Understanding Lease Arrangements in a Franchise

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Table of Contents

• Your Franchisee Holds the Lease
• You Assign the Lease to Your Franchisee
• You License the Occupation of the Premises to Your Franchisee
• Key Takeaways
• Frequently Asked Questions

As a franchisor, you can choose three primary leasing arrangements for your franchisee. Although, the arrangement you choose will vary depending on several factors, including the nature of the franchise network and the level of control you wish to retain over the business premises. To help you decide which lease arrangement is suited to your franchise network, this article will break down various lease arrangements and explain the benefits and drawbacks of:

• having franchisees hold the lease;
• holding the lease as a franchisor and subsequently assigning the lease to franchisees; and
• holding the lease as a franchisor and subsequently licensing occupancy rights for the lease to franchisees.

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Your Franchisee Holds the Lease

This first lease arrangement involves your franchisee:

• locating the business premises;
• negotiating the lease terms with the landlord; and
• entering the lease agreement directly with the landlord.

While you might retain the right to approve the franchise business premises through the franchise agreement, you are not involved in the relationship between the tenant and landlord.

Benefits

This lease arrangement poses the least financial and operational risk for franchisors. This is because the lease is in the franchisee’s name. Hence, if your franchisee does not pay rent, it does not fall on you to pay the landlord.

Drawbacks

Under this lease arrangement, you have little to no control of the premises. This can cause disruptions when the franchisee wants to terminate the franchise agreement. Further, if you do not have a step-in clause or deed in place, you might not be able to retain the business premises. Finally, if the franchisee cannot pay rent, you may lose the site to a competitor without being informed. 

Another issue stemming from your need for more control over the premises is when a franchisee refuses to pay franchise fees. If you license or sub-lease the premises to a franchisee, you will have greater power to prevent them from trading since you have physical control over the site. However, if the franchisee holds the lease, forcing them to stop trading is more challenging since they have physical control of the business premises. In this instance, you can rely on a restraint of trade clause to bring legal action against a franchisee who continues to operate despite not paying their fees. However, this can be much more expensive than removing them from the site.

You Assign the Lease to Your Franchisee

This second lease arrangement involves you:

• locating the franchise business premises;
• negotiating the lease terms; and
• entering the lease agreement directly with the landlord.

Once you hold the lease, you will assign the lease to the franchisee. Next, the franchisee will become bound by all the terms of the original lease agreement. Typically, you will require a step-in deed to be entered concurrently with the assignment. 

Benefits

In this case, you retain absolute control over the lease of the premises. This can be critical in the negotiating stage with the landlord. For example, franchisors of large national chains generally have better bargaining power with landlords than franchisees entering the franchise system. In this sense, you can have more say on the lease terms regarding rent payments and fit-out of the premises.

Drawbacks

With great control also comes the most significant risk. For example, you may enter the lease but need help finding a franchisee to take over the site. In this instance, you may have to run the franchise business indefinitely. This means that you will:

• be liable to pay rent until you find a franchisee; and
• not receive an immediate return on the costs of entering the lease and the fit-out you might have received had you sold the franchise business as a “package”.

You License the Occupation of the Premises to Your Franchisee

This third lease arrangement involves you locating the franchise business premises, negotiating the lease terms and entering the lease agreement directly with the landlord. Once you hold the lease, you will then license the right to occupy your franchisee. This means you remain the lessee under the lease agreement for the duration. Therefore, you must pay rent, not the franchisee.

Benefits

This lease arrangement is the most common franchise lease model. You retain absolute control of the:

• transaction; 
• site; and 
• premises lease. 

If the franchisee terminates the franchise agreement, you can keep control of the site. Installing another franchisee in your network with minimal business disruption is easier.

You also retain control because you are independent of the franchisee paying rent on time. Instead, you are directly reliable for paying rent to the landlord regardless of whether the franchisor paid you.

Drawbacks

However, since you are the leaseholder, you are liable to the landlord if your franchisee defaults on the licence agreement and lease. For example, a default can arise if rent is not paid or there is damage and destruction to the premises. In this sense, a failure to ‘make good’ the damage to the premises can default the lease terms. 

Key Takeaways

When it comes to leasing a franchise business, you may have a:

• franchisee holds the lease;
• hold the lease as a franchisor and subsequently assign the lease to franchisees; or
• hold the lease as a franchisor and subsequently license the lease to franchisees.

If you have any questions about which lease arrangement will work for your franchise system, 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