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BUYING A FRANCHISE ? FRANCHISING YOUR BUSINESS ?

by: Ben Hanuka, Hanuka & Associates Barristers & Solicitors

Consider some legal stuff...

Many franchisees often pour all of their savings into a franchise business without obtaining advice regarding what obligations will be involved. Similarly, many franchisers spend a substantial amount of time and money developing a successful system, only to turn it over to franchisees without adequately protecting their rights to it. Both franchisers and franchisees need to obtain expert advice on these issues and others before proceeding further.

The Franchisee

Franchisees should be cautioned against placing substantial sums of money into the hands of another party without clearly understanding what they are getting in return. Further, franchisees will want to consider whether they will have any rights to get out of the agreement if it is not to their liking.

There are three reasons why a lawyer should be retained by a prospective franchisee before entering into a franchise relationship:

A. Ensure that the franchisee understands the obligations that the franchiser will expect from the franchisee.

B. Provide advice with respect to common provisions of franchise agreements and related documents.

C. Ensure that negotiated changes to the franchise agreement and related documents are properly documented.

The Obligations

The obligations that will be owed by the franchisee to a franchiser are substantial. Of course, the franchisee will be required to pay some sort of initial fee to enter into the franchise system and ongoing “royalty” of some kind on product or service sales.

However, franchisees will also be require to fulfill personal obligations, including successful completion of a training program or devotion of their full-time efforts to operating the franchised business. Franchisees should consider exactly what their personal obligations to the franchised business and the franchiser will be. In addition, the franchisee will be required to ensure that his or her business is run in accordance with the standards set by the franchiser and found in the franchise agreement or operations manual.

It is also important for the franchisee to understand that he or she will in most cases by required to personally guarantee the obligations of the franchised business, whether he or she incorporates a company to act as a franchisee or not.

The Advice

Franchise agreement are unique commercial documents, and a lawyer with experience in the franchise law area has probably reviewed many franchise agreements in different industries, and will therefore have a strong understanding of whether clauses which are found in a franchise agreement and related documents are reasonable or particularly onerous for the franchisee. The franchise lawyer should also be able to provide a prospective franchisee with advise regarding other documents in the “franchise agreement package”, including lease documents, and personal guarantees.

The Franchiser

A Franchiser understands that what sets its business apart from those of his or her competitors is its “system”; that is , the way the franchiser does its business, the goodwill that it has, including the goodwill which attaches to its trade-mark and trade-name. A franchiser should also understand that the continued success of the system is dependent upon protecting the way that the franchiser (and any franchisees it brings into the system) does business.

Since system protection is often the key to ensuring the continued success of a franchise system, a franchiser should seriously consider what the best ways of protecting the unique elements of its system. While there are several ways to protect a franchise system, the following are three common ways for a franchiser to protect a system:

A. Trade-mark and trade-name protection,

B. Trade secret protection, and

C. Restriction of competition.

Because a franchise agreement is a unique commercial contract, a franchiser should explore all possible system protection options with and experienced franchise lawyer.

Trade-mark and Trade-name

The goodwill of a franchise system usually attaches to the name and marks that are used by the system. The first issue which must be considered by a franchiser in this area is whether its trade-mark or trade- marks are registered with the Canadian Intellectual Property Office. Unregistered trade-marks will be open to challenge by competitors or others claiming a prior use of the trade-marks, and therefore they may be of little value to either the franchiser or prospective franchisees.

If the trade-marks have been registered with the Canadian Intellectual Property Office, then the franchiser will want to ensure that the franchise agreement is drafted to give a franchisee rights to use the trade-marks only for certain purposes. Franchisers will also want to ensure that any use of the grade-marks by franchisees has been given prior approval by the franchiser.

Trade Secrets

Trade secrets are also known as “confidential information”. A franchiser has usually developed unique methods of producing or selling certain products or services. These unique methods help or set the franchiser apart from it's competitor. However, if the methods are not protected, competitors may copy the methods and use them also. Therefore, it is important for a franchiser to ensure that whatever confidential information is give to a franchisee or his or her employees is not passed on by them to others. Franchisers should therefore discuss with their lawyers exactly what elements of their system should be kept confidential, and how to do so.

Restriction of Competition

Often franchisers will bring franchisees into their franchise system who have no previous experience in the particular industry of the franchise system. Franchisers will train the franchisees, and provide them with ongoing assistance in operating the franchise, including providing access to the confidential information discussed above. Therefore, franchisers will want to prevent franchisees from competing against the franchise system for a period of time if the franchise agreement ends or is terminated by including a clause on the issue in a franchise agreement.

Since clauses which prevent franchisees from competing against franchisers for a specific period of time in a specific region (know as “restrictive covenants” or “non competition clauses”) are often difficult to enforce, a franchiser should discuss in detail the nature of the restriction which it wishes to place on the franchisee, and the likelihood that such a clause would be enforceable.

Conclusion

The basis of the franchise relationship is formed in a contract. Therefore, it is important for both the franchisee and a franchiser to understand the basic contractual principles and terms which will govern their relationship.

It is only with the assistance and professional advice that a franchiser can develop a franchise contract which accomplishes its goals and objectives. Similarly, it is only with the assistance and professional advise that franchisee can understand the often arcane terminology used in the commercial contracts which will govern its relationship with the franchiser.

Ben Hanuka is a finance lawyer at Hanuka & Associates specializing in business purchases & sales, commercial leases , partnership agreements, joint ventures, shareholders agreements, commercial litigation.