Legal and commercial issues for franchisees

Evaluating a franchise opportunity

The primary rationale for becoming a franchisee is that it involves acquiring a ready-made business, which already has goodwill associated with its trade mark, and has a clearly defined business system, including a source of supply of products and a detailed manual as to how to operate the business. This advantage needs to be weighed up against the disadvantages. These include the requirement to pay initial and ongoing franchise fees, and the fact that the franchisor remains the real owner of the goodwill of the business.

The disclosure document which the franchisor is required to provide prior to the signing of a franchise agreement can be an important part of evaluating whether to acquire the franchised business. The most important points to look for in the disclosure document are as follows:

• • The franchisor’s experience. Long experience as a franchisor, combined with absence of litigation, and favourable reports from other franchisees is a good basis for trusting a franchisor.
• • Litigation. The Franchising Code of Conduct contains detailed provisions for the supply of information about current and completed litigation against the franchisor or any of its directors relevant to their conduct of the franchising business.
• • Other franchisees. The disclosure document is required to include information about current and previous franchisees, including their contact details. Contacting these other franchisees can be an important part of evaluating a franchise opportunity.

Sometimes, the most important red light in a disclosure document is not what it says, but what it does not say. A franchisor with a poor record or relationship with its franchisees may seek to avoid disclosure by inserting statements such as, “This information is on our website” or “This information is available on request”. Any reluctance by a franchisor to disclose any of the information referred to above should be viewed with deep suspicion.

Consideration of the franchise agreement is also an important part of evaluating a franchise opportunity. Franchise agreements are almost always heavily one-sided in favour of the franchisor, and franchisors are reluctant to negotiate amendments. As this relates to almost all franchise agreements, it should not necessarily discourage the franchisee. Important points to look for are as follows:

• • The term of the franchise agreement, including any options. This is important as, once the franchise period expires, the franchisee is left with nothing, unless a franchisor agrees to grant a further period.
• • Restrictions on transfer of the franchise. Franchisees regularly sell their businesses. The Franchising Code of Conduct provides that the franchisor cannot unreasonably withhold its consent. However, some franchise agreements place requirements upon such transfers, including payment to the franchisor of part of the price of sale of goodwill.

Clause 10 of the Code provides that the franchisee must provide a statement as to their understanding of the disclosure document and the Code before the franchise agreement is entered into, and before any non-refundable payment is made. Clause 26 of the Code provides for a cooling off period of seven days from entering the franchise agreement, or making a payment under the franchise agreement, whichever is earlier.

See Legal and commercial issues for franchisees.