When becoming a franchisee, it is easy to overlook the potential legal pitfalls lurking within the depths of lengthy franchise agreements. The purpose of this article is to highlight ten legal pitfalls for franchisees in franchise agreements.
- The franchise agreement is likely to be one-sided in favour of the franchisor and impose substantial restrictions on a franchisee’s day-to-day management of the franchise, particularly with regards to branding, suppliers, product offerings and pricing.
- A franchisee may be required to pay a franchisor an initial fee and royalties or a mark-up on products received either directly from the franchisor or its nominated supplier.
- Franchise agreements are typically granted for 5 years to comply with competition laws. However, UK law does not regulate the duration of franchise agreements, so franchisors can grant longer contract terms such as 10 years. The franchisor will often have the right to terminate the franchise agreement early in wide-ranging circumstances, but the franchisee will have no contractual right to terminate the agreement early. This means that unless the franchisor commits a very serious breach, the franchisee will be tied to the franchise until the expiry of the fixed term period, which can be several years.
- If the franchisee is a limited company, a franchisor may require a director or shareholder of the limited company to provide a personal guarantee. Such personal guarantee will enable the franchisor to enforce the terms of the franchise agreement against the individual director/shareholder, holding them personally liable for any breach of the franchise agreement by the company franchisee.
- Franchise agreements often contain non-compete clauses. Such clauses aim to prevent a franchisee from setting up a business in the same or similar industry to that of the franchise for a set period after termination of the franchise agreement. However, the UK courts have refused to enforce a 12-month non-compete clause when the specific circumstances of the case meant the post-termination restrictions imposed by the non-compete clause were unreasonable.
- There are no disclosure obligations on UK franchisors. Franchisors are not required to proactively disclose all material facts to franchisees. A franchisee should therefore carry out extensive due diligence before signing the franchise agreement. However, a franchisor will be liable to a franchisee if it misrepresents the viability of the franchise.
- The franchise agreement will often include a disclaimer stating that the success of the franchise is not guaranteed. If the franchise is unsuccessful, the franchisee will still be required to perform their obligations under the franchise agreement (including, for example, payment of fees) and will not be able to recoup their losses from the franchisor.
- In addition to the fees payable, a franchisee may also have to pay an advertising levy. The advertising levy is often set at around 2%-3% of gross monthly receipts, but this depends on the business context.
- Any operating manual(s) provided by a franchisor to a franchisee can be just as important as the franchise agreement. Franchise agreements usually give the franchisor the right to update the franchise manual(s) from time to time, and the franchisee is usually obliged to comply with the manual as updated, even if this causes the franchisee to incur unexpected expenditure.
- Generally, franchise agreements will include a clause which states that the franchise agreement makes up the entire agreement between the franchisor and the franchisee. This means that a franchisee may not be able to rely on or enforce what was previously promised by the franchisor unless such promises are reflected in the franchise agreement. A franchisee should therefore check that the terms of the franchise agreement align with what has been previously agreed with the franchisor. In any event, the franchisor may refuse to amend their standard-form franchise agreement.
Whilst most franchise agreements share common characteristics, the terms of a franchise agreement can vary depending on the specific industry and the relationship between the franchisor and franchisee.
How Moore Barlow can help
If you are a franchisee or aspiring franchisee who is unsure of their obligations under a franchise agreement, we will be able to review the franchise agreement and advise you on the legal risks.
Get in touch with our Franchising and licensing team for guidance and assistance.
