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Finding commercial premises to lease is the last piece of the puzzle when buying a franchise. You should ensure you understand the implications if you are presented with a ‘step-in’ deed. By entering into a step in deed with the franchisor, you are consenting to the landlord transferring the lease to the franchisor if the franchise agreement is terminated or in other limited circumstances. This article will outline the implications of signing a step in deed as a franchisee.

Does the Franchisee Always Hold the Lease As the Tenant?

A franchisee can occupy premise fo run the franchise business in a number of ways. The legal structure of this depends on the franchise model and the franchisor’s preference.

Two common arrangements include the:

  1. franchisor signing the lease as the tenant, and offering the franchisee a licence (or sub-lease) to occupy the premises; or
  2. franchisee signing the lease as the tenant directly with the landlord.

Under the first arrangement, the franchisor retains direct responsibility to pay rent. They have the ability to take over the premises easily should you be terminated. 

Under the second arrangement, the franchisor is effectively relinquishing some control over the premises as they cannot automatically take over if you are terminated. A step in deed covers this contingency by allowing them to notify the landlord. The deed compels the landlord to allow this to happen in certain circumstances. 

What Do I Need To Know When I Enter Into a Step in Deed?

When you enter into a step-in deed, this arrangement formally consents for the franchisor to request the landlord assign the lease to them directly. Essentially, it means you may not be able to run a business from the premises if you are terminated. This is because the franchisor may take over the lease following termination. 

Separate to your obligations to the landlord under the lease, a step in deed may give the franchisor a number of rights in relation to the lease, on a conditional basis. If the conditions in the step-in deed become a reality, the franchisor may have rights to take action. This includes a:

  • requirement for the franchisee to assign the lease to the franchisor;
  • requirement for the landlord to give notice to the franchisor before terminating the lease; or
  • first right of refusal to enter into a new lease for the premises. This is according to the provisions of the deed.

This arrangement can be useful where:

  • parties have terminated the franchise agreement, but the franchisor wants to retain control of the premises. This is due to the success or prominence of the location; or
  • the franchisee wants to sell the franchise, and the franchisor wishes to buy the business off the franchisee.

When Can the Franchisor Step-In? 

In an ideal situation, you will never need to worry about the implications of a step in deed. This is because there will be no issues with compliance.

The conditions which usually permit a franchisor to exercise their rights under the step-In involve a breach of the

  1. lease; or 
  2. franchise agreement.

Breach of the Lease

Be mindful that even under ordinary circumstances, where a tenant breaches the terms of their lease, the landlord may be open to exercising their rights to notify you of an intention to terminate the lease. Where you hold the lease as a franchisee and have signed a step-in deed, the effect of your breach of the lease could be that the franchisor’s rights to step in are triggered.

For example, this can manifest through the franchisor serving the landlord and the franchisee with a notice of their intention to exercise their right.

In another example, the step-in deed may place an obligation on the landlord not to accept a surrender of the lease or terminate the lease without giving at least 14 days’ prior written notice to the franchisor.

Breach of the Franchise Agreement

Similarly, even under ordinary circumstances, you can expect there to be serious consequences if you do not comply with your obligations as franchisee under the franchise agreement. In this second instance, if the breach triggers the franchisor’s right to terminate the agreement, the franchisor may exercise their rights in relation to your lease, by providing notice in accordance with the step-in deed.

For example, this can affect you by restricting your ability to continue trading in the same business premises after your franchise agreement is terminated. This effectively stops you from re-branding and continuing to operate in the same location. 

Some franchisees attempt to continue to trade but re-brand following termination, hoping that the franchisor will not enforce the restraint of trade so that they can at least continue trading under an independent brand. In the case of a step-in deed being triggered, this will not be possible.

You will be entitled to the value of your fit-out, but you would not be entitled to the value of the business as a going concern. It is vital that you obtain legal advice if you receive a breach notice in such circumstances and potentially you may be forced to litigate to preserve your right to operate from the premises if there are grounds to suggest the termination is unlawful.

Key Takeaways

When leasing premises for your new franchise, it is important to consider what the step-in deed means. Generally, the franchisor only has the right to step-in under very limited circumstances. For example, in the event you default on the lease or breach the franchise agreement. This is a reasonably common expectation from the franchisor. To get advice on the implications of signing your step-in deed, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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