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A franchise agreement is a legally binding contract that sets out the rights and obligations of the franchisor and franchisee regarding the operation of a franchise. While the contents of a franchise agreement will vary from franchise to franchise, there are some essential terms you should include so your franchise system can operate effectively.

This article outlines some key terms you should consider when drafting a franchise agreement.

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1. Financial Obligations

The Franchise Agreement should outline franchisees’ financial obligations, including the payments you require them to make to enter the franchise system and continue to operate for the term of that agreement. These payments will likely include:

  • upfront costs, such as the franchise purchase price; and
  • ongoing costs, such as a royalty fee and a marketing fee.

Furthermore, you will need to consider the franchise’s costs and whether your franchisees can cover these costs by paying fees. To factor in these costs, you might need to conduct business forecasting before constructing the franchise agreement.

2. Exclusive Territories

An exclusive territory is a geographical area where only one franchisee can operate or market their business. As a franchisor, you should conduct market research to find an area with enough potential consumers to generate a profit for the business. Moreover, depending on your business model, granting an exclusive territory can sometimes help the franchise system overall. This is because the franchise business will not have to compete with another franchise in the same area. 

Moreover, including an exclusive territory within your franchise agreement is not required. If you do not wish to do so, the lack of exclusivity should be made clear in the agreement.

Furthermore, exclusive territories can become a little complex when a franchise business operates online. In this instance, you may need systems to direct online orders to the right franchise business.

3. Licensing Your Intellectual Property

Protecting your intellectual property (IP) is crucial to all businesses. A franchise’s intellectual property often plays a critical role in the brand’s image. For instance, IP is an excellent way for customers to identify your business. Furthermore, you must license your business’ intellectual property so customers can receive the same experience across your network under the same brand. 

Licensing involves you (the licensor) permitting the franchisee (the licensee) to use your intellectual property in exchange for payment or some other return.

It is common for franchisors to licence any registered trade mark, as well as copyright attached to operational and systems based documents. Essentially, a registered trade mark protects the signs of a business that distinguish its goods and services from others, such as the business name or logo. Furthermore, your franchise agreement should adequately protect your ownership of your trademarks. Additionally, your agreement should grant the franchisee a license to use your intellectual property, but only for the duration of the agreement.

4. Length of the Original Term

The “original term” in franchise agreements refers to the time a franchisee can operate its business utilising your business’ brand. Moreover, it may be helpful to consider the benefits and shortfalls of a shorter and longer term. 

For instance, a shorter term means you might receive renewal fees more often. In addition, each time the franchisee renews the agreement, you might also have the opportunity to change the agreement terms. However, it could also mean a higher turnover of franchisees.

Alternatively, a longer term allows franchisees to build a successful business and turn a profit before they renew the franchise agreement. However, it could also mean that franchisees lock themselves into an unprofitable business. Additionally, a longer term will generally limit your ability to change the contractual terms as often. 

When determining the appropriate term (and any renewal term), it is helpful to consider how the period will line up with the applicable lease.

5. Ending the Franchise Agreement

When drafting a franchise agreement, you must consider how the agreement will end. You may wish to terminate the agreement, meaning you end the franchise agreement before the original term is up. 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. Additionally, you must set out the nature of the default and what the franchisee should do to rectify the default within a reasonable period. If your franchisee fails to correct their default within the set period, you may have the right to terminate the agreement.  

Alternatively, you or your franchisee may decide to transfer the agreement. This process involves selling the business and transferring the franchise agreement to a new franchisee. You can include a transfer term in the franchise agreement, although you must outline the transfer process and which approvals you must first obtain before a sale can occur. Generally, a right to transfer allows you to choose a prospective franchisee, or at least approve them.  

If the franchisee wishes to sell the franchise during the term, you may include a right of first refusal to purchase the business. This means the franchisee must offer to sell the business to you before they offer the sale to anyone else.

6. Restraint of Trade

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

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

In addition, a sufficient restraint clause can prevent a former franchisee from soliciting the customers of the franchise network. 

However, an unfair restraint of trade could render the term ineffective. For this reason, you should ensure that the restraint of trade protects a legitimate business interest, such as the profitability of your business.

7. Dispute Resolution

Almost all franchise agreements will include a dispute resolution clause. A dispute resolution clause must reflect the dispute resolution procedures in the Franchising Code of Conduct (‘the Code’). Where you cannot resolve a dispute informally between you and a franchisee, the Code requires you to attend alternative dispute resolution (ADR). Before going to court over the dispute, you must first attempt mediation or arbitration unless the circumstances are urgent. Since the Code prescribes the dispute resolution process, it is worth retaining a skilled franchise lawyer to help draft your franchise agreement.

Key Takeaways

Some terms you should include in your franchise agreement to effectively operate your franchise system include:

  • a term outlining your franchisee’s upfront and ongoing fees;
  • any exclusive territories in which your franchisee should operate;
  • a provision to protect your intellectual property;
  • the length of the “original term”;
  • how to end the franchise agreement;
  • any reasonable restraints on trade; and
  • a dispute resolution 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 franchise agreement?

A franchise agreement is a legally binding contract that sets out the rights and obligations of the franchisor and franchisee when operating a franchise.

What is an “original term” in a franchise agreement?

 The “original term” refers to the length of time a franchisee can operate the franchise business under your business’ brand.

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