The Role of the Franchise Agreement

In the previous issue of Franchise Law News, Terrence Dunn and Michael Einbinder authored an article on how to strengthen your franchise agreement. This article expands on that theme, focusing on the role of the franchise agreement in the franchise system.

The bottom line is that a strong franchise agreement is critical to the franchise system's ability to (i) meet the needs of the franchise brand's customers, including making necessary changes as those customers' needs evolve, and (ii) protect the interests of the various stakeholders who have an interest in the brand, including the franchisor and its owners and the franchisees.

More than a legal contract

At its foundation the franchise agreement is the legal contract between the franchisor and franchisee. It defines each party's rights and obligations regarding many important facets of the franchise relationship. Clarity, rather than ambiguity, should be the goal when addressing the franchisor's and franchisee's rights and obligations. For example, if a franchisor does not grant any form of territory protection, then the franchise agreement should clearly state that the franchisee has the right to operate at the authorized location only and the franchisor can develop additional locations or use alternative methods of distribution in any way it deems appropriate. If the franchisor does not want to expressly reserve those rights, then include the appropriate language that provides some limitations--just do it clearly and avoid ambiguity.

Beyond the foundation, however, the franchise agreement is a living, breathing document that must allow the franchise system to change over the life of that agreement. Franchisors often compete with larger companies with corporate locations as opposed to franchised locations. Those companies can implement new product lines or new marketing campaigns with executive decisions. If a franchisor cannot compete effectively with those competitors, it and its franchisees will not survive. Accordingly, a franchisor must reserve rights in its franchise agreement to implement systemwide changes and otherwise evolve the system.

The franchise agreement also is the document that balances the interests of the franchisor, the franchisees, and the system as a whole. Using an economic analogy, it's the franchisee free rider who refuses to play by the rules who potentially creates great risk to all the other stakeholders in the system. The franchisee who refuses to contribute to a marketing fund, who uses unapproved vendors or products, or who violates the noncompete covenants, is the franchisee who hurts not only the franchisor, but also the franchisees who play by the rules and the system as a whole. All stakeholders in the brand should want a strong franchise agreement to allow the franchisor to effectively deal with free-riding franchisees.

It's all about the brand

Disgruntled franchisees and franchisee advocates proclaim that the franchise agreement is a contract of adhesion with all rights and powers reserved to the franchisor, leaving franchisees with no bargaining power or rights. This view is too myopic and refuses to recognize that the franchise agreement is not one-sided to protect the franchisor, but rather is focused on brand protection.

Franchisors should not shy away from any questions about any perceived inequities in the franchise agreement. Instead, they should accurately explain that the role of the franchise agreement is to protect the brand. Those conversations should begin during the franchise development process and continue throughout the franchise relationship. The franchisor and franchisees then more easily focus on customer-centric activities with the mutual objective of finding and keeping highly satisfied and loyal customers. Contrast that approach with systems in which the franchisor and franchisees are at odds, constantly fighting over whether the franchisor has the right to force system changes and whether the franchisees must implement those changes.

The difference maker

Highly successful franchise systems and struggling franchise systems often have very similar franchise agreements. So, it's not crazy to assert that the franchise agreement is not the problem. The key factors are how the franchisor and franchisees interact and collaborate with one another and whether the system focus is on the brand and its customers. Further, the highly successful franchisors include franchisees in conversations regarding system-wide decisions and value franchisee opinions, still reserving the right as the franchisor to make system-wide decisions. These franchisors explain their decisions without having to rely on a reason that includes some form of "I can make this decision because I am the franchisor and you must comply because you are the franchisee." The franchise agreement then permits the franchisor to protect the brand if free-riding franchisees refuse to play by the rules.

Understanding the role of the franchise agreement in these critical dynamics will make a difference to you as the franchisor, your franchisees, and the system as a whole, including your brand customers.

Brian Schnell is a leader of the Faegre & Benson Franchise Team, which represents more than 200 franchisors in 35 states and 7 countries. He is a past chair of the IFA Supplier Forum; a member of its Legal/Legislative, Awards, and Membership committees; and in 2009 became the first male to receive the IFA Women's Franchise Committee Crystal Compass. Contact him at 612-766-7472 or bschnell@faegre.com.

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