In Short
Leasing arrangements are critical to the success of a franchise and must align with your franchise agreement. Misaligned lease terms, prohibited licensing arrangements, or poorly drafted demolition, relocation, or step-in clauses can expose franchisees to serious financial and operational risk. Careful review and negotiation of the lease is essential before committing.
Tips for Businesses
Check that the lease term and renewal options match your franchise term and renewal rights. Confirm the lease allows the franchisor to licence or sublet the premises if required. Obtain landlord consent for fit outs, and review demolition, relocation, and step-in clauses closely to ensure fair compensation and no ongoing liability after exit.
Summary
This guide explains key leasing issues franchisees should consider when operating from leased premises in Australia, including lease terms, licensing rights, fit outs, and risk clauses. It is prepared by LegalVision’s business lawyers, which specialises in advising clients on franchising and commercial leasing arrangements.
Many franchise businesses will operate from leased premises, such as a commercial building or retail shopping centre. Franchisees either lease a commercial premises directly or the franchisor leases the premises and licenses it to the franchisee for the term of the franchise. Large shopping centres often prefer to lease their premises to known franchisors as opposed to individual franchisees.
This article explains key lease risks and protections franchisees must negotiate when operating from leased commercial premises.
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Lease Term
It is important to ensure that the lease term corresponds with the franchise term. A mismatch between these terms can create significant problems. For example, if your franchise agreement is for 5 years but your lease is only for 3 years, you may find yourself with franchise rights but no premises from which to operate. If your lease extends beyond the franchise term, you may still owe rent on premises you cannot use.
Ensure the lease includes a renewal option that aligns with your franchise renewal rights. Most franchise agreements include options to renew for further terms, often dependent on meeting certain performance criteria. Your lease should mirror these renewal options so that if you are entitled to renew your franchise, you can also secure the premises for that additional term. Without aligned renewal options, you may successfully renew your franchise agreement but lose your established business location, forcing you to relocate and potentially lose awareness from local customers.
It is also worth considering the timing of lease renewal notices. Commercial leases typically require you to provide notice of your intention to exercise a renewal option within a specific timeframe (sometimes 6-12 months before the lease expires). Ensure this deadline falls after the franchisor decides on your franchise renewal, so you avoid committing to unusable premises.
Right to License
Some leases expressly prohibit the tenant from assigning, licencing or subletting the premises under any circumstances. This type of clause is problematic in franchise arrangements where the franchisor leases the premises and then licenses or subleases them to the franchisee to operate the business. If the franchisor is leasing the premises directly and licensing it to you, you should request an amendment to the lease to remove any absolute prohibition on licensing or subletting.
At a minimum, the lease should be amended to allow the franchisor to license, sublet or assign the lease to a franchisee, subject to the landlord’s consent not being unreasonably withheld or delayed. This provides the landlord with appropriate oversight while still enabling the franchise model to function. Requiring the landlord’s consent is reasonable, but an outright prohibition makes the franchise arrangement unworkable.
Do not assume that just because the franchisor has offered you a licence arrangement, they have the legal right to do so under their lease. Always verify this critical point before committing to the franchise by obtaining written consent from the landlord or signing a deed of consent with the landlord.
If you are licensing premises from a franchisor (or an associate), make sure you are familiar with:
- the amount of rent payable (including annual increases);
- recurring expenses each financial year, including any prepaid or adjusted outgoings;
- bank guarantee and insurance requirements; and
- timing to commence renewal negotiations.
Fit Out
There is often an obligation on you as franchisee to fit out the premises as directed by the franchisor. Franchise systems typically have detailed specifications for how premises must be fitted out to maintain brand consistency. This can include flooring, lighting, signage, equipment, counters and seating arrangements. These fit out requirements are usually mandatory and can represent a substantial capital investment, sometimes costing tens or even hundreds of thousands of dollars depending on the nature of the business.
You should ensure that the landlord has consented to any fit out required under the franchise agreement before you commit to the lease. Most commercial leases require the landlord’s approval for any alterations or improvements to the premises. If you proceed with a fit out without the landlord’s consent, you may be in breach of your lease, and the landlord could require you to restore the premises to their original condition at your expense.
It is advisable to provide the landlord with the franchisor’s fit out specifications during lease negotiations, well before signing the lease. This allows any concerns to be addressed upfront and avoids costly delays or disputes once you have committed to the franchise and lease.
You should also clarify what happens to the fit out at the end of the lease term, as some leases require you to remove all fixtures and restore the premises to their original condition. Understanding these obligations upfront allows you to factor them into your business planning and financial projections.
Demolition
A demolition clause allows a landlord to terminate the lease at any time if they want to demolish the premises, by giving reasonable notice. A notice period of at least 6 to 12 months is generally considered reasonable, allowing you time to relocate or wind down operations.
To be fair, this clause should provide that the landlord will pay you at least the depreciated value of your contribution to the fit out of the premises. You may also want to negotiate for additional compensation to cover removal costs, equipment storage, loss of goodwill, and fitting out new premises. Some leases provide for compensation based on a formula such as a specified number of months’ rent.
If the landlord is unwilling to provide adequate compensation, consider whether the demolition clause makes the lease too risky for your franchise business, particularly where you are making substantial fit out investments and are still accountable to the franchisor for operating the business.
Relocation
Relocation clauses are common in shopping centre leases. They allow the landlord to move your business within the complex. Under this clause, the landlord can usually relocate the business to another location within the same shopping centre, for example, if there is a refurbishment which requires vacant possession of your premises, or if the landlord wants to reconfigure the centre’s tenancy mix.
While relocation within the same centre may seem less disruptive, it can still significantly impact your franchise business. The new premises may have lower foot traffic, less visibility, a different layout, or be located near competitors. You should ensure the relocation clause specifies that the new premises must be of comparable size, quality and location to your original premises. The clause should also require reasonable notice of at least 3 to 6 months.
Again, the landlord should pay you by way of compensation the cost of dismantling and reinstalling any fixtures and fittings. This should include all reasonable costs such as removing and reinstalling fit out and equipment, modifications required for the new premises, new signage, and business interruption losses during the relocation period. The clause should clearly state that the landlord bears all these costs. You should also clarify whether your rent will be adjusted if the new premises are smaller or less favourable.
Step-in Rights for a Franchisor
Many franchisors require the option to take over a franchisee’s lease in a few circumstances, such as if:
- the franchise agreement expires or is terminated (but the lease is ongoing);
- the franchisee (as tenant) breaches the lease, and the landlord threatens to terminate the lease; or
- the franchisee wants to sell the business to a third-party but the franchisor exercises their right of first refusal.
These rights allow a franchisor to step-in as the tenant and have the lease transferred to them. They may be part of the lease or in a separate step-in deed signed by the franchisee, franchisor and landlord.
If the franchisor does require step-in or assignment rights, you should ensure that:
- the circumstances in which they may apply are fair and reasonable;
- there is a limited window in which the franchisor can exercise their option;
- you are appropriately reimbursed for any fit out, fixtures and equipment that remain in the premises;
- you are not responsible for future rent and expenses for the lease once the franchisor assumes control; and
- you are not responsible for the landlord’s legal costs.
Key Takeaways
Franchisees must align lease terms with franchise renewals, allow licensing where required, and review rent and ongoing obligations. They should secure landlord consent for fit outs and understand reinstatement costs. They must also negotiate fair demolition, relocation and step-in clauses to protect their investment and avoid ongoing liability.
If you need assistance when leasing the premises for your franchise business, LegalVision provides ongoing legal support for all businesses through our fixed-fee legal membership. Our experienced franchise lawyers help businesses across industries manage contracts, employment law, disputes, intellectual property, and more, with unlimited access to specialist lawyers for a fixed monthly fee. To learn more about LegalVision’s legal membership, call 1300 544 755 or visit our membership page.
Frequently Asked Questions
Yes. Your lease term should align with your franchise term and any renewal options. If the lease ends earlier, you may hold franchise rights without premises. If it runs longer, you could remain liable for rent after the franchise ends. Misaligned terms commonly lead to disputes and unexpected financial exposure.
You should confirm the head lease allows the franchisor to license or sublet the premises. Some leases prohibit this entirely. If the lease does not permit licensing, the arrangement may be unenforceable. Always review the lease or obtain written landlord consent before committing to the franchise.
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