This post provides an overview of the recent seminar: Franchising presented by Jas Cheema of Moore Blatch LLP.
The seminar aimed to give an overview of franchising and in particular current trends in franchising growth, importance of developing a brand and demonstrating a proven business model and key issues to be aware of when entering into a franchise agreement.
What is a franchise?
The British Franchise Association states that a franchise is the granting of a license by one person/entity (franchisor) to another (franchisee) whereby the licence entitles the franchisee to trade as their own business under the franchisor’s brand under a proven business model. The franchisee also receives a package, comprising of all the elements necessary to establish a previously untrained person in the business and to run it with continual assistance on a predetermined basis.
Therefore franchisors can expect to see the following key components under a franchise:
- Franchisor allows franchisee to use a name or trade mark which is associated with the franchisor. To the average consumer or client, it will seem as if the franchise is run by the franchisor.
- Franchisor may wish to exercise quality control over how the franchise is run by the franchisee.
- Continuing assistance/ training provided to franchisee.
- Payments to the franchisor.
Franchisors may be attracted to set up a franchise model and replicate the business in various territories as successfully run franchises will provide the franchisor with the opportunity to secure distribution for products or services faster than would be the case if the franchisor had to train up its own employees and develop its own internal marketing, sales and distribution organisation.
The franchisor can use the franchisee’s capital to facilitate the expansion of a network more quickly than would be the case if the franchisor had to find the funds itself. Ultimately the franchisee’s financial well-being links to the franchisor’s business and growth.
The ability for a franchisor to set up a franchise network of a proven business model increases the franchisor’s purchasing power and possibly also reduces overheads and may be able to increase the profitability of each franchise unit.
Franchising is a growing business trend as demonstrated from the findings of the Natwest/ British Franchise Association 2016 annual survey which reports that franchising is growing:
- The contribution of franchising to the UK economy is now reckoned to be £15.1 billion, an increase of 46% over the past 10 years and up 10% since the last survey in 2013.
- The number of franchisee-owned businesses has increased by 14% in two years, to 44,200.
- Most interesting is that 80% of franchise brands in this country are UK-owned and developed.
Why have a franchise agreement?
Franchisors and franchisees should enter into franchise agreements to ensure there is contractual certainty over the rights of the franchisee, obligations of both parties at the outset of setting up the franchise and any continuing obligations such as the franchisor’s obligation to provide continuing training and any quality control it may wish to exercise over the franchisee.
Most importantly, the franchise agreement provides a licence to the franchisee expressly setting out the terms on which the franchisor provides a licence to its brand name and trademarks and also certain know-how belonging to the franchisor. Therefore the franchise agreement needs to be drafted well to ensure there is no ambiguity on the parties’ intentions.
What are the key terms of a franchise agreement?
- Charges and payments are of most importance to franchisors.
- You would expect to see a combination of initial and on-going charges under a franchise agreement. Initial fees are designed to reimburse the franchisor of its costs to set up a franchise.
- It is usual for franchisors to charge on-going management fees and advertising levies throughout the term of the agreement. Management fees are where franchisors are likely to make a profit on a franchise and are usually calculated on a percentage of the franchisee’s gross monthly receipts. Most well known brand franchisors usually run nation-wide marketing campaigns and typically each franchisee will pay a percentage of the advertising costs.
IPR and licensing
- Licensing intellectual property is central to the whole concept of franchising. Franchisors should ensure they have obtained the benefit of registration of important marks and trade names before they licence use of the same to franchisees.
- Franchisors should also think about the scope of intellectual property which they will be licensing to franchisees; in addition to trade marks, it is important to scope out the level of commercially sensitive information and know-how which will be made available to franchisees and ensuring there are appropriate confidentiality obligations within the agreement.
- Franchisors will also be concerned with how their trade names and trade marks are used and should ensure the franchise agreement contractually binds franchisees to abide by the franchisor’s brand and marketing guidelines or policies to ensure its reputation is not diluted by any act of the franchisee.
Termination and post–termination restrictive covenants
- It should be clear from the outset who is able to terminate the franchise agreement and what events would give the other party a right to terminate the agreement.
- During the term of the agreement, the franchisee is likely to acquire trade secrets and important information about the franchise business, customers and suppliers which the franchisee could use to set up a similar business in competition with the franchisor in the territory after termination of the franchise. Restrictive covenants are therefore very important to ensure franchisors are not faced with the situation where franchisees use the information they have gathered from running the franchise and compete with franchisors after termination.
- Restrictive covenants must however be well drafted and water tight to ensure there is no ambiguity over the intentions of the parties after termination and that restrictive covenants are enforceable.
- In the case of Chipsaway International Limited v Kerr 2009, Chipsaway owned the rights and know-how in a system for filling and restoring damage to the bodywork of cars. Kerr, a franchisee did not renew the franchise agreement and ceased to use the Chipsaway name and products after termination but continued the business of a car care centre at the same premises. The franchise agreement prohibited Kerr, for the period of 12 months following the termination of the agreement, from competing with the business within the area. The restrictive covenants were ambiguous and the High Court originally ruled that as the franchisor did not appoint a new franchisee in the area or trade itself after termination there was no ‘competition’ and therefore no breach. On appeal, this interpretation was rejected and it was decided that in fact the commercial purpose of the restrictive covenant was to protect the franchisor’s goodwill and there did not have to be actual competition – after both parties expending a great deal of time and money the franchisee was found to have breached the restrictive covenant.
Overall it is essential that franchisors are aware of the importance of having brand protection from the outset and any intellectual property is licensed under a franchise agreement. Both the franchisor and franchisee must ensure the franchise agreement is well drafted and is unambiguous as to the parties intentions from the outset.
Jas Cheema 11 May 2017