Crafting a well-structured lease arrangement is crucial for you as a franchisor, as it lays the foundation for a successful and mutually beneficial relationship with your franchisees. Typically, a premises-based franchisee will operate their franchise business from a fixed location. You and your franchisee must determine the best-suited strategy for securing premises and entering into a lease. In particular, you must consider who holds the lease and how this will impact both you and the franchisee if a dispute arises or if a franchisee wishes to leave the franchise network. This article will discuss the options available to you for structuring the lease for your network.
What Are the Lease Options?
Either the franchisee or you, or a related entity of yours, will hold the lease. Who holds it is a commercial decision for you. You should consider the:
- nature of the franchise system and size of the franchise network;
- risk and commercial factors regarding the premises; and
- potential exposure and liability.
The two most common structures for leasing premises in franchising are:
- the franchisee holds the lease; or
- you hold the lease and grant the franchisee a licence to occupy the premises with the landlord’s consent.
1. The Franchisee Holds the Lease
If the franchisee holds the lease, they are the legal tenant who enters into the lease agreement with the lessor or property owner. The franchisee is responsible for fulfilling the obligations outlined in the lease, such as paying rent and adhering to any terms or conditions specified within the agreement.
You are not responsible for fulfilling any obligations under the lease. If the business struggles, the franchisee (as the lessee) is still liable for continuing to pay rent until the end of the lease term. You may assist the franchisee to locate a suitable property and negotiate with the lessor to secure:
- control of the site selection;
- competitive rent;
- a rent-free period; or
- incentives for the franchisee.
Many franchisors provide this service, and some charge an additional fee to the franchisee for this support. However, you must accept the risk that you may have a level of responsibility if the site is unsuccessful. If you are providing this assistance, it is good practice to reduce potential liability by obtaining a signed letter of acknowledgment from the franchisee stating that the franchisee 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.
When bringing on board new franchisees, it is important to negotiate agreements that strike a balance. This factsheet explains how.
What Happens If the Franchisee Exits the Network?
If the franchisee holds the lease, you will have no control of the site should the franchisee exit the franchise network. In this instance, it is easier for the franchisee to rebrand and continue to trade from the premises, exploiting the goodwill they acquired while operating under your brand. To reduce this risk, you may request that the lessor:
- insert a clause stating that they will terminate the lease if either you or the franchisee terminate the franchise agreement or that allows you to take over the lease in this instance; or
- enter into a ‘step-in deed’, which is triggered if the franchise agreement comes to an end.
2. You Hold the Lease
If you hold the lease, you retain control over the leased property and may sublease or provide the franchisee with a licence to occupy the premises to conduct the franchise business. You have the right to access the premises or contact the lessor; these rights can be beneficial and provide protection for you. If the franchisee does not operate the business to standard or causes reputational damage to your business, you can act quickly by entering and taking possession of the premises. You may also be able to terminate the licence to occupy the premises and manage the franchisee’s business to ensure standards are met.
Lessors may also be more willing to lease to a well-known franchisor versus a franchisee, particularly when there may be an option to take multiple sites in various shopping centres. Lessors may be familiar with your rental history at another location and provide preferential access to new opportunities and premises.
What is Your Responsibility Under the Lease?
If you hold the lease, you assume all liability under the lease agreement. Although you can pass some of these obligations on to the franchisee through any licence to occupy, such as the payment of rent, the lessor has no contract with the franchisee. If the franchisee fails to pay rent to the landlord or pay licence fees to you, you must 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, which would be costly for you.
However, you may be able to recover any costs from the franchisee. An additional effective strategy to reduce your liability is to have a director of the franchisee provide the personal guarantee required under the lease. The lessor could then commence proceedings against the franchisee director as there would be an existing contractual relationship.
Key Takeaways
Overall, as a franchisor, structuring your lease arrangements thoughtfully is essential to ensure the stability and success of your franchise network. You may decide to have the franchisee hold the lease or to hold the lease yourself. However, each option comes with its own set of responsibilities, risks, and benefits. You may choose to implement safeguards such as a step-in deed to mitigate the risks to your business. Ultimately, you should weigh up the commercial risks to your business against the benefits of exercising control over premises.
If you are drafting a lease, our experienced franchise lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.
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