Risks of Franchise Agreement?

A Franchise agreement is a legally binding contract between the franchisor and the franchisee. As a part of the agreement the franchisor gives the franchisee an authorization to carry on business in his name and ideally lends his support in all aspects to run the business efficiently. But this at the same time could mean risky business, if the terms of the agreement are not weighed properly. A Franchise agreement is generally a non- negotiable agreement and the demand of such a franchise itself makes it non-negotiable one, though it does not preclude one to see that it is not a one-sided agreement.

Generally, franchisees look for companies which are renowned as it would be easier to make profits with their name-tag itself. While doing so most franchisees overlook certain important terms and conditions in the agreement which could repudiate itself. One of the top priorities of the Franchise agreement is to save the franchise company as a whole. This includes brand, operating system and the franchisees business in the aggregate. The franchisor believes that he can achieve these by having such a contract in place. And the franchisee on the other hand looks for a stable business without much interference.

The Franchisor being at a higher pedestal dictates terms in the Agreement. In other words, their agreement says that it is either my way or the highway. Nevertheless, a Franchisee must question “What Franchise Agreement is a good agreement?” before jumping into an agreement. The Franchisor’s willingness to negotiate on the agreement is a good sign and this is when the Franchisee has the option questioning the value of certainty in relation to the brand and the operating system.

One must always read a Franchise agreement and consult a lawyer on terms which he cannot comprehend. If a franchise finds a particular clause or condition term ambiguous then it is advisable to request the franchisor to ask for a letter of clarification which would minimize the further problems.

Franchise Laws – Globally and India

Most countries have a rules or an association governing franchises. The USA has Federal Trade Commission’s Rules on Disclosure Requirements and Prohibitions Concerning Franchising and Business Opportunity Ventures (1979) regulate the information a franchisor is required to supply the prospective franchisee revealing vital information helpful to the Franchisees.

In Canada, the Ontario legislature have framed brought in the Arthur Wishart craft which deals at length with the disclosure of the information of the with regard to franchising agreements and fair treatment towards each other and the right of action of damages it breach occurs.

In the United Kingdom there are no laws in relation to franchise but the different aspects are governed by British Franchise Association. This body has an ethical conduct, disciplinary procedure, complaints and appeals procedure.

In Australia, franchising is regulated by the Franchising Code of Conduct. Countries like Brazil, New Zealand, China, etc have a codified framework for franchises. However, Indian franchising is still at its infancy and does not have such franchise-related laws.

Franchising in India is gaining a lot of popularity with FDI opening up and franchising could be the ideal way to take benefit of the vast market in India. India is one of the biggest emerging markets globally ranging from basic necessities to the expensive luxury products and services.

At present, it is the age-old laws The Indian Contract Act 1872 and Specific Relief Act, 1963 which govern these Agreements. Hence, there is a need for a proper framework to regulate Franchises and Franchise Agreements in order to make sure that Franchisees don’t fall prey to a Franchisor.

10 Things to Watch for in a Franchise Agreement

The following are some things to look out for in the Franchise Agreements:-

1. “Must and should” – these are two words that would be appearing very often in the contract of the franchise and indicating that they are bound to perform that particular part and have no other choice. A franchise agreement can contain additions or restrictions. The franchisor can add few clauses keeping in mind the future for company and it is for the franchisee to look into the validity of the clause and calculate the risks involved.

2. Revenue Sharing – A Franchisee must measure the cost effectiveness and royalty. The agreement may contain a clause to pay royalty to the franchisor for transferring the franchisee and for every sale proceeds. However, some agreements have clause drafted in such a way that the Franchisee must deposit all his sale proceeds to a bank account and the Franchisor after deducting his share make payments to the Franchisee. This clause seems to be unfair since a Franchisee requires money to sustain cost of business while waiting for payment from the Franchisor.

3. Exclusivity Clause – A new franchisee may not have as much power as the experienced franchisees. A new Franchisee hence, must look into the location and competition involved in the area while protecting his own interests.

4. Indemnity Clause – Few Agreements have incorporated an indemnity clause, wherein the Franchisee will indemnify the franchisor. While it should be other way round, let us say when the business shuts down suddenly, the franchisee may suffer out of the loans taken, investments,etc

5. Taking Over your Franchise – Certain Agreements compel you to incorporate a clause in your Lease/License Agreement that a Franchisor can take over the business in the same premises after the Franchisee has quit before efflux of time or made to quit by the Franchisor. Such a clause is arbitrary, as where the outlet is your private property, you might be forced to lease out your premises to the Franchisor.

6. At who’s Expense?– A Franchise agreement may have clause for training programmes or annual inspection or arbitration, etc where the burden of cost is imposed upon the Franchisee.

7. Franchisor’s Obligations– An agreement may impose several obligations on the Franchisee, while it may evade its own obligations. For e.g.: A defective product sold or anti-competitive pricing, etc would be the Franchisor’s liability and it is bound to indemnify the Franchisee.

8. Dispute Resolution Mechanism – Accessibility and Viability of a dispute resolution mechanism should be in place.

9. Lock-In Period – A lock-in period is more like a jail term and one must ascertain whether the business can sustain for that long and what are the consequences of breach of lock-in. A Franchisor would like to look for stability in the Franchisee before giving the Franchise and vice versa. Some Agreements arbitrarily impose a penalty of Rs.50 Lakh for breach of Lock-in, but let us say where the problem lies in the Franchisor and because of this the profit reduces to a negligible sum it would be a loss for the Franchisee and a win-win for the Franchisor.

1. Exit Strategy: A Franchisor may have a clause in restraint of trade. This condition might deter your exit strategy. Most of the franchise agreements last for 10 to 20 years and where a franchisee seeks to exit before the completion of this term, the same can prove to be problematic.

In conclusion, the only risk the franchisor is likely to face is the disclosure of certain confidential subject which might be spill to his competitors. On a positive note, the franchisee has to usurp an established franchise and run the business and where the Franchisor grows through the franchisee, the recognition could bring great results for both. In such cases, even the Franchisor would be willing to negotiate terms of the agreement. He undergoes lower financial risk where the franchisor takes care of the establishment and indemnifies for the loss incurred. It’s a great opportunity and environment to learn about working of a business and market developments but involves huge risks. Ultimately, a franchisee has to transfer the goodwill that he has earned over the period if the contract is not renewed and could seem unsatisfying but one must remember that he does not have the last word.