Strengthen Your Franchise Agreement
Franchisors typically have developed franchise agreements that have been tailored by time and experience to address the issues that most often arise in the development of their franchised businesses. However, even the most polished agreement can benefit from a periodic review and revision. Here are five areas that frequently require attention to enhance enforcement rights, protect against competition, protect intellectual property, and protect against claims by third parties.
1. Security interest in the franchisee's assets. In the event of a franchisee default, the franchisor should be able to take possession of a franchisee's assets for the purpose of selling those assets (possibly to a new franchisee) to recover monies due from the franchisee or to keep those assets to operate the unit. To ensure the right to do so, the franchisor should take a security interest in the furniture, fixtures and equipment used in the franchised business. This security interest can be created in the franchise agreement and can be perfected by a recorded UCC financing statement (UCC-1).
2. Collateral assignment of lease. In the event of a franchisee's default under its lease for its business premises, the lease should provide that the franchisor has the right, but not the obligation, to assume the lease without having to pay any consideration to the landlord, cure any defaults, or replenish the security deposit. The latter two conditions are sometimes difficult to extract from a landlord, but the assumption right is imperative. To protect itself in this manner, the franchisor should require a collateral assignment of lease that is entered into simultaneously with the franchisee's lease. This will allow the franchisor to enforce its rights upon default without requiring the cooperation of the franchisee or the consent of the landlord.
3. Non-competition agreements. Every franchisor should have a noncompete provision in its franchise agreement. However, the franchisor must be certain that the scope of both in-term and post-term covenants are not too broad and provide for limited duration and limited territory. The clauses should be drafted to protect the franchisor's business interests. The provision must take into account the specifics of applicable law. California, for instance, does not allow for such non-competitive restrictions. In Atlantic Bread Company v. Lupton-Smith et al., 285 Ga. 587 (2009), the Supreme Court of Georgia held that in-term restrictions are governed by the same strict scrutiny standard as to length and area as post-term restrictions. All limitations in the relevant jurisdictions must be identified and accounted for in the provision to the extent possible. It is generally advisable to include a "savings" clause in the non-competition provision that provides that if any part of the provision is deemed excessive, the court can limit it.
4. Trade secrets and trademarks. It is essential that the franchisor protect its brand and other intellectual property. This is the lifeblood of its business.
- Franchise agreements should contain strong protections of trade secrets:
- i. The non-competition clause should assist in this by referring specifically to trade secrets;
- ii. The franchise agreement should require that the franchisee obtain a nondisclosure agreement from all of its employees, independent contractors, agents, management, owners, etc.;
- iii. The franchise agreement should provide a form non-disclosure agreement for the franchisee to use;
- iv. The franchisor should develop enforcement procedures and vigorously apply them; and
- v. The franchisor should clearly mark all trade secrets as confidential.
- It is important that the franchisor monitor the use of its trademark. The franchise agreement should strictly define a franchisee's permitted use of trademarks. A franchisee's use must be consistent with the franchisor's plan--color, size, shape, approved advertising formats, and media (print, TV, radio, Internet); the franchisee may not use a similar mark in any way; and the franchisee must not have created a separate Internet presence using the mark if prohibited by the franchisor. The franchisor should regularly review USPTO and state filings to be certain that similar marks are not filed. If filed, the franchisor should determine if a mark is confusingly similar and oppose registration. The franchise agreement should provide that the franchisee must participate and cooperate in these endeavors.
5. Insurance. In addition to requiring that a franchisee obtain the types of liability insurance generally obtained by any business, the franchise agreement should also require the franchisee to obtain employment practices insurance to cover claims alleging sexual harassment and age discrimination. It should also require franchisees to purchase business interruption insurance, the proceeds of which should be included as part of the franchisee's gross revenues and factored into the franchisee's royalty payments to the franchisor, if royalties are calculated as a percentage of gross revenues.
Terrence Dunn and Michael Einbinder are the founding partners of the New York-based law firm Einbinder & Dunn LLP. Contact them at 212-391-9500.
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