By: Konstantine Chatzidimos and Jayson Schwarz LLM
As corporate/commercial lawyers we come across many a wide-eyed client chomping at the bit to (blindly) buy into the latest-and-greatest franchise ‘opportunity’. This article will hopefully give you a taste of the legal considerations that you will be facing.
What is a Franchise?
A ‘franchise’ is a legal structure where a ‘franchisor’ grants to a ‘franchisee’ the right to use a trade name, trademark and can include a business methodology in association with the running of a particular business. Franchise arrangements are quite common in the retail and restaurant sectors of the economy but can be found in virtually all segments. In exchange for the right to use the franchisor’s trade name or trademark and following their guidelines, the franchisee typically pays the franchisor an initial franchise fee plus ongoing royalty payments linked to the gross sales of the franchised business.
Due Diligence
Many prospective franchisees believe – or are led to believe by franchisors – that since a particular franchise may have been around for a while less research, investigation or even business knowledge are required on their part when considering this type of investment. They will hear the ‘turn-key operation’ and erroneously put their financial suspicions to rest.
The Canadian Franchise Association implores prospective franchise purchasers to “investigate before investing”. This, thankfully, has been made easier in Ontario with the passage of legislation in 2000 requiring franchisors to provide prospective franchisees a Disclosure Document at least fourteen days before they sign any agreement or pay any money to the franchisor. This Disclosure Document is supposed to furnish prospective franchisees with germane and meaningful detail regarding the franchise they are eyeing to purchase.
It is imperative that prospective franchisees review the complete Disclosure Document, and any accompanying schedules, with a commercial lawyer experienced in this area of the law. An experienced lawyer will determine whether the disclosure provided satisfies the franchisor’s obligations under the law. Too often clients have retained us to close the purchase of their new franchise well after signing the franchise agreement and after having all but glossed over the Disclosure Document. A thorough review of the complete Disclosure Document is essential in assisting prospective franchisees to assess the nature of the franchised business. This is not an occasion to be stingy and the investment in a lawyer’s time at this stage can end up saving thousands of dollars later.
Part of the required disclosure includes provision to prospective franchisors of financial statements. As with legal advice, financial advice at the front end is critical to ensure you are not buying “a pig in a poke”. Review any financial detail provided with a chartered accountant (not a bookkeeper). If you do not have or know an accountant, your lawyer can certainly refer you to one capable of providing you with answers.
The Franchise Agreement
Included within or appended to the Disclosure Document should be a copy of the draft Franchise Agreement. I refer to it as a ‘draft’ because incumbent in all commercial situations is some negotiation wiggle-room. It is imperative that the noted fourteen day window is taken advantage of and that any provisions within the Franchise Agreement which you and/or your lawyer find particularly onerous are addressed.
Here are some things to watch for that ordinarily are points of contention: the franchise fee; royalty rates; pricing of products that have to be bought from the franchisor; training (if any), territory: exclusivity; degree of control by Franchisor over operation of the business and term of the agreement. Ensure you are comfortable with the degree and scale of any such ‘big-brothering’ exacted by the franchisor.
Be aware, however, that franchisors pay hefty legal fees to draft their standard form Franchise Agreements and, as a consequence, typically do not want to change anything. Thus, it is best to select a handful of issues for negotiation instead of nit-picking on every second or third line; choose your battles.
Conclusion
There are a host of issues to be addressed when purchasing a franchised business however the new legislation passed has made it easier for prospective franchisors to make more informed decisions. The thing is the prospective Franchisee has to take the step to become informed