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When drafting a franchise agreement, there are many considerations you should keep in mind. For instance, your franchise agreement is the contract that binds you and your franchisees. It outlines the franchisor’s and franchisee’s rights and obligations when operating the franchise. Of course, a franchise agreement’s contents will vary between franchises. However, you should consider some key terms when drafting any franchise agreement.

This article defines and explains some key terms you should consider when drafting a franchise agreement.

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Intellectual Property Clause

Franchising involves allowing a franchisee to market and distribute goods or services under your brand. Many business owners protect the features of their brand that distinguish their goods and services from others by registering their trademarks. A trade mark registration gives you the exclusive your trade mark. This means that only you can:

  • use it; 
  • license it to another party; and 
  • sell it.

Your franchise agreement should adequately protect your intellectual property rights. Furthermore, your franchise agreement should outline a licensing arrangement that allows your franchisees to use your trade mark for a specific period.

Licensing involves you (the licensor) permitting the franchisee (the licensee) to use your intellectual property. Typically, this occurs in exchange for payment and other returns.

Protecting your intellectual property through your franchise agreement ensures franchisees properly use your business’ branding. This can help assure that customers who enter any of your stores will receive the same quality experience across the brand.

Exclusive Territories

The success of many franchises comes down to their market outreach. For instance, if your franchise businesses operate within the same area, you increase competition, limiting their market outreach. Therefore, you could grant an exclusive territory in your franchise agreement to avoid this.

An exclusive territory is a geographical area where only one franchisee can operate or market their business. Not all franchise systems operate under exclusive territories.

Granting an exclusive territory can generally help the franchise system overall. For instance, you might conduct market research and find an area with enough interested consumers to generate a profit for the business.

Locking in an exclusive territory means your franchise business will not have to compete with another business in the same area.

Although, exclusive territories can face complications if your franchise also has an online component. In this instance, you may need systems to direct online orders to the right franchise business.

Restraint of Trade

A restraint of trade clause can prevent franchisees from competing with the franchise system after the agreement ends. The restraint can exclude franchisees from operating a business:

  • for a specific period after the franchise agreement ends; and
  • in a specific geographical area.

However, you should be aware of unreasonable restraints of trade. A restraint of trade that does not protect a legitimate business interest, such as the profitability of your business, may not be enforceable. For example, if your franchise operates in Victoria, but the restraint applies to all of Australia, this would likely be unreasonable. In this case, where a court finds that a restraint of trade clause is unreasonable, you may not be able to restrain your franchisee’s conduct following the agreement.

Although, in certain states, a court can also tweak the scope of the restraint to become reasonable. For example, a court can change the Australia-wide restraint to prevent the operation of a similar business only in Victoria.

There are ways to ensure that a restraint of trade will be enforceable, even if a court strikes out a provision. Namely, a cascading clause that ensures a lower-tier restraint may apply if the first-tier restraint is unenforceable.

Terminating or Transfering the Franchise Agreement

When drafting a franchise agreement, it might seem counterintuitive to think about how the agreement will end. However, it is crucial to consider termination rights to ensure you protect your rights if an issue arises.

Termination

Generally, you cannot terminate a franchise agreement at will. Instead, you must provide a franchisee with written notice that they are in default of their obligations. In this instance, you must:

  • set out the nature of the default; and
  • what the franchisee should do to rectify the default within a reasonable period.

If the franchisee fails to rectify the default within the reasonable period you set, you may have the right to terminate the franchise agreement.  

Transfer

Alternatively, transferring refers to selling the business and transferring the franchise agreement to a new franchisee. You can include such a term in the franchise agreement, including what the transfer process involves. Generally, a right to transfer allows you to choose or at least approve the next prospective franchisee.  

Key Takeaways

While the contents of a franchise agreement will vary between franchises, there are some key terms you should consider when drafting a franchise agreement. This includes:

  • an intellectual property clause that overlooks how you will license your trademarks to your franchisees;
  • an exclusive territory clause that prevents franchise businesses from competing with one another in the same location;
  • a restraint of trade clause that prevents franchisees from operating in competition with the franchise system after the agreement has ended; and
  • a termination or transfer clause.

If you need help drafting your franchise agreement, our experienced franchising lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions

What is a restraint of trade clause?

A restraint of trade clause can prevent franchisees from operating in competition with the franchise system after the franchise agreement ends.

What is an exclusive territory?

An exclusive territory is a geographical area where only one franchisee can operate or market their business. 

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