Many franchise agreements are ‘site based’ meaning that the franchise business operates from a particular premises (premises) as set out in the franchise agreement. Site based franchising relies on establishing the following:
- The franchise agreement between the franchisor and franchisee and any guarantors for the franchisee (franchise agreement); and
- A lease for the premises (lease).
We explain below how franchisors can lease the premises for their next franchise.
Leasing a Premises
Leaving aside the franchise agreement which we have discussed here, there are two options for the lease:
- The franchisee can enter into the lease direct with the landlord of the premises; or
- The franchisor can enter into a lease with the landlord of the premises and then subsequently issue a licence agreement (licence agreement) to the franchisee. A licence agreement allows the franchisee to occupy the premises and comply with the franchisor’s lease during the term of the franchise agreement.
Directly Entering Into the Lease With the Landlord
The second option (i.e., the franchisor acting as tenant) is popular with many franchisors for the following reasons:
- The franchisor, particularly if it is a large national chain, generally has better bargaining power with landlords – especially when large shopping centres such as Westfield or Stockland are involved and the franchisor is in a position to negotiate more favourable lease terms;
- The franchisor retains absolute control over the lease of the premises, from negotiating the terms of the lease to control over rent payments and fit out of the premises. This ensures the franchisor can better ensure the quality of its brand and image;
- The franchisor licences its occupation rights under the lease to the franchisee using a licence agreement, noting this document requires the franchisee/licensee to comply with the lease as if it were the tenant named on the lease;
- If the franchise agreement ends for any reason, the franchisor can evict the franchisee, and it retains the right to occupy the premises. In practice, this means that it is easier to install another franchisee in its network with minimal business disruption.
What are the Drawbacks?
There are, however, some drawbacks for the franchisor in entering directly into a lease and licensing the premises to the franchisee – particularly if the lease negotiation isn’t handled well. The following issues can cause difficulty:
- If the franchisee defaults on the licence agreement and lease, the franchisor (who is the lessee and licensor), will continue to remain liable to the landlord (being the lessor). Default can be in the form of rental arrears or damage and destruction to the premises. Similarly, failure to ‘make good’ damage to the premises at the end of the lease can result in a default of the lease terms. Many franchisors can, however, circumvent this risk by requesting the franchisee provide a bank guarantee/security bond and personally guarantee the lease and licence agreement.
- Unless the lease has specific franchise clauses inserted which allow the franchisor/lessee to license the premises to a franchisee, the landlord may insist on providing approval before the licence agreement can be signed/franchisee can occupy the premises.
- The franchisor, or directors of the franchisor company, may be required to provide personal guarantees for the obligation of the franchisor as lessee. This can be risky if the franchisee defaults. It is preferable for the directors of any franchisee/licensee company to provide personal guarantees so that the directors of the franchisor company can limit their personal liability, particularly if they have a large national network of franchise stores.
LegalVision’s franchise law team acts for national franchisors and assists them to negotiate lease terms. If you have any questions about your lease agreement or drafting a lease that contains franchise specific clauses, get in touch on 1300 544 755.