A franchise is a form of business in which a company which has developed a product or service (the franchisor) enters into a contractual relationship with other entities (franchisees) which usually operates under the franchisor’s trade name and guidance in exchange for a consideration. The concerned parties enter into a franchise agreement which is legally binding, and which outlines franchisor’s terms and conditions for a franchisee. It envisages the terms in accordance to which a franchisee shall conduct business and also the rules that need to be adhered to. The business into which new entrepreneurs or franchisees invest money must be planned properly or must be in accordance with a mode, which yields good return from the investment.
B. MODELS OF FRANCHISE:
The concept of franchising is generally run based on the following models:
1. Company Owned Company Operated (COCO):
In the initial phase, when the company has just started its operations, the company usually runs on COCO model until it gets established in the market.
2. Franchisee Owned Franchisee Operated (FOFO):
In the FOFO model, the company licenses its brand to the franchisee for an agreed time and consideration. Prices and merchandise are decided by the company. In this model franchisee is the owner of the store and it bears all the operational cost. The Franchisee has to provide an assured percentage share of revenue to the company.
3. Franchisee Owned Company Operated (FOCO):
In this model of a franchise, the initial set up cost is born by the franchisee and the company is responsible for operating it and taking care of all the things necessary to run an outlet, and in return, the franchisee gets a minimum guarantee or percentage of revenue earned.
4. Company Owned Franchise Operated (COFO):
In this model, the company usually leases the operations of the company to a franchisee to take over and makes sure that standards set by the company are met.
The parties shall based on various commercial considerations, decide a model to operate and run a franchise. It is very important that the terms of revenue sharing, territorial exclusivity, roles and responsibility of each party is clearly laid down in the agreement. In this article, we will focus on some of the key elements of the franchise agreement.
One way of doing the franchise is that the franchisor enters into a master franchise agreement with one franchisee to give away the overall control of the franchising activities conducted in a specific area, to a person or an entity called the “master franchisee”. The master franchisee is granted with the right to own and operate many units and also to enter into a sub-franchise agreement with other franchisees with the approval of the franchisor and the master franchisee is responsible for overall supervision of all the sub-franchisees and shall also ensure that the payment due to franchisor is paid by all the sub-franchisees.
C. NEGOTIATION OF IMPORTANT CLAUSES:
The standing foundation of a franchise relationship is a well-drafted and negotiated franchise agreement. Some of the important clauses that need consideration and attention are as follows:
1. License of Brand Name and Logo:
For setting up a franchise, a franchisor in order to expand its business in specified areas and to set up a franchise would grant a limited, non-exclusive license of the brand name and the logo of the franchisor to the franchisee. Determination of the intellectual property which is associated with the franchisor and the extent to which the franchisor is licensing its intellectual property to the franchisee is a very important aspect under franchise agreements. The franchisor should ensure limited usage of the intellectual property licensed to the franchisee and shall ensure that it shall not be misused in any way causing damage to the company and its goodwill. On the other hand, a franchisee should obtain adequate representations and warranty from the franchisor on the ownership of the intellectual property so licensed to ensure that it does not infringe the rights of a third party.
2. Territorial Exclusivity:
It is important that the agreement clearly lays down the territory for which the franchise is granted to the franchisee. The franchisee should ensure that exclusivity is covered in the agreement for a minimum territory or area such that the profitability of the franchisee is not hampered and similarly, depending on the demand and market for the products/service, the franchisor should ensure that the exclusivity is granted on a reasonable area/territory.
3. Minimum Guarantee:
The key benefit of including this clause in the agreement is to guarantee a fixed income to the franchisor. This clause is basically to ensure that the franchisee ensures to provide a minimum return to the franchisor during the term of the franchise agreement.
4. Obligation of Parties:
The obligations of the franchisor and the franchisee are to be clearly established and laid down in the agreement. These obligations which will be enumerated in the agreement shall govern the relationship between the franchisor and franchisee and the dos and don’ts for the parties. Therefore, the activities that a party must perform during the course of the agreement and also the activities that the party must not perform must be distinctive and clearly mentioned for either parties to the contract. The franchisor and the franchisee may for better functioning of the franchise execute a standard operating procedure (SOP) which enumerates the roles and responsibilities of the parties clearly. This SOP shall ensure clarity in the functioning of the franchise to avoid conflicts.
The franchise agreement must clearly lay down the fees, which is usually two-fold, one is the initial one-time franchise fees payable by the franchisee for taking the franchise and second is the recurring fees that is to be paid based on the monthly sale of the product/service. However, the consideration and the payment terms may vary depending on the type of franchise model that the parties choose to enter into. The manner and the timelines for the payment should be clearly spelt out in the agreement. Further, the repercussions of non-payment of the fees should also be clearly mentioned in the agreement.
Non-compete in general means, to restrict parties to enter into a competitive business. The importance of inclusion of this clause in the agreement is to ensure that the franchisee does not enter into competitive business with any other franchisor, during the course of the agreement and even after the agreement has expired or terminated for a reasonable time period. The aim of including this clause in the agreement is to protect the business of the franchisor from any possible loss.
7. Rights upon Termination:
The rights and obligations of parties upon termination of the agreement have to be well negotiated between the parties. The clauses pertaining to the amounts payable to either party on termination of the agreement, use of intellectual property etc. needs to be clearly mentioned in the agreement so that the termination is smooth amongst the parties.
In order to successfully develop a franchise agreement, each of the aforementioned clauses and other relevant clauses needs to be assessed properly before incorporating them into an agreement. The franchisor shall have a motive of expanding the business through franchise and therefore the parties shall have a strategic plan. Keeping an eye on the future perspectives of the business and its expansion, the parties shall enter into the franchising business. It is therefore very important to negotiate a franchise agreement in a planned manner so that relationship between the franchisor and the franchisee in relation to the business goes hand in hand and that there would be a minimization of disputes.
Author: Jaisis Srikrishna Das, Associate.
Disclaimer: The content of this article is intended to provide a general guide to the subject matter. For any queries, the author can be reached at firstname.lastname@example.org.
Updated as on April 22, 2020
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