchisor’s name within a certain locality. The Franchisee should ensure it is granted appropriate exclusivity in the Franchise Agreement. This will reduce the franchisee’s competition from other franchisees. From the franchisee’s perspective, the broader the location, the better.

Additional considerations franchisees should make prior to entering into a Franchise Agreement will be explored in future articles.

Joel Gocool specialises in advising on and negotiating franchise agreements. Joel has a wealth of experience in identifying the key considerations a franchisee should make before starting a new franchise venture. If you require advice on franchising, please contact Joel Gocool on 01276 686 222 or at Joel.Gocool@Herrington-Carmichael.com.

This reflects the law at the date of publication and is written as a general guide. It does not contain definitive legal advice, which should be sought as appropriate in relation to your own particular matter before action is taken.

Joel Gocool

Joel Gocool

Solicitor, Corporate and Commercial

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