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One of the most significant decisions you will need to make as a franchisor is who holds the lease to the franchise business location. Before leasing your business premises, consider whether you want your franchisee to enter into the lease directly with the landlord of the premises. Alternatively, as the franchisor, you may lease with the landlord. In this case, you will need to enter a licence agreement with your franchisee. To help you decide whether to lease or licence the franchise premises, this article will explore the advantages and disadvantages of both.

Franchisee Directly Enters Into the Lease

If your franchisees enter into the lease with the landlord of the premises, you will not be responsible for fulfilling any obligations under the lease. As a result, if the business struggles, the franchisee will be primarily liable for continuing to pay rent until the end of the lease term.

However, this does not necessarily mean you have no control over what premises the franchise business operates from. Franchisors assist the franchisee in locating a suitable property and negotiating with the landlord. This way, franchisors can help secure competitive rent and rent-free periods.

Some franchisors will charge their franchisees an additional fee for this service. However, this might also mean you accept responsibility if the site is unsuccessful. To reduce potential liability, you should obtain a signed letter of acknowledgement from the franchisee stating that they will:

  • conduct their due diligence concerning the premises;
  • satisfy themselves that the location is suitable;
  • enter into the lease as a result of their assessment of the premises; and
  • not rely on any representations or statements the franchisor made relating to the suitability of the premises.


Benefits and Shortfalls

If a franchisee decides to exit the franchise network, you will not have control of the site since you are not the leaseholder. Consequently, the franchisee could rebrand and continue to trade from the premises, exploiting the goodwill they acquired while operating under your brand. 

To avoid this, you should include a clause in the lease agreement which states that the lease will terminate if either party terminate the franchise agreement.

Additionally, you should enter into a ‘step-in deed’, which you can trigger upon the termination of the franchise agreement. A step-in deed gives you the first right of refusal to enter into a new lease for the premises or have the franchisee assign the existing lease. Although this can limit your exposure to other viable business premises, a step-in deed can help you secure the premises, which may have begun to generate brand awareness amongst consumers.

Franchisor Issues a Licence to the Franchisee

Instead of permitting a franchisee to enter into a lease agreement directly, you can enter into the lease with the landlord directly. Subsequently, you must issue a licence agreement to the franchisee which allows them to occupy the premises and comply with your lease terms.

In this instance, you will assume all liability under the lease agreement when you enter into the lease. Although you will pass your lease obligations on to the franchisee through the licence to occupy the premises, the landlord ultimately has no direct contract with the occupying franchisee. As a result, if your franchisee continuously fails to pay rent, you may need to decide whether to:

  • operate a corporate store from the premises,
  • grant a franchise to a third party, or
  • negotiate with the lessor to surrender the lease.

You should note that while you may be able to recover unpaid rent from the franchisee through litigation, this can be a costly process.

Nevertheless, you can reduce your liability by having a director of the franchisee provide the personal guarantee necessary under the lease agreement. Furthermore, this can incentivise compliance with the lease obligations since the landlord will be able to commence proceedings against the franchisee director.

Additionally, it would help if you considered establishing a separate leasing entity to limit your exposure and liability under their leases. It is a good idea to seek legal advice from an experienced franchise lawyer.

Benefits and Shortfalls

By entering into the lease directly with the landlord, you retain absolute control over the lease of the premises. Consequently, you will have greater control when: 

  •  negotiating the lease terms; 
  • controlling rent payments; and 
  • organising the fit-out of the premises.

If the franchise agreement terminates, you will also have the ability to evict the franchisee. Additionally, you will retain the right to occupy the premises as the lessee. This can make installing another franchisee in the franchise network much more manageable with minimal disruption to the business.

However, if the franchisee defaults on the licence agreement and lease, you will remain liable to the landlord. A default can include failure to pay rent or any damage and destruction to the premises. In this sense, a failure to ‘make good’ the damage to the premises can result in a default of the lease terms. 

You can limit your risk by requesting the franchisee to provide a bank guarantee or security bond to guarantee the lease and licence agreement fulfilment personally.

Another shortfall to license arrangements is that the landlord may insist on approving the licence agreement between yourself and the franchisee before the franchisee can sign it and occupy the premises. However, the landlord’s power to approve the agreement depends on the clauses you negotiate for inclusion in the lease agreement.

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Key Takeaways

The two most common strategies for leasing premises in a franchise agreement are:

  • the franchisee enters into the lease direct with the landlord of the premises; or
  • you enter into a lease with the landlord of the premises and enter into a licence agreement with your franchisee.

If your franchisees directly enter into the lease with the landlord of the premises, you will not be primarily responsible for fulfilling any obligations under the lease. Alternatively, if you enter into the lease agreement, you will assume all liability under the lease agreement if you enter into the lease. Nevertheless, you will retain greater control over the business premises.

If you have questions about leasing and licensing business premises, 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 licence?

A licence allows a franchisee to occupy the business premises and comply with your lease terms if you enter into a lease agreement directly with the landlord.

What happens to the licence arrangement if a franchisee exits the franchise network?

If the franchise agreement terminates, you will generally be able to evict the franchisee if they occupy the premises under a licence agreement. However, this will depend on the terms of your agreement. 

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