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Understanding the Franchise Contract

The Financial Disclosure Document (previously known as the Uniform Franchise Offering Circular or UFOC) is arguably the most important document in the franchise transaction process. It is a required disclosure document that is provided by the franchisor.

In addition, the franchise contract should provide the franchisor's provisions and expectations to the franchisee in writing and should be airtight against scrutiny. 

The franchise contract consists of two main parts: the purchase agreement and the franchise or license agreement. Sometimes the franchise transaction is divided into two stages, with a separate contract for each stage. Having two contracts can be preferable when there is a comprehensive equipment and initial services package included in the terms of the franchise agreement.

The purchase agreement covers:

Franchise package: The franchise package includes an equipment or inventory list, which must contain all the items the franchisee has been told to expect. Some franchises require this list to be kept confidential.

Price: Both the price and manner of payment are specified in the agreement. This may be cash on signature, although that is pretty rare. Usually a deposit is required on signature, and the balance is due upon delivery of the equipment or at other stages of the transaction.

Services to be provided: This section includes an overview of the franchisor's responsibilities to the franchisee. Services the franchisor is required to provide before the franchisee opens for business are called the initial services, and services the franchisor provides periodically are called continuous services. A more detailed explanation of the services provided by the franchisor is included in the next section of the license agreement.

The franchise or license agreement covers:

Franchisee’s rights: This section spells out the rights extended to the franchisee, including but not limited to rights to trademarks, patents, copyrights, territorial exclusivity, recipes, secret formulas, access to suppliers, etc.

Franchisor’s obligations: This section details what the franchisor is required to do for the franchisee, prior to startup and on an ongoing basis. 

Franchisee’s obligations: Franchisee obligations include a wide range of restrictions that may include but aren’t limited to issues related to operations, advertising, training, insurance, operating hours, cleanliness, corporate image, suppliers, accounting systems, etc. There should also be details about the royalties and fees a franchisee must pay the franchisor after the franchise opens for business.

Franchisee’s trade restrictions: The franchisor may prohibit franchisees from carrying on a similar business, recruiting staff from other franchisees, maintaining a similar business within a set proximity to other franchised businesses within that chain, and continuing to use any of the franchisor's trade names, secrets, and so forth after termination of the franchise contract.

Assignment/death of franchisee: The franchisee may need to ensure that, in the event of death, a personal representative or dependent will be able to maintain the business until one of them can qualify as a franchisee. Arrangements can also be stipulated to keep the business going until a suitable assignee can be found.

Termination provisions: Many states have laws that govern franchise relationships, and they typically bar termination by the franchisor prior to the expiration of its stated term except for "good cause," "reasonable cause," or "just cause" as defined by those laws. Generally the franchisor must give the franchisee written notice of any defaults that can be cured and a reasonable opportunity to correct them. Minimum advance notice usually includes an opportunity to cure the default and avoid termination. The required notice can range from five to 90 days. 

Events that often permit termination by the franchisor include:

  • Criminal conviction
  • Bankruptcy or insolvency
  • Failure to pay royalties to the franchisor or report revenue
  • Loss of necessary licenses or leases
  • Failure to follow the franchisor's required business operations
  • Failure to correct defaults after notice and an opportunity to cure has been granted by franchisor

Events that may permit the franchisee to terminate the contract include:

  • Bankruptcy or insolvency
  • Failure to provide training and support as agreed
  • Fraud or misrepresentation regarding potential profits
  • Failure to protect the franchisee's business opportunity or territory

Franchisors have typically carved out franchise agreements that address the issues that most often arise among franchisees and have been time tested to withstand the rigors of a litigious society. However, even the most polished franchise contract can benefit from a periodic review to protect the interests of your franchise. 

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