For any potential business owner considering purchasing a franchise, it is important to understand what exactly you are purchasing as a part of the franchise. You should be aware of the operational period of the franchise and what happens after the period ends.This article sets out the common end of term arrangements for franchise systems and includes some tips for franchisees when it comes to understanding the franchise agreement before the purchase of a franchise.
Franchising Code of Conduct
The Franchising Code of Conduct sets out prescriptive regulations of which all franchisees and franchisors are required to comply. One requirement set out in the Franchising Code of Conduct is the need to provide all potential franchisees with a disclosure document. The disclosure document needs to include details of “end of term arrangements,” and follow the format as set out in the Franchising Code of Conduct. For example, the franchisor will need to disclose:
- whether there is a renewal term,
- whether the franchisor will allow for an extension of the franchise agreement,
- details of what will happen to the stock/ assets of the franchise business, and
- whether compensation will be payable at the end of a term.
What is a Term?
It is firstly important to understand the terminology associated with franchise agreements. The word “term” often describes the time period at which a franchisee may operate the franchise. For example, a term may be the time period from the commencement date to expiry date or the time period of five years. From a legal perspective, the term is the period where a franchisee will be able to:
- use the intellectual property, including trade marks, of the franchise system; and
- access the franchise system, including the manuals, training, support, advice/ assistance of the franchisor.
After the term expires, a franchisee will often need to return all items relating to the franchise back to the franchisor and stop operating the business, particularly if the franchise includes a restraint of trade provisions.
Before entering a franchise agreement, a potential franchisee should consider whether they will be:
- able to obtain a return on their initial investment by operating the franchise for the term;
- capable of continuing to operate the franchise for the length of the term, and whether there are associated costs (e.g. paying rent to lease a premises);
- affected by any restraint of trade clause after the term expires, e.g. if you are an accountant, will you be prevented from being employed by an accounting business after the term expires?
What is a Renewal Term?
A renewal term in a franchise agreement refers to a period after the initial term at which the franchisee can choose to continue operating the franchise. Usually, there is no automatic right to renewal. The franchisee needs to fulfil specific criteria before granting the franchisee with the right to continue operating the franchise for the renewal term. In most cases, the franchisor may request for the payment of a “renewal fee” to authorise the grant.
For all potential franchisees who are considering renewing a franchise, they should consider whether:
- there are potential costs associated with renewing the franchise agreement (e.g. renewal fees, costs related to undertaking further training/ refurbishing or upgrading the premises or equipment);
- they can obtain a return on their additional investment by continuing to operate the franchise for the renewal term;
- they need to secure additional rights to continue operating from a premises/ maintaining upkeep of a vehicle; and
- what terms and conditions will the renewal term operate, e.g. will the commercial terms differ for the renewal term?
What is an Extension?
An extension differs from a renewal term as in most cases it will largely depend on the franchisor’s discretion. From a legal perspective, an extension will allow the terms and conditions of the franchise agreement to continue. In most cases, the continuation of terms means that there no new terms will be added to the agreement.
In most cases, a franchisee should not rely on an extension of a franchise agreement to be provided automatically. The franchisor will need to:
- disclose in the disclosure document whether a franchisee will be able to extend the term of the franchise agreement, and
- detail the process they will use to determine whether they should grant an extension of the term.
A common form of an extension of a franchise agreement is a “holding over period”, whereby the franchisor allows the franchise agreement to continue on a periodic basis.
Key Takeaways
Renewing a franchise agreement and extending a franchise agreement are fundamentally different from each other. The rights attached to each depends on the terms of the franchise agreement. Each potential franchise purchaser should thoroughly review the franchise agreement to understand their rights and obligations after the franchise expires. This aids a potential franchise owner in understanding whether they can return their initial investment in the initial term and what the franchisor requires to ensure that renewal is not an issue. If you have any questions about purchasing a franchise or need advice on renewing or extending your franchise agreement, get in touch with one of LegalVision’s franchise lawyers on 1300 544 755.
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