A franchisor needs to remain competitive and ensure that their franchise agreement provides adequate incentive and certainty for a franchisee to continue in business. Ensuring that the right of renewal in a franchise agreement is commercially realistic is a good step in growing a franchise system.
In most franchise agreements it states that a franchisee can give written notice to its franchisor within a prescribed period and on following the process in the franchise agreement, the franchisee will be granted a renewal for a further term. However it is not always straight forward.
The number one step for any prospective franchisee entering into a franchise system is to speak with as many existing franchisees within the system as possible. This provides up to date honest comment on the culture of the franchise system and the attitude and methods of the franchisor. A key question to ask during this process will be “Were there any complications in getting a renewal or extra term of the franchise?” But what do you do in the case of a franchise where no renewals have as yet been granted?
Most franchise agreements state that the franchisee has the automatic right to request a renewal. Many franchisees assume that this means that there is a guarantee of an additional franchise term on exactly the same terms and conditions as they signed at the start of their first term. This assumption is almost always wrong. The most common situation will be that the franchisee must give a written notice within a specific three or six month window of time. If the franchisee misses this window of opportunity the right of a renewal is lost and the franchisee will have to negotiate just like any prospective franchisee for a franchise agreement. If a proper written notice is given then the franchisee will receive the “then current terms of a franchise” which the franchisor wants to offer. This may be a completely different set of terms and conditions to what the franchisee was expecting.
What can a franchisee do to protect their right of renewal?
The franchisee applicant must read the rights in the franchise agreement carefully. Once the franchisee realises that the franchisor will offer a new franchise based on terms that will not exist for at least another five years, a careful commercial decision will need to be made.
The franchisee could decide that the franchisor is convincing and decide to leave it to chance as to what the renewal franchise terms will be. This risk is increased by the fact that the franchisor that the franchisee is dealing with could sell the entire business to a new person and the franchisee could be faced with a totally different business plan, principals and standards by the new owner. When a franchisee realises this it highlights the need for written promises to be given by the franchisor to the franchisee that are additional to the standard terms in the agreement.
What should a franchisee ask for to protect the right of renewal?
A franchisee needs to focus on increasing the franchisee’s bargaining power at the time of asking for the renewal and yet at the same stage making sure that there is some level of flexibility so that the franchisee can get any improvements that have been developed and are to be included in new franchise agreements after the date of renewal. This balancing exercise will need to take into account what type of franchise the franchisee is entering into, e.g. a restaurant/café or mobile service or manufacturing franchise. Where the franchise has a fixed ongoing royalty the franchisee should insist that that royalty figure cannot be changed without the consent of the franchisee. The same should occur for any fixed territory that the franchisee has been granted in the initial term. Where a franchisee has negotiated special conditions it should be stated that these also carry forward on renewal.
Where a franchisee wants additional protection a franchisee can ask for written confirmation that the franchise agreement offered on renewal will not be substantially or materially different to the current document and that the new terms will not materially lessen the rights of the franchisee or the obligations of the franchisor, unless the franchisee agrees to those changes. Where the franchisee has the bargaining power the franchisee can ask for a written guarantee that the terms of the franchise agreement will be identical to the existing terms. The difficulty that the franchisee will have is that most franchisors will either refuse this proposal or state that if this term is added and over time it turns out that the new franchise agreement would in fact be more beneficial to the franchisee, that the franchisor will refuse to offer those terms to the franchisee leaving the franchisee as an island possibly paying more royalties and having to complete more onerous terms and conditions that the rest of the franchisees in the system.
There is rarely a simple solution to giving the franchisees certainty
Most franchisees will find that there is a guarantee of a right of renewal in a franchise however there is no guarantee as to the actual terms and conditions that will apply during the renewed term. Franchisors usually want to continue doing business with a franchisee that has successfully operated the franchise for the first term of the agreement. Franchisors know that it is very expensive to find a replacement franchisee, go through the training process, the establishment of new customer relationships and the integration of a new franchisee into the franchise system. None of these costs are incurred where an existing franchisee renews. Unfortunately there are a few rare franchisors that do not understand or accept this proposition and that there are some franchisees that are offside or in disagreement with their franchisor at the time of renewal.
Under current franchise agreements where the franchisor and franchisee are in disagreement at the time of the franchisee exercising a renewal there are many methods that a franchisor can exercise to try and defeat the ability of the franchisee to complete a renewal while still technically acting within the terms of the franchise agreement and the broad obligation of good faith negotiations. Consequently it remains essential for the franchisee to protect the rights and negotiate terms up front. Where a franchisee is concerned a clause which states that on renewal the franchisee will receive or have the right to choose between the terms and conditions already signed by the franchisee or the terms offered in the latest current version of the franchise agreement to another independent franchisee. Where the franchise system is active and in a relatively competitive industry where the franchisor is competing to recruit franchisees, the broad principal outlined above will give most franchisees adequate protection.
Most renewals occur satisfactorily
It has been suggested that despite the vast majority of renewals occurring to the satisfaction of franchisees that compulsory renewal terms be established which would materially change the rights that exist between franchisees and franchisors. If these new rules impose an obligation that the parties negotiate in good faith then this is unlikely to change the situation from what is already occurring. A more appropriate protection would be to introduce a definition of what can be the “then current franchise agreement” within a franchise system. With a right that the parties could vary from that predefined definition but only if the franchisee has signed a clear certificate that the franchisee has obtained or waived legal advice. Further that the Disclosure Document should have an additional clause added to specifically require the franchisor to detail the process that will occur on renewal and require the franchisee to indicate whether the franchisee does intend either to use an unchanged franchise agreement or to offer a renewal franchise agreement which does have changes from the current agreement.
The awareness of a franchisee to the difficulty that can occur on renewal is needed. There are many options to solve the situation. This article provides many alternatives, which will assist both franchisors and franchisees to enter into a discussion with the aim that all parties obtain a fair result.
- Update the franchise agreement to be Code compliant to the changes 1 January 2015
- Plan ahead
- Read the renewal clauses in the franchise agreement
- Ask other franchisees what they have done to renew
- Check with the franchisor early
- Know exactly what the Conduct allows
- If a dispute with the Franchisor occurs consider prompt mediation
- Secure the support of key experts to help
Prepared by Alan Branch
President – Global Development
Alan Branch has received multiple awards from the Franchise Council of Australia and is a recognised international consultant and speaker.
This article is for general information and the reader should seek specific expert advice before taking any action.