Franchise dictionary
Advertising fees
To promote the franchise business, both the franchisor and the
franchisee including developers and master franchisees will need to
undertake advertising and promotional activities. Where the
franchisor undertakes international, national or regional
advertising, the franchisee is typically obliged to pay advertising
fees to the franchisor. These fees can either be a flat,
weekly, monthly or quarterly fee or calculated as a percentage of
the franchisee’s monthly gross turnover. Alternatively the
franchisor may provide the franchisee with advertising and
marketing materials in consideration for a fee or simply oblige the
franchisee to obtain the franchisor’s pre-approval to any
advertising and marketing materials that the franchisee
produces.
Advertising fees paid by franchisees may be held in a separate
advertising fund by the franchisor. This fund can then be
used by the franchisor for marketing campaigns with a right for the
franchisees to audit the financial statements relating to the
fund
Alternative dispute resolution
Alternative Dispute Resolution or “ADR” is a means of resolving
franchise disputes without resorting to court action. The best
known method of ADR is Mediation but it also includes Arbitration,
Expert Determination and direct settlement negotiations. The UK
courts are very much in favour of ADR and parties will often need
to show that they have, at the very least, considered ADR before
resorting to court action.
Arbitration
Arbitration is perhaps best thought of as private litigation.
The parties to a franchise agreement might agree that in the event
of a dispute they will follow the rules of an international
arbitration body such as the London Court of International
Arbitration or UNCITRAL (the United Nations Commission on
International Trade Law). These rules set out procedures very
similar to those used by the courts, with exchanges of relevant
documents and statements of case in preparation for a trial of the
issues in dispute. Arbitration clauses in franchise agreements
are not uncommon, although arbitration can be as time-consuming and
expensive as litigation at court. Its most pronounced advantage is
perhaps that where court proceedings are mostly public, arbitration
is usually secret (enabling the franchisor to protect its brand
from bad press). In addition, instead of a judge allocated to the
case by the court, the parties to an arbitration can often select a
decision-maker (the arbitrator, or even a panel of three) with
specialist experience of their own market sector as well as a legal
background.
Audit
During the term of the franchise agreement and for a period
thereafter the franchisor should be contractually permitted to
audit the franchisee’s books of account. The main purpose for
the audit will be for the franchisor to determine whether it has
received the royalties and advertising fees to which it is
entitled.
Where any such audit reveals any discrepancy in the fees paid or
payable to the franchisor; the franchise agreement should oblige
the franchisee to redress the discrepancy and in certain scenarios
to cover the franchisor’s audit costs.
Business format
This is a set of business systems and procedures which are
capable of replication by franchisees. It is those operational
elements which define how the franchise business works.
Buyback
This refers to an option whereby the franchisor has a right to
purchase the franchise back from its franchisee. If the option is
granted the franchise agreement should set out those scenarios
where a buyback is possible – usually where the franchisee wishes
to sell its franchise business to a third party or on termination
of the franchise agreement - and the terms and conditions which
apply to the buyback.
Developer
Where a franchisor wishes to expand its franchise business into
relatively large new territories - which may include new
regions within a country, or whole new countries - one option
is to appoint a developer (another is to appoint a master
franchisee). The developer will be granted the non-exclusive
or exclusive right to expand the franchised business within its
designated territory usually in accordance with a development or
roll out schedule. Subject to certain terms and conditions
the developer will be granted the right to operate individual
franchise businesses within the Territory. The developer will
therefore have two roles:
(i) as the developer for the territory;
and
(ii) as the franchisee for individual
outlets/stores/franchise business units.
Another term which may be used to describe a Developer is ‘Area
Developer’.
Disclosure
Disclosure within a franchise context is where a franchisor
provides information to prospective master franchisees, developers
or unit franchisees before a franchise agreement (which here
includes a master franchise agreement or a development agreement)
is concluded. In a number of countries the provision of certain
franchise related information - prior to the grant of franchise
rights - is a legal obligation on the franchisor. Disclosure
is not a legal requirement in the UK but it is recommended best
practice. It is also recommended by the British Franchise
Association. The typical information which is required to be
disclosed includes: details of the franchisor; details of the
franchise business; number and location of franchisees; key legal
and operational obligations; intellectual property rights which
form part of the franchise; and details of any franchise
litigation. Disclosure has a different meaning in legal
proceedings, where it can refer to the exchange of documents which
are relevant to a claim.
Expert determination
Expert determination is a form of alternative dispute
resolution. Whilst it might be most appropriate for a
franchisor and franchisee to engage in litigation, arbitration or
mediation where they do not agree on the facts or law of a dispute,
and need an impartial "referee" to decide who is right , expert
determination is often most useful in very technical disputes where
specialist knowledge is vital. The expert will be appointed by
the parties to evaluate their position, and the issues at stake,
and make a final decision on the issue put to him. An example
might be where a franchise agreement contains particularly complex
royalty payment provisions and a financial expert is needed to
confirm which party has applied them correctly. An expert
determination is - like arbitration and mediation - usually
private, and will provide a binding decision which might resolve
the dispute in its entirety or might help the franchisor and
franchisee narrow the terms of the dispute before it is referred to
the courts.
Franchise
A legal and commercial relationship between a franchisor and a
franchisee which allows the franchisee to operate a business, under
the franchisor’s established brand and in accordance with the
franchisor’s system, know how and business format.
Franchise agreement/franchise contract
The franchise agreement is the legal document which
contractually binds the franchisor and franchisee. It should
contain each party’s legal obligations, and is the framework within
which the franchisee’s business must operate (although elements of
the business format, know how and system should be described
further in an Operating Manual).
Franchisee
This is the term used to describe a party appointed by the
franchisor to run an individual franchise business. Master
franchisees will also appoint franchisees. The franchisee’s
legal obligations and responsibilities will be set out in the
franchise agreement. Another term which may be used to
describe a franchisee, particularly in a master franchise structure
is a ‘subfranchisee’ or ‘unit franchisee’.
Franchising
Essentially, franchising is a business model where one party
(the franchisor hyperlink) has developed a successful product or
service and allows another party (the franchisee) to operate under
its brand name in accordance with its business methods (which
includes the business format, know how and system in exchange for a
fee. As a result the franchisee benefits from consumer
goodwill towards the franchisor’s brand and product(s) or
service(s) and access to the franchisor’s proven methods of doing
business.
Franchisor
This is the ultimate owner of the franchised business including
the intellectual property rights in particular the brand, the know
how and the system. It is the franchisor who appoints developers,
master franchisees, unit franchisees or a combination of these.
Goodwill
This refers to the reputation amongst consumers enjoyed by the
franchisor as a result of selling its product(s) or service(s)
under its brand. In time a franchisee will also develop local
goodwill through the operation of the franchised business.
Intellectual property rights
In a franchise context a franchisor’s intellectual property
rights typically include unique trade marks, copyright and patents.
Typical examples of intellectual property rights include a business
logo protected as a trade mark i.e. the brand, a secret recipe
protected by copyright and/or a unique product protected by a
patent.
Know-how
A franchisor’s know-how is the franchisor’s knowledge and
experience of how to operate its particular business within the
industry sector. The know how forms a key part of the business
format and the system. The franchise agreement should
expressly grant franchisees the right to use the franchisor’s know
how. As know how is not intellectual property it does not have
the same level of statutory protection as, for example, is enjoyed
by copyright or patents. Therefore it is essential that the
franchise agreement provides protection for the franchisor’s know
how, typically by ensuring the franchisee keeps it secret and
confidential.
Master franchisee
Where a franchisor wishes to expand its franchise business into
relatively large new territories - which may include new regions
within a country, or whole new countries - one option is to appoint
a master franchisee (another is to appoint a developer). The
master franchisee will usually be granted the exclusive right to
expand the franchised business within its designated territory.
Subject to certain terms and conditions the master franchisee will
be granted the right to appoint its own franchisees in the
territory. The master franchisee effectively becomes the
franchisor for its franchisees. Another term which may be
used to describe a master franchisee is “subfranchisor”.
Mediation
Mediation is a form of alternative dispute resolution and is
designed to help the parties to a dispute resolve their differences
without the cost of time-consuming litigation. Unlike
litigation and arbitration, mediation is less a battle of
statements prepared by lawyers and more an effort to resolve the
dispute by dialogue between the parties. It is relatively
informal and, where successful, produces a settlement which is
generally not binding until recorded in a settlement agreement. The
parties will try to select a mediator who will either discuss the
dispute with both parties together or perform "shuttle diplomacy"
between parties who don't see eye to eye. The mediator will
not make a formal judgment or decision, but will assist the parties
in agreeing a voluntary resolution. Even unsuccessful mediation can
be beneficial in helping the parties to a franchising dispute
identify the real issues and thus save costs in litigation.
Misrepresentation
A misrepresentation is a statement of fact made (in the
franchise context usually by the franchisor) prior to the signing
of the franchise agreement which induces or partially induces the
other party (in this case the franchisee) to enter into the
agreement and the franchisee later discovers that the statement was
not correct at the time it was made. Misrepresentations are often
in the form of exaggerations of the estimated success of the
franchise, such as unrealistic earnings projections based on
assumptions rather than previous data. A franchisee
(including developers and master franchisees) which purchased its
franchise in reliance on untrue statements may be able to bring a
claim against the franchisor for misrepresentation.
National accounts/clients/customers
The franchisor itself may have built up a portfolio of certain
clients or customers for its products or services, which due to the
client’s/customer’s size, geographical coverage or purchasing
power, are accorded special status compared with smaller, less
frequent clients/customers. Such clients/customers may be termed
‘National Account clients/customers’. National Account
clients/customers may enjoy preferential terms compared to other
clients/customers of the franchise business. These preferential
terms are often set by the franchisor for franchisees to follow and
adhere to. In some franchise businesses, the franchisor may
itself provide the services or products direct to National Account
clients/customers – even in scenarios where the National Account
clients/customers are located in a franchisee’s territory.
Operations manual
The operations manual should contain all the information
that is needed by the developer, master franchisee or franchisee
(as the case may be) to run its business in accordance with the
franchisor’s system, business format and know how.
Pilot operation
Sometimes, before setting up a full network of franchisees, a
franchisor might run one or more outlets in exactly the same way as
it proposes the franchises be run. The pilot operation is
essentially the franchisor’s learning or testing ground. The
franchisor will appoint one or more pilot franchisees who may, for
the term of the pilot franchise relationship, be granted more
favourable commercial terms as an acknowledgement that the
franchisor is still refining the franchise concept and system. The
pilot operation allows the franchisor to develop its operations
manual based on the pilot franchisees’ operating experiences.
It also enables the franchisor to test its franchise agreement to
see which provisions work and those which do not. Taking this
approach means the franchisor might better understand its
franchisee’s businesses, and might lessen the risk of making
statements which misrepresent the truth.
Post termination restrictive covenants
Many franchise agreements contain a prohibition on the
franchisee from being involved in a business which is similar to,
or competes with, the franchisor’s business for a certain period of
time after expiry or termination of the franchise agreement,
Such a restriction is, on its face, in restraint of trade and
therefore void pursuant to Competition Law. However, the courts
have held that the franchisor/ franchisee relationship is similar
to a vendor/purchaser relationship, rather than a consumer or
employee/employer relationship and a post termination restriction
in a franchise agreement is enforceable provided that it goes no
further than is reasonably necessary to protect the franchisor’s
legitimate business interests. Such clauses need to be
carefully drafted by an experienced professional to ensure their
enforceability as what is and is not reasonable will vary from
business to business based on a variety of different factors.
Renewal
A franchisee (or indeed a developer or master franchisee) will
be permitted to conduct business in accordance with the franchise
agreement only for a specified period of time. It is only granted
the use of the franchisor’s brand (hyperlink to intellectual
property rights) for that period. Some franchise agreements
will contain terms and conditions which dictate what needs to be
undertaken by the franchisee and franchisor to allow the franchisee
to continue after the original franchise agreement would have
expired. These are the terms and conditions for a renewal of
the franchise.
Royalties
As consideration for the grant by the franchisor to the
franchisee of the right to use the franchisor’s know how, system
and brand and in return for ongoing training and support, the
franchisee is obliged to pay the franchisor royalties on an
ongoing, usually monthly basis. These royalties are often
calculated as a percentage of the franchisee’s monthly gross
turnover. Other terms which may be used for royalties are ‘Service
Fees’ or ‘Management Fees’.
Subordinated equity agreement
A franchisor may decide that it wishes to invest in its
operations in new territories. It may therefore look to set up
a new company with the developer, master franchisee or unit
franchisee in that territory. The parties will enter into a
subordinated equity agreement which will govern how the new company
is to operate. The new company - which will be partly funded
by the franchisor - will then be granted either master
franchise rights (via a master franchise agreement), development
rights (via a development agreement) or unit franchise rights (via
a franchise agreement) from the franchisor.
System
The system represents the franchisor’s methods for conducting
the franchised business. The system encompasses the
franchisor’s know how and the business format. The operational
elements of the system should be set out in the operations
manual.
Term
The term of a franchise agreement (or a master franchise or
development agreement) is the period of time, usually a specific
number of years, for which the franchisee can operate the franchise
business. If the franchisee wishes to continue after the term
expires, a renewal of the franchise agreement will be needed.
Termination
Termination describes the scenario where the franchise agreement
(and therefore the relationship between a franchisor and its
franchisee) comes to an end. Termination may arise in a number
of scenarios including: (i) where the franchise agreement has
reached the end of its contractual term (also referred to as
expiration); (ii) in scenarios where the parties mutually agree to
end it early; or (iii) in circumstances where one party has broken
its contractual obligations in a way which allows the other party
to end the franchise agreement. It is recommended that the
grounds for termination, including any opportunity to remedy, are
expressly detailed in the franchise agreement.
Territory
The specific geographical area (whether a city, region or
country) within which the franchisee is granted the right to
operate. Often a franchisee will be given exclusive rights to
a territory (meaning no other franchisee of the business will
operate there in competition with it) but in some businesses this
is not the case.