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Franchise agreement: drafting note
Resource type: Drafting note
Status: Maintained
Jurisdictions: England, Wales
This drafting note accompanies the standard document franchise
agreement.
PLC Commercial (with thanks to John Pratt of Hamilton Pratt)
Standard document: Franchise agreement
Contents
General document notes
Legal issues
Negotiating and drafting issues
Clause notes
Parties
Background
Definitions: clause 1
Clause 1.1
Advertising Levy
Business
Equipment
Financial Package
Gross Monthly Receipts
Initial Fee
Intellectual Property
Lease
Manual
Premises
Products
Services
Start Date
System
Territory
Trade Marks
Trade Name
Interpretation
Rights granted: clause 2
Clause 2.1
Clause 2.2
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Clause 2.3
Term: clause 3
Clause 3.1
Clause 3.2
Clause 3.3
Clause 3.5
Clause 3.6
Fees: clause 4
Clause 4.1
Clause 4.2
Clause 4.5
Franchisor's initial obligations: clause 5
Clause 5(a) and (b) - Premises
Clause 5(d) supply of equipment and products
Clause 5(e) - public relations launch of the franchisee's
business
Clause 5(f) - the provision of the franchisor's operations
manual
Clause 5(g) - local advertising
Clause 5(h) - provision of the financial package
Franchisor's continuing obligations: clause 6
Clause 6(b)
Clause 6(c)
Clause 6(d)
Franchisee's obligations: clause 7
Employees: clause 8
Training: clause 9
Clause 9.1
Clause 9.2
Anti-bribery compliance: clause 10
Clause 10.1(b): outside the UK
Clause 10.1(c): relevant policies
Clause 10.1(d): adequate procedures
Clause 10.1(e): reporting bribes
Clause 10.1(f): foreign public officials
Clause 10.1(g): monitoring and review
Clause 10.2: supply chain
Clause 10.4: definitions
Accounting records: clause 11
Advertising: clause 12
Clause 12.1
Clause 12.2
Telephone numbers: clause 13
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Insurance: clause 14
Premises: clause 15
CRC Energy Efficiency Scheme: clause 16
Clause 16.1
Clause 16.2
Clause 16.3(b)
Clause 16.5
Clause 16.6
Clause 16.7
Clause 16.8
Clause 16.9
Intellectual Property: clause 17
Clause 17.1
Clause 17.2
Clause 17.4
Clause 17.5
Clause 17.6
Sale of business: clause 18
Clauses 18.1 and 18.4
Clause 18.2
Clause 18.4
Clause 18.6
Clause 18.7
Death or incapacity of individual: clause 19
Clause 19.1
Clause 19.2
Confidentiality: clause 20
Termination: clause 21
Clause 21.1
Clause 21.2
Conditions following termination: clause 22
Clause 22.1
Clause 22.3
Clause 22.4
Restrictions: clause 23
Indemnity: clause 24
Individual's guarantee and covenants: clause 25
Entire agreement: clause 26
Further assurance: clause 27
Data protection: clause 28
Assignment: clause 29
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Rights of third parties: clause 30
No partnership or agency: clause 31
Force majeure: clause 32
Set-off: clause 33
Default interest: clause 34
Severance: clause 35
Variation: clause 36
Waiver: clause 37
Expert: clause 38
Counterparts: clause 39
Notices: clause 40
Alternative dispute resolution: clause 41
Governing law and jurisdiction: clause 42
Trade marks: Schedule 2
GENERAL DOCUMENT NOTESThe Standard document, Franchise agreement
(www.practicallaw.com/9-223-1966) is an agreement which may be
adapted according to whether non-exclusive or exclusive rights in a
particular territory are to be granted.
This drafting note does not discuss taxation in relation to
franchises.
Legal issuesFor discussion of franchising arrangements
generally, see Practice note, Franchising: overview
(www.practicallaw.com/2-107-3749).
The CRC Energy Efficiency Scheme (CRC), which applies to
franchises, came into force on 1 April 2010. For information, see
Practice note, Franchising: overview: CRC Energy Efficiency Scheme
(www.practicallaw.com/2-107-3749).
A franchise agreement is a typical vertical agreement - that is,
an agreement between parties at different levels in the economic
supply chain. On 1 June 2010, the new vertical agreements block
exemption (Regulation 330/2010) and its associated vertical
restraints guidelines came into force (replacing the previous
vertical agreements block exemption (Regulation 2790/1999) and its
associated vertical restraints guidelines).
Broadly, the vertical agreements block exemption provides a
"safe harbour" for vertical agreements that meet certain
conditions. Where the market share of the franchisor does not
exceed 30%, and the market share of the franchisee does not exceed
30%, the vertical agreements block exemption covers:
The licensing of intellectual property rights in franchise
agreements insofar as the licence provisions do not constitute the
primary object of the agreement and are directly related to the
use, sale or resale of goods or services; and
Vertical restraints (such as selective distribution, non-compete
or exclusive distribution obligations) on the purchase, sale and
resale of goods and services under a franchising arrangement.
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However, to have the benefit of the vertical agreements block
exemption, the agreement must not contain certain listed "hardcore"
restrictions. The inclusion of any such restraints prevents the
entire agreement from obtaining the benefit of the block exemption,
not merely the clause or sub-clause in which the restraint is
contained: there is no severability for hardcore restrictions. The
vertical agreements block exemption also identifies a number of
"grey list" obligations that fall outside the scope of the vertical
agreements block exemption, even though the market share threshold
is not exceeded. Unlike hardcore restrictions, severability does
apply to these obligations, so that the inclusion of such an
obligation will mean that the benefit of the vertical agreements
block exemption is only lost in relation to any part of the
agreement from which the offending obligation cannot be
severed.
The inclusion of reference to the market share of the franchisee
is a key change brought about by the new vertical agreements block
exemption (in the previous vertical agreements block exemption
(Regulation 2790/1999), the market share of the franchisor was
generally decisive (except in the case of exclusive supply
obligations)).
For information, see Practice note, Franchise: overview: EU
competition law (www.practicallaw.com/2-107-3749) and
Distributorships: overview: EU competition law and regulation
(www.practicallaw.com/6-107-3648).
This standard is not drafted to fall within the "safe harbour"
provided by the vertical agreements block exemption (assuming the
parties satisfy the requirements for relevant market shares), as it
includes provisions that as drafted do not comply with conditions
in the vertical agreements block exemption (see commentary at
clause 7). If the parties can and wish to rely upon the vertical
agreements block exemption, practitioners should seek specialist
competition law advice and amend accordingly. Where the vertical
agreements block exemption is not available, specialist competition
law advice will be necessary to assess any restrictions or
exclusivity in light of Article 101 of the Treaty on the
Functioning of the European Union (formerly Article 81 of the EC
Treaty). For information, see Practice note, Franchise: overview:
EU competition law (www.practicallaw.com/2-107-3749) and
Distributorships: overview: EU competition law and regulation
(www.practicallaw.com/6-107-3648).
A franchisor owes a duty of care in tort to franchisees and
prospective franchisees. In MGB Printing and Design Limited v Kall
Kwik UK Limited [2010] EWHC 624 , the High Court held that a
franchisor owed a duty of care in tort and gave negligent advice to
a prospective franchisee when, at the relevant time, the
prospective franchisee was considering buying an existing franchise
business as a going concern and the franchisor advised on the cost
of refitting the premises to the franchisor's mandatory
requirements. It transpired after the acquisition that these costs
were significantly lower than the true cost of the refitting works.
For more information, see Legal update, High Court holds franchisor
owes duty of care to franchisee
(www.practicallaw.com/5-502-0180).
The Bribery Act 2010 (BA 2010), effective 1 July 2011, replaces
the existing bribery offences and introduces new offences. In
particular, it introduces a strict liability offence which may
affect franchisors. Under section 7, a commercial organisation
(which includes a company or partnership) commits an offence if a
person associated with it bribes another person, intending to
obtain or retain business or a business advantage for the
organisation. A person (A) is associated with a relevant commercial
organisation (C) if A is a person who performs services for or on
behalf of C (section 8, BA 2010). In certain circumstances, a
franchisee may be an associated person to the franchisor: for
further information, see the commentary at clause 10.
Negotiating and drafting issuesIn practice, it is the
franchisor's solicitors who prepare the franchise agreement.
However, as the agreement will be the same one that is used for all
franchisees, it will also be part of the package which potential
franchisees consider when negotiating the franchise deal.
Therefore, although the standard document has been drafted from
the
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perspective of the franchisor, it is intended to strike a
balance between protecting the franchisor's interests and being
acceptable to potential franchisees.
A franchisor should not generally vary the terms of its
franchise agreements because this may cause strong feelings between
franchisees if they discover that some have better terms than
others. Disparities in contract terms may also result in a greater
administrative burden on the franchisor. The only times at which
variations in terms should be considered are at the development
stage, where the franchisor may find it expedient to offer better
terms to the first franchisees in return for assistance in setting
up certain elements of the franchise system and where external
circumstances, such as the terms of a third party lease,
necessitate a variation.
A franchise agreement should be well set out and contain no
typing mistakes, as an agreement that is difficult to follow or
written in "legalese" may put off a potential franchisee. A
prospective franchisee will have every reason to believe that a
poorly presented franchise agreement reflects poor preparation of
the franchisor itself.
CLAUSE NOTES
PartiesThe franchisee may be a sole trader, partnership or a
limited liability company. This will depend largely on the
requirements of the franchisor and the advice concerning the tax
and legal implications of carrying on business without limited
liability which has been given to the franchisee.
The individual will normally be the majority shareholder in the
franchisee, and the standard document is drafted on the basis that
there is just one individual. If, however, there is more than one,
then references to the individual should be amended accordingly and
the agreement should make it clear that they have joint and several
liability for all their obligations.
The franchisor will almost inevitably be a limited liability
company.
If a franchise is to be given to a franchisee trading as a
limited liability company, the franchisor will ideally try to
obtain a guarantee of the obligations of the franchisee company
from the individual who has set up the company and who will operate
the franchise. The reason for this is that franchisee companies are
very often newly incorporated with few or no assets, and if the
franchisee breaches the agreement, it may not have sufficient
assets to meet a claim. However, it is harder for individuals to
put their assets beyond the reach of a franchisor. The franchisor
should also consider restrictive covenants and undertakings from
individuals (such as those set out in clauses 17, 22 and 23) so
that they will not transfer their shares in the franchisee.
BackgroundThis section (recitals) sets out the background and
purpose of the agreement. It can be used to provide brief details
of any master franchise agreement.
Definitions: clause 1
Clause 1.1
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Advertising Levy
The Advertising Levy is paid by the franchisee to cover a
proportion of the cost of the advertising undertaken by the
franchisor on a national basis. Consider whether the franchisee
should be required to undertake its own point-of-sale advertising
as well as paying the Advertising Levy.
Business
The definition of the Business is crucial to the grant of the
franchise and must be as accurate as possible, while allowing for
business development. However, as it is used for the purposes of
clause 22 (restrictions), it should not be too widely drafted to
avoid the risk that a court would refuse to enforce the provisions
of that clause.
Equipment
List here (or in a schedule) all of the equipment that will be
supplied by the franchisor in order to set up the franchise. This
standard is drafted on the basis that the franchisee will buy the
equipment from the franchisor on the franchisor's then standard
terms.
Financial Package
This refers to the finance and accounting package licensed by
the franchisor to the franchisee (see clause 5). This package will
help the franchisee be efficient in its book and record keeping,
and will also greatly assist the franchisor in ensuring that the
information it requires from the franchisees is readily available
and in a consistent format.
Gross Monthly Receipts
This term is used in the calculation of the payments to the
franchisor, so it is important that it is correctly defined to
reflect the intentions of the franchisor.
Consider whether payments are to be made to the franchisor on a
weekly or monthly basis. The more frequent the payments, the better
control the franchisor will have over its cash flow and the better
its view of the franchisee's business will be. However, this may
not be practical and so the standard document envisages payments
being made on a monthly basis.
It is usual to specify whether this definition extends to sums
receivable (which is usual) or only to amounts banked, and which
items (such as VAT, income of a capital nature, sales rebates or
discounts, credit card discounts or charges, the cost of any
marketing initiatives such as free offers, sums received under
business interruption insurance and so on) should or should not be
included in the calculations.
Initial Fee
The Initial Fee is paid by the franchisee to the franchisor and
is intended to cover the start-up costs incurred by the franchisor
in relation to the franchisee. Consider whether the franchisor's
legal fees should be included in this amount or whether they should
be reimbursed separately.
Intellectual Property
The intellectual property which the franchise uses may be
limited to a trade name only or a complete suite of intellectual
property, including patents and design rights, as well as trade
marks and names. Check to what extent these need to be identified
and referred to in the franchise agreement. This definition is used
in relation to the grant of the franchise, and
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so it is important from the franchisor's point of view that only
the intellectual property that relates to the Business is included,
and not its other intellectual property.
Consider whether the definition should be extended to include
intellectual property rights which come into existence, or are
registered by the franchisor, during the term of the agreement and
which relate to the Business.
For further information, see PLC IPIT & Communications,
Standard clause, Definition of intellectual property rights
(www.practicallaw.com/1-201-3359) and its accompanying drafting
note (www.practicallaw.com/9-201-3360).
Lease
This term is currently drafted for where the franchisee is to
take a lease of premises from the franchisor (see Practice note,
Franchising: overview: Property
(www.practicallaw.com/2-107-3749)).
This may not always be the case (and the franchisee will often
take its lease of the premises directly from a third party
landlord, as this will involve the franchisor in less risk).
For a case which emphasises the importance to both parties of
dovetailing the terms of a franchise agreement into the terms of
the lease agreement for the property from which the franchise is to
be operated, see Miscela Ltd & Ors v Coffee Republic Retail Ltd
[2011] EWHC 1637 (QB), where the High Court held that the failure
of a company related to the franchisor to make available the
franchise property pursuant to a lease agreement (one of the
agreements forming part of the franchise package) did not put the
successors to the franchisor in breach of the franchise
agreement.
If the franchisee takes its lease directly from a third party,
this term and all references to the Lease should be checked and
amended to reflect the reality of the situation, for example, the
franchisor may require prior approval of the terms of the Lease to
make sure that the franchise business can operate effectively from
the premises. Other considerations include:
Where the franchisee does not take a lease from the franchisor,
the franchisor may require a separate deed of option to be entered
into to enable the franchisor to take over the premises at
termination of the franchise agreement (subject, of course, to the
terms of the Lease).
Additional clauses may be necessary if the CRC applies to the
franchise agreement. For background and information, see Practice
note, Franchising: overview, CRC Energy Efficiency Scheme
(www.practicallaw.com/2-107-3749).
(Note that, under clause 1.13, a reference to the Lease is a
reference to it as altered from time to time.)
Manual
The Manual will set out how the franchise is to be run, and is
an essential part of the operation. Under clause 7, the franchisee
is obliged to run the Franchisee's Business in compliance with the
Manual. According to this definition, the Manual may be altered by
the franchisor from time to time. This will give the franchisor
flexibility and the ability to respond to changing market
conditions without having to alter the franchise agreements every
time it wants to alter the way in which its franchise outlets are
run. (Note that, under clause 1.13, a reference to the Manual is a
reference to it as altered from time to time.)
Premises
If the franchisor is not leasing the Premises to the franchisee,
it may have site selection criteria. The franchisee must be made
aware of these (they could, for example, be incorporated into the
Manual). The selection of a suitable site is of
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the utmost importance for the franchisee, as it is only allowed
to trade from the Premises and nowhere else (see clause 7).
You must also consider the impact of the CRC. For background and
information, see Practice note, Franchising: overview, CRC Energy
Efficiency Scheme (www.practicallaw.com/2-107-3749).
Products
The list of Products is set out in Schedule 3, or in the Manual
which would make the agreement more flexible from the franchisor's
point of view, as the franchisor can update Manual without
agreement of the franchisee. However, if this is the case, the
franchisor must not alter the list of Products in a way that could
be unreasonable under the Unfair Contract Terms Act 1977 (UCTA).
For further information, see Practice note, Supply contracts:
overview (www.practicallaw.com/0-107-3646).
Ensure that all relevant products are listed, including (if
appropriate) stationery.
Services
The Services are those which will be used in or supplied by the
Franchisee's Business. The list of Services is set out in Schedule
3, or in the Manual which would make the agreement more flexible
from the franchisor's point of view, as the franchisor can update
Manual without agreement of the franchisee. However, if this is the
case, the franchisor must not alter the list of Services in a way
that could be unreasonable under UCTA. For further information, see
Practice note, Supply contracts: overview
(www.practicallaw.com/0-107-3646).
Start Date
It is important for the franchisor to know, having allocated a
territory to the franchisee, that the franchisee is going to start
trading (and therefore generating income for the franchisor) within
an agreed time frame. This date may also be used as the date at
which the term begins (see clause 3.1) and the date from which
payment of the Management Fee and Advertising Levy are triggered
(see clause 4.2).
System
Ensure that the definition of the System is adequate to cover
all relevant and distinctive aspects of how the business is run.
Details of the System should be contained in the Manual.
Territory
The Territory should be very specifically set out in Schedule 1,
using a map if appropriate.
Trade Marks
Consider whether this definition should be extended to include
trade marks which are registered by the franchisor, and which
relate to the Business, during the term of the agreement.
Trade Name
Where the Trade Name is included as one of the trade marks (as
is often the case), delete this definition and all uses of it in
the agreement.
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Interpretation
For discussion of clauses 1.2 - 1.16 and other interpretation
provisions, see Standard clause, Interpretation
(www.practicallaw.com/5-107-3795) and its accompanying drafting
note (www.practicallaw.com/3-107-3796).
Rights granted: clause 2
Clause 2.1
This clause sets out the nature of the rights granted by the
franchisor to the franchisee.
Not all franchise agreements will grant exclusive territories
and, indeed, many franchisors are hostile to the grant of exclusive
rights.
From the franchisor's point of view, the main advantage of
granting an exclusive territory is that it will be easier to sell
the franchise.
The main disadvantages for a franchisor are that:
It may cause commercial difficulties for the franchisor who
subsequently finds that it has given too large a territory to its
franchisee when its franchise proves a success, with the result
that the franchisee's territory is not fully developed. (The Body
Shop is an example of this. At the beginning of The Body Shop
operation no one could predict its subsequent success and,
accordingly, exclusive territories were granted for UK cities such
as Glasgow, Edinburgh and Nottingham. Franchisees in these
territories were only obliged to open one store, but the
territories should have had three or four stores. As a result, The
Body Shop bought back the territories for sums in excess of 1
million each.)
Terminating a franchise for poor performance may, in practice,
be difficult and it may be simpler to put another franchisee into
the territory of an under-performing franchisee.
From the franchisee's point of view, the main advantage of
exclusivity is that it will be protected from competition from the
franchisor and other franchisees. The main disadvantage will be
that the franchisor may take a strict approach in enforcing
performance criteria in order to ensure that a territory is being
properly exploited.
If exclusivity is granted, care should be taken in establishing
the territories to be granted. If, for instance, customers for a
franchised business are likely to be obtained by way of telephone
directories, the territories to be given should be linked to the
area covered by the directory.
For more about the competition law implications of granting
exclusive or non-exclusive rights, see Practice notes, Franchising:
overview: EU competition law (www.practicallaw.com/2-107-3749) and
Distributorships: overview: EU competition law and regulation
(www.practicallaw.com/6-107-3648).
Clause 2.2
Trade mark licence
Although it is common for the parties not to enter into a
separate trade mark licence, it may be preferable for them to do
so.
From the franchisor's point of view, as long as the Manual has
been carefully drafted to include all the obligations that would
normally be contained in a trade mark licence, it can rely on
licence terms being incorporated by inclusion in the
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Manual. However, if this is to be the case, the Manual must deal
with common obligations of trade mark licensees, such as not doing
anything to damage the trade marks' reputation or value, notifying
the franchisor of any infringements by third parties, and following
quality control procedures. It is also very important that the
franchisee is provided with a copy of the Manual, and with any
revised versions. Even if a separate licence is used, it must
incorporate the Manual as part of its terms, so as to be consistent
with the main agreement.
If the franchisor has registered trade marks or registered
service marks, it may be desirable to require a franchisee to enter
into trade mark licences because this would ensure that the
franchisee did not claim that the use of the trade marks by him
gave him any rights to the trade mark.
There is no statutory requirement that trade mark licences must
be registered, although a licensee will want to ensure that the
transaction is recorded, since it will otherwise be ineffective
against a third party acquiring a conflicting interest in the mark.
Therefore, from the franchisee's point of view, filing a copy of
the licence and registering it with the relevant trade marks
registries ensures that the franchisor cannot sell the registered
trade marks free of the licence.
In addition, if a licence is not registered within six months of
the date of the transaction, the licensee has no right to its costs
relating to any infringements occurring in the period from the date
of the transaction to the date of registration of the licence.
Registration provides licensees with a statutory right (in the
absence of any contrary agreement) to bring infringement
proceedings in default of an action by the registered proprietor
(section 30(2),(3), Trade Marks Act 1994). For more information on
registration of licences, see Clause 15.2 below, and see Practice
note, Registration of interests in UK trade mark applications and
registrations (www.practicallaw.com/6-201-3390).
Both an exclusive non-revocable licence for consideration and a
non-exclusive licence are free from stamp duty.
See also Practice note, Franchising: overview: Trade mark
licences (www.practicallaw.com/2-107-3749) and PLC IPIT &
Communications, Practice note, Overview of Trade marks:
Exploitation of trade marks (www.practicallaw.com/4-107-3668).
For a draft trade mark licence, see PLC IPIT &
Communications, Standard document, Trade mark licence agreement
(www.practicallaw.com/6-500-6579). This licence is not drafted
specifically for franchisee use, but could be adapted.
Lease
In relation to the lease, see comments on clause 14 below.
Clause 2.3
Under this clause, the franchisor itself undertakes not to
operate, or license anyone else to operate, the Business in the
Territory.
When drafting a franchise or trade mark licence agreement, you
must consider the likely effect of the arrangements on competition
in the market for the relevant goods or services. A franchise
agreement is a typical vertical agreement - that is, an agreement
between parties at different levels in the economic supply chain.
For information on competition law implications, see Legal issues
and Negotiating and drafting issues. For further detail, see
Practice note, Franchise: overview: EU competition law
(www.practicallaw.com/2-107-3749) and Distributorships: overview:
EU competition law and regulation
(www.practicallaw.com/6-107-3648). If in doubt, seek specialist
competition law advice before finalising the agreement.
Term: clause 3This clause sets out the duration of the
franchise.
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Clause 3.1
Most franchises are for an initial term of five years. The
European Code of Ethics for Franchising requires that the duration
of the agreement should be long enough to allow individual
franchisees to amortise their initial investments specific to the
franchise (a copy of the European Code of Ethics is available on
the website of the British Franchise Association
(www.practicallaw.com/2-335-0952)).
If the Premises are being leased from a third party landlord,
consider whether the term should commence after the Lease has been
executed and whether to include a requirement for the franchisor to
approve the terms of a third party lease.
See also the rules on trading schemes (and the cooling off
period for new franchisees joining trading schemes) - see Practice
note, Franchising: overview: Trading schemes
(www.practicallaw.com/2-107-3749).
Clause 3.2
The European Code of Ethics for Franchising (see above) requires
the agreement to include the basis for any renewal of the
agreement. The British Franchise Association Code of Ethical
Conduct: Extension and Interpretation states that the basis for
contract renewal should take into account:
The length of the original term.
The extent to which the contract empowers the franchisor to
require investments from the franchises for relinquishment or
renovation.
The extent to which the franchisor may vary the terms of a
contract on renewal.
The overriding objective is to ensure that the franchisee has
the opportunity to recover his franchise specific initial and
subsequent investments and to exploit the franchised business for
as long as the contract persists. When drafting this clause,
consider whether the franchisee should have the right to renew an
indefinite number of times or only once.
This clause includes a timetable for the service of notices and
the right to renew is made conditional on:
Payment of a renewal fee.
There being no material breaches of the agreement by the
franchisee or the individual.
There being no grounds on which the franchisor can terminate the
agreement under clause 19.
The franchisee and individual having performed their obligations
to the reasonable satisfaction of the franchisor. This condition
allows the franchisor some discretion as to whether to renew or
not.
Note that, provided that the conditions set out in clause 3.2(a)
are fulfilled, the franchisor is effectively under an obligation to
renew the agreement.
From the franchisee's perspective, he will want the right to
renew the franchise at the end of the initial term and (if the
franchisor will agree) that the renewal can be exercised without
further payment. The right to renew should not be lost merely for
minor breaches of the franchise agreement.
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Clause 3.3
Renewal is effected either by the parties entering into the then
current form of franchise agreement, or (more rarely) a simple
confirmation in writing. Using the former method allows the
franchisor to bring all franchisees into line if there have been
changes to the franchise agreements which it uses during the
lifetime of the franchise business. This clause is drafted,
however, to ensure that the franchisee does not have to pay an
initial fee, or fulfil its initial obligations, for a second time.
This clause should be considered carefully to see whether it is
likely that these obligations should be included or excluded.
Consider also whether the renewal provisions should be included
in the renewed term. If they are, then the franchise agreement
could be renewed perpetually (assuming all other conditions are
met). If this is not the intention, amend clause 3.3(c) by deleting
the word "not" which is in square brackets.
Consider adding provisions so that:
Refresher training must be completed by the franchisee and its
employees.
The franchisee must pay the legal costs of the franchisor.
The franchisee must refurbish the Premises (although, if this is
to be included, note that, under the Lease, the landlord's consent
(if it is a third party) is likely to be required).
The franchisee must give up any claims which it may have against
the franchisor.
Clause 3.5
This clause states that the agreement will terminate at the end
of the Term. At this point, the provisions of clause 21
(consequences of termination) will take effect.
Clause 3.6
This clause addresses what will happen if the parties allow the
agreement to run on after the end of the Term, without having gone
through the formal process of renewal. Consider whether the
subsequent right to terminate the agreement should be exercisable
by all of the parties or just the franchisee and the franchisor,
and whether the notice periods should be different for each of
them.
Fees: clause 4
Clause 4.1
There are two guiding principles concerning the initial fee,
which will vary depending on the type of franchise:
It should not contain a profit element for the franchisor. It is
aimed only at reimbursing the franchisor's costs in setting up and
expanding the franchise. If franchisors were to make a profit (or a
significant profit) on the initial fee, the emphasis of their
business would be selling franchises rather than ensuring that
franchises are profitable.
The "thin air" element, being that part of the Initial Fee which
does not relate to the supply of equipment, stock, training or
promotional assistance, should not exceed 10% of the total
investment which the franchisee will have to make. Ultimately, the
amount which can be charged by way of an initial fee will depend on
the reputation of the
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franchisor, the profitability of his franchise, the term
granted, whether it contains an exclusive area, and so on. The
average amount is 5% to 10% for a successful franchise.
Consider whether the franchisee should also pay the franchisor's
legal fees as a part of, or in addition to, the initial fee. This
may help discourage the franchisee from attempting to renegotiate
the franchise agreement.
It may be preferable to stagger payment of the initial fee if it
is a large amount.
Clause 4.2
This clause sets out the mechanics of the payment of fees under
the agreement.
The Management Fee and the Advertising Levy are calculated as a
percentage of the franchisee's takings or, more usually,
receivables. As both of these are based on a percentage of the
Gross Monthly Receipts, it will be important to ensure that they
are payable from an appropriate date.
The Management Fee is usually set at around 8%. It reimburses
the franchisor for the cost of providing the continuing backup to
the franchisee and provides the franchisor with its profit. If,
however, a franchisor is supplying products to a franchisee at a
profit, the franchisor will not usually charge a full management
fee. In such a case, the franchisor's mark-up on products supplied
may already contain the franchisor's profit element. If the
franchisee is required to purchase products from the franchisor,
this may have competition law consequences. See Practice notes,
Franchising: overview (www.practicallaw.com/2-107-3749) and PLC
Competition, Practice note, Transactions and practices: EU vertical
agreements (www.practicallaw.com/9-107-3703) for further
information.
The Advertising Levy is usually set at around 2.5% of gross
monthly receipts.
Ideally, from the franchisor's point of view, the Management Fee
should be paid weekly or monthly, since this will improve the
franchisor's cash flow and enable the franchisor to establish a
franchisee's ability to pay the fees at an early stage.
Note that time is not of the essence for payment of sums, but
that non-payment, after being notified in writing to make such
payment, is a ground for termination under clause 20.
Clause 4.5
Include this clause if determination of the Gross Monthly
Receipts is likely to lead to dispute. Check the time periods
inserted into this clause to ensure that the timing of payments
works.
Franchisor's initial obligations: clause 5The purpose of the
franchisor's initial obligations is to put the franchisee (who
probably has no knowledge of the business to be franchised) in a
position to operate the franchised business. Note that additional
obligations relating to training are set out in clause 9, to
advertising are set out in clause 11, and to the premises are set
out in clause 14.
Clause 5(a) and (b) - Premises
Clause 5(a) should only be included if the parties are not
entering into a lease of premises between them. Where this is the
case, check:
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Whether the start date is appropriate, or whether the term
should only start once a lease for the Premises has been
executed.
The input needed by the franchisee (which may vary), from the
selection and refurbishment of existing premises to the
construction and fitting out of new premises.
Check the timing of this clause to ensure that it will work
where the Premises have not been identified by the time the
franchise agreement is entered into.
Clause 5(d) supply of equipment and products
The equipment supplied could include vehicles, machinery,
furniture, signage, stationery, IT equipment and software. Each
type of equipment should be considered separately to ensure that
any specific provisions relating to it are included.
On what basis will the equipment be supplied by the franchisor?
Who owns it? If the franchisor is to retain title to it, then the
reference to the equipment should be put into a separate clause
which should state the terms on which is it loaned and require the
franchisor's interest to be noted on any insurance policy.
Where title to the equipment and other products is to pass,
incorporate the franchisor's standard terms of sale, either by
reference or by setting them out in a schedule, and consider
whether payment for them should be included in the Initial Fee.
Clause 5(e) - public relations launch of the franchisee's
business
Details of the PR launch should be set out in the Manual or,
preferably, in a schedule to the agreement. Consider whether the
cost of this will be covered by the Initial Fee, or whether the
franchisor will want to allow for any additional costs to be
reimbursed by the franchisee.
Clause 5(f) - the provision of the franchisor's operations
manual
Note that the provision of the Manual is expressed to be on
loan, in order to emphasise that the franchisee does not own the
Manual or the intellectual property in it.
Clause 5(g) - local advertising
The parties can agree and insert into this clause the minimum
requirements for local advertising, which may specify, for example,
a sum to be spent or the number and type of advertisements to be
placed.
Clause 5(h) - provision of the financial package
If a Financial Package is being supplied, check the licensing
terms applicable to this and whether the training should cover its
use.
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Franchisor's continuing obligations: clause 6It is advisable to
set out in detail the obligations accepted by the franchisor.
Franchisees will find it unacceptable to enter into an agreement
where the obligations which they will have to accept are extensive,
but are limited in respect of the franchisor. If the obligations
are too vague, the agreement may fall foul of the European Code of
Ethics.
Note that additional obligations relating to training are set
out in clause 9, to advertising are set out in clause 11, and to
the premises are set out in clause 14.
Clause 6(b)
This clause requires the franchisor to update the Manual and the
System from time to time. The aim is to ensure that it tracks
changes in the relevant market and in the legislation affecting it.
In exercising its rights and obligations under this clause, the
franchisor should be cautious and should not act to the detriment
of the franchisee.
Clause 6(c)
This clause requires the franchisor to supply the Products on
its standard terms and conditions in effect at the time of the
placing of the order for those products.
Ensure that these terms and conditions actually exist and, if
not, include (preferably in a schedule) the relevant terms of
supply (including terms as to the limitation of liability and
exclusion of statutory warranties). (See Standard document, Terms
and conditions for the supply of goods (pro-supplier)
(www.practicallaw.com/9-100-9608).)
If the franchisor does have standard terms of supply, ensure
that these are available to the franchisee (perhaps in the Manual)
and that all updated versions are made available to the franchisee
in a timely manner.
Consider whether the franchisee is to be restricted in the
products it can use in the Franchisee's Business. If it is to be
restricted to products supplied by the franchisor or specific
suppliers, this may have competition law implications.
Note that the vertical agreements block exemption only permits
such ties as are necessary if, owing to the nature of the goods, it
is not practical to apply objective quality specifications and to
protect the franchisor's intellectual property.
If the vertical agreements block exemption is not available,
then this sort of provision will need to be assessed in the light
of Article 101(1) of the Treaty on the Functioning of the European
Union (TFEU) (formerly Article 81(1) of the EC Treaty). It will
usually fall outside Article 101(1) if the obligations imposed are
necessary to maintain the common identity and reputation of the
franchised network, or there is a transfer of substantial know-how.
Practitioners should note that the definition of "substantial" in
relation to know-how in the vertical agreements block exemption now
refers to know-how that is "significant and useful" (Article
1(1)(g), Regulation 330/2010), which represents a lower threshold
than that of the previous vertical agreements block exemption (in
which "substantial" know-how referred to "information that is
indispensable"). This is a useful change for franchisors.
For further information, see Practice notes, Franchising:
overview: EU competition law (www.practicallaw.com/2-107-3749) and
Distributorships: overview: EU competition law and regulation
(www.practicallaw.com/6-107-3648).
Depending on the type of franchise, the franchisor may have to
allow the franchisee credit on buying Products, up to an agreed
credit limit. If so, include a definition of "credit limit" (which
should cover both financial and time limits). However, franchisors
should use these limits with caution as indiscriminate use could
give rise to a claim for equitable relief if it is shown that the
franchisor is withholding supplies from the franchisee,
particularly if the
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franchisee could not source the supplies from elsewhere (see Sky
Petroleum Ltd v VIP Petroleum Ltd [1974] 1 All ER 954).
Clause 6(d)
This clause requires the franchisor to assist the franchisee in
procuring such goods and services (other than the Products) as are
necessary for the purposes of the Franchisee's Business. If this
clause is included, take care that the definition of Products is
drafted so that it only includes products supplied by the
franchisor. Adapt the wording of the clause to reflect the
agreement between the parties as to the type and extent of help
offered.
Consider also whether to include additional obligations on the
franchisor relating to:
Consultation.
Creation and promotion of credit card schemes (and, if so, allow
for appropriate deductions to be made in the turnover
calculations).
Staff selection assistance.
Provision of standard contracts.
Continuation of research and development.
Equal treatment of franchisees.
Franchisee's obligations: clause 7In order to maintain the
uniform quality of the franchise network and to protect the
franchisor's brands, detailed operating restrictions and
obligations are imposed on franchisees in franchise agreements and,
in relation to day-to-day trading, in the franchisor's operations
manual. Obligations and restrictions are imposed on all franchisees
for the protection and benefit of franchisees generally, because a
franchisee who does not comply with the franchisor's system may
have a detrimental effect on the entire franchise network.
This clause sets out the franchisee's obligations in relation to
operating the Franchise's Business. Its obligations in relation to
employees, training, the Premises and so on are set out in separate
clauses.
Legal issues
When drafting these provisions, you must consider carefully the
provisions of the vertical agreements block exemption. As drafted,
the clause does not comply with the vertical agreements block
exemption (see Negotiating and drafting issues). Therefore, where a
large organisation (or an organisation conducting its business in a
very narrow product market) wishes to franchise, it should consider
amending this clause by altering or omitting some sub-clauses,
including clauses 7(g), (h), (i), (k), and (n). Practitioners
should seek specialist competition advice. For information, see
Practice note, Franchise: overview: EU competition law
(www.practicallaw.com/2-107-3749) and Distributorships: overview:
EU competition law and regulation
(www.practicallaw.com/6-107-3648).
The requirement for the franchisee to be registered for VAT must
take effect before the start date because nearly all franchise
agreements now fall within the scope of the Trading Schemes Act
1996 (which deals with pyramid selling) and must comply with the
trading scheme legislation, unless they fall within one of two
exclusions:
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Single-tier trading schemes under which all UK participants or
franchisees operate at a single level except for the
franchisor.
Where all the franchisees in the network are registered for VAT
(regulation 3(a) and (b), Trading Schemes (Exclusion) Regulations
1997 (SI 1997/31)).
If a franchise agreement falls within the scope of the Trading
Schemes Act 1996, a franchisor's freedom of action will be
substantially restricted. For further information, see Practice
note, Franchising: overview (www.practicallaw.com/2-107-3749).
Negotiating and drafting issues
Clause 7(a) should be considered in the light of MMP GmbH v
Antal International Network Ltd [2011] EWHC 1120
(www.practicallaw.com/3-506-0855), where the High Court held that,
on a true construction of the clause in question, the franchisor
was required to produce evidence of actual damage to its brand
caused by the conduct attributable to the franchisee, which it
could not. The franchisor's fear or concern of damage to the brand
was insufficient. The wording of Clause 7(a) protects the
franchisor in this situation, as it includes sufficient
flexibility, referring to acts that "could or might" affect the
brand, and there is also optional wording which is more in favour
of the franchisor. However, a franchisee might request that the
words "sole opinion of the franchisor" be replaced by "reasonable
opinion of the franchisor".
Clause 7(b) is intended to ensure that the franchisee does not
slacken its efforts in relation to the Franchisee's Business. This
will be particularly important where the franchisee has an
exclusive territory. The clause could be expanded to refer to
specifics - for example, requiring the franchisee to offer a
minimum range of goods or services.
Clause 7(c) contains a broad obligation on the franchisee to
comply with relevant legislation relating to the Premises. This
could cover, for example, legislation in relation to planning. The
Lease itself is likely to have a detailed clause specifying
legislation, where appropriate, as well has containing the general
obligation.
Clause 7(g) may take the agreement outside the vertical
agreements block exemption where the agreement is not one of minor
importance. For further information, see Practice note,
Franchising: overview: EU competition law
(www.practicallaw.com/2-107-3749) and comments on clause 6(c).
Clause 7(h) is included so that the franchisor can protect the
integrity of the franchise network, but may take the agreement
outside the vertical agreements block exemption. See Practice note,
Franchising: overview: EU competition law: Hardcore restrictions
(www.practicallaw.com/2-107-3749).
Clause 7(i) is included so that all franchisees are supplying
the products and services to third parties on the same terms.
Clause 7(q) could be used by the franchisor to obtain records of
sales as well as other business information, such as customer (and
potential customer) lists. Consider specifying the information that
is required in the agreement, if it is not included in the
Manual.
Clauses 7(t) to (v) allow the franchisor to ensure that anyone
dealing with the franchisee knows that the franchisee is a separate
entity from the franchisor and to protect its intellectual
property.
Clause 7(v) is included to ensure that customers of the
franchisee are made aware that they are dealing with a franchisee
under licence from the franchisor.
Consider also whether to include additional provisions relating
to trading - for example:
Compliance with any credit card scheme that the parties agree
should be set up.
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Undertaking not to pledge the credit of the franchisor.
Compliance with the franchisor's complaints procedures.
Whether the franchisor be permitted to sell via a website (if it
is to have a website, ensure that this is in accordance with the
franchisor's requirements). Note that a prohibition on passive
sales (www.practicallaw.com/4-107-6978) will take the agreement
outside the vertical agreements block exemption. Passive sales
generally include internet sales, however the new vertical
restraints guidelines now contain guidance on the extent to which
restrictions on the sale of products or services over the internet
may fall within the scope of the vertical agreements block
exemption. See Practice note, Franchising: overview: EU competition
law: Hardcore restrictions (www.practicallaw.com/2-107-3749).
Whether any requirements as to the use and updating of software
should be included. This will depend on whether the franchisor
requires the franchisee to enter into a separate software licence
for the Financial Package and any other software.
Whether the franchisee will be required to update old equipment
as the franchisor thinks fit?
An obligation to consult with the franchisor as to pricing and
not to charge more than a maximum amount. A franchisor may impose
maximum resale prices or recommend resale prices, provided neither
of these equate to a fixed or minimum sale price. Any form of price
fixing or resale price maintenance will take the agreement outside
the vertical agreements block exemption and will constitute an
infringement of Article 101(1) of the TFEU (See Practice note,
Franchising: overview: EU competition law: Hardcore restrictions
(www.practicallaw.com/2-107-3749).)
The extent to which the franchisee should be free to sell the
products and services which it produces as part of the franchisee's
business to third parties will there be any restrictions on selling
to third parties, for example, by limiting sales to end users or
other franchisees of the franchisor? If it is intended to include
this sort of provision, consider the competition law implications.
See Practice note, Franchising: overview: EU competition law
(www.practicallaw.com/2-107-3749).
Will the franchisee be obliged to pay the franchisor a
commission on any sales that it makes as a result of a lead given
to it by the franchisor?
Vehicles: if the franchise business is such that vehicles are
required, consider including obligations relating to vehicle
maintenance, licensing and tax and as to the driving standards of
the relevant employees.
Employees: clause 8These obligations are stated to relate to the
franchisee's employees, but this should be expanded to cover
agents, consultants and sub-contractors if appropriate.
Training: clause 9
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Clause 9.1
It is desirable to set out the franchisor's training obligations
in some detail. The initial training is usually provided free of
charge, but further training during the term of the franchise is
usually provided subject to the reimbursement of the franchisor's
standard charge. Details of the initial training programme,
including the number of people to be trained, the length and
location of the training, the cost to the franchisee and payment
terms (if any) should be set out, either in this clause, in a
schedule to the agreement or in the manual.
If a franchisee "fails" the initial training, the franchisor
usually reserves the right to terminate the agreement and return to
the franchisee payments which have been made, less all expenses
incurred by the franchisor, although sometimes the individuals are
given the right to appoint a manager to undergo training in these
circumstances (see clause 20.1(c)).
Clause 9.2
This clause sets out the franchisee's obligations with regard to
training.
Consider including specific requirements as to assessment of
individuals and reporting to the franchisor any problems that arise
after, or in connection with, training.
Should the franchisor be entitled to call staff in for training
on new developments or changes to the System?
Consider whether the franchisor should be obliged to give
training in any improvements to the System which it requires the
franchisee to introduce.
Anti-bribery compliance: clause 10Under section 7 of the BA
2010, a commercial organisation (which includes a company or
partnership) commits an offence if a person associated with it
bribes another person, intending to obtain or retain business or a
business advantage for the organisation. A person (A) is associated
with a relevant commercial organisation (C) if A is a person who
performs services for or on behalf of C (section 8, BA 2010).
Section 7 is a strict liability offence. The only defence
available to the commercial organisation is if it can show it had
in place "adequate procedures" to prevent associated persons
bribing others. The BA 2010 does not set out prescriptive adequate
procedures, but the Ministry of Justice has published guidance to
assist a commercial organisation putting in place procedures to
prevent persons associated with it from bribery (Guidance).
In the context of a franchise arrangement, in most cases it is
unlikely that the risk of a section 7 offence arises because:
A franchisee is unlikely to fall within the definition of
"associated person", since the franchisee does not (as such) supply
services back to the franchisor under the franchise agreement. It
simply carries on its own business and pays various fees to the
franchisor. In other words, a franchisee performs services for
itself, not for the franchisor.
If a franchisee bribes someone (for example, a municipal
official in order to obtain planning permission for the franchise
premises), the franchisee could not be considered to have the
intent necessary for a section 7 offence because its intention
would be to obtain or retain business or a business advantage for
itself, not for the franchisor.
However, there are two situations where there is a risk of the
section 7 offence:
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If the franchisor operates a national account work system, so
that the franchisee obtains work from the franchisor.
If contracts are entered into directly between a franchisor and
its franchisees customers in respect of which the franchisee
performs services as the franchisors agent.
Despite what appears to be a low risk of exposure, it is prudent
to include an anti-bribery clause in a franchise agreement. This is
partly because the wording of sections 7 and 8 is far from clear,
and the inclusion of an anti-bribery clause will reduce the risk of
exposure arising out of an unexpected future interpretation. In
addition, as noted above, some types of franchise agreement may
incorporate other legal structures which might provide the context
for section 7 exposure, and it is difficult to predict all the
situations in which a franchisee might be considered to be acting
as agent for or supplying services to the franchisor.
In any event, many franchisors will wish to include an
anti-bribery clause for ethical reasons even though the
circumstances in which the clause might be legally relevant appear
to be limited.
For information on the BA 2010, see Bribery Act 2010: Toolkit.
(www.practicallaw.com/9-503-9451)
Clause 10.1(b): outside the UK
If the franchisee (or any of its associated persons) has no
"close connection" with the UK and commits bribery outside the UK,
then its activities are not caught by the BA 2010, although any
such bribery on behalf of the franchisor might result in liability
for the franchisor under section 7 of the BA 2010. See Practice
note, Bribery Act 2010: Territorial application
(www.practicallaw.com/5-500-8692) (section 12) for further
information on the territorial scope of the BA 2010 and the meaning
of "close connection".
This clause ensures that a non-UK distributor is contractually
bound to avoid bribery as defined in the BA 2010, even though the
BA 2010 may not be applicable to it. Clause 10.1(a) combined with
this clause obliges the distributor to ensure that its non-UK
associated persons similarly avoid bribery as per the BA 2010.
If the franchisee is UK based and will not delegate, appoint
sub-franchisees or subcontract outside the UK then this clause and
the cross reference to it in clause 10.1(d) may be omitted.
Clause 10.1(c): relevant policies
This clause refers to the franchisor's policies, which should be
annexed at schedule 9. For advice on creating an anti-corruption
policy, see Practice note, Anti-corruption policies
(www.practicallaw.com/9-502-3153). In addition, there may also be
industry codes that the franchisee should comply with.
The franchisee may have its own anti-corruption policies which
conflict with or differ from those of the franchisor. In this case,
the franchisor may need to review the franchisee's policies to
assess whether they are adequate.
If acting for the franchisee, consider whether the franchisor
should bear some of the costs incurred by the franchisee in
complying with changes to the franchisor's policies and whether the
franchisee should have the right not to comply with changes to the
franchisor's policies which it has not approved. If acting for the
franchisor, note that this is an issue that is likely to be raised
by a well-advised franchisee.
Clause 10.1(d): adequate procedures
The term "adequate procedures" is defined in clause 10.4 by
reference to the BA 2010.
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Clause 10.1(e): reporting bribes
This clause could be omitted if such an obligation is already
contained within either the franchisor's Ethics and Anti-Bribery
Policy which the franchisee has committed to in clause 10.1(c) or
the franchisee's own such policies, as referred to in clause
10.1(d).
Clause 10.1(f): foreign public officials
Section 6(1) of the BA 2010 creates the offence of bribing a
foreign public official. A person is guilty of the offence if his
intention is to influence the official in the official's capacity
as a foreign public official. A foreign public official is defined
in sections 6(5) and 6(6) of the BA 2010 (and for the purpose of
this clause is defined in clause 10.4 by reference to such
sections). Foreign public officials include, among others,
government officials and those working for international
organisations. The offence does not cover accepting bribes, only
offering, promising or giving bribes. For further information on
the offence see Practice note, Bribery Act 2010: Bribery of foreign
public officials (www.practicallaw.com/5-500-8692) (section 6).
There is no express restriction in the BA 2010 on employing a
public official, or on the ownership of a direct or indirect
interest in a company by a public official. The purpose of the
notification requirement and the warranty is to flag the issue and
elicit information about any relevant foreign public officials. If
the franchisee notifies the franchisor of a relevant foreign public
official then the franchisor should ascertain the identity of the
relevant person and their role within the franchisee, in order to
assess the risk of an offence being committed.
However, ideally, enquiries about any relevant public officials
should form part of the due diligence conducted by the franchisor
on the franchisee, and should also be included as part of any due
diligence questionnaire. Contractual warranties are no substitute
for proper investigation into a prospective partner.
This clause will not be appropriate if the franchisee is an
individual.
Clause 10.1(g): monitoring and review
According to the Ministry of Justice Guidance, organisations
should have appropriate monitoring and review mechanisms in place
(Principle 6: Monitoring and Review, Guidance). Effective
monitoring will, in turn, depend on effective record keeping; for
suggesting record keeping clauses, see Standard clause:
Anti-bribery clause (long form)
(www.practicallaw.com/5-504-3582).
This clause 10 does not include audit rights for the principal;
it only requires the franchisee to certify its compliance and
provide supporting evidence of compliance on request. For
appropriate drafting for a principal to reserve audit rights,
seeStandard clause: Anti-bribery clause (long form
(www.practicallaw.com/5-504-3582).
Clause 10.2: supply chain
On a strict construction of the definition of associated person,
the franchisee's own associated persons (essentially its own
franchisees, subcontractors and franchisors) may also be associated
persons of the franchisor, with the result that bribery by such
persons might result in liability for the principal, unless the
principal can demonstrate that it has put adequate procedures in
place to prevent such bribery.
As such, where the arrangement includes a supply chain, a
franchisor will need to consider how best to mitigate itself from
this risk. This clause requires the franchisee to extend the
anti-bribery compliance obligations to its own agents and
subcontractors, where such persons are performing services in
connection with this agreement. This reflects the approach
suggested in the Guidance. According to the Guidance:
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Where a supply chain involves several entities, or a project is
to be performed by a prime contractor with a series of
subcontractors, a commercial organisation is only likely to
exercise control over its relationship with its contractual
counterparty. Indeed, the organisation may only know the identity
of its contractual counterparty, and not of those further down the
supply chain.
In this situation, it is likely that persons who contract with
that counterparty will be performing services for the counterparty
and not for other persons in the contractual chain (that is, the
ultimate customer), suggesting that a franchisor will not be liable
for bribery committed by its franchisee's subcontactors.
The Guidance recommends that the principal way in which
commercial organisations may approach bribery risks which arise as
a result of a supply chain is by employing the anti-bribery
procedures proposed in the Guidance, for example, risk-based due
diligence and the use of anti-bribery terms and conditions, in its
relationship with its contractual counterparty and requesting that
the counterparty adopt a similar approach with the next person in
the chain.
In certain circumstances, it may be appropriate to include
additional safeguards, for example in high profile transactions in
high risk jurisdictions or sectors, or where the principal has
itself selected the subcontractors and the franchisee is merely
acting as the prime contractor for logistical reasons. In such
cases, the principal may wish to implement additional safeguards,
see Standard clause: Anti-bribery clause (long form)
(www.practicallaw.com/5-504-3582) for more prescriptive supply
chain clauses.
Clause 10.4: definitions
For more information on the significance of adequate procedures
and associated persons see Legal Background in Anti-Bribery Clause
(short form) drafting note. (www.practicallaw.com/9-505-7906).
Accounting records: clause 11This clause details the accounting
records the franchisee must keep in respect of the franchise.
The franchisor will usually impose strict provisions concerning
accounting and financial information to be maintained and provided
by the franchisee where the franchise fee is calculated on the
franchisee's turnover.
VAT returns are usually required to be provided because they
enable the franchisor to check the financial information provided
by the franchisee.
Check that the Manual sets out the form that reports are to
take. Consider:
Specifying additional financial information that the franchisee
should send, as it can be helpful to have a number of types of
report and information so that the franchisor can cross-check the
figures that the franchisee sends, for example:
weekly sales figures;
in retail outlets, the provision of till rolls;
profit and loss accounts on a four-weekly basis.
Including requirements for stocktakes.
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Including requirements to accept unsupervised accounting and
stock control systems as and when introduced by the franchisor.
Requiring the franchisee's financial year end to be the same as
the franchisor's. (This may cause difficulties for the franchisor,
who may need to vet all his franchisees' accounts in a short space
of time.)
Requiring the franchisee to allow the franchisor's accountants
to carry out audits and checks on reasonable notice. Some
agreements provide for the cost of the audit to be reimbursed by
the franchisee if a discrepancy between the audited information and
that supplied to the franchisor is discovered.
Requiring the franchisee to appoint a firm nominated by the
franchisor as auditors (bearing in mind any potential conflict of
interest that firm may have, if appointed on that basis).
Advertising: clause 12
Clause 12.1
Clause 12 sets out the franchisor's obligations relating to
advertising the Trade Name and Business nationally and how the
Advertising Levy is to be handled. The clause leaves a significant
amount of discretion to the franchisor and does not set a minimum
amount that must be spent on advertising. This will allow the
franchisor to concentrate advertising in one area at a time or to
mount a national campaign, as appropriate. Consider specifying that
the advertising should take place in newspapers, television or
radio and whether the franchisee should be consulted before an
advertising campaign is started. The franchisor is not allowed to
use the Advertising Levy for any other purpose.
Clause 12.2
A franchisee will be required to undertake advertising strictly
in accordance with the franchisor's instructions. A franchisor will
wish to ensure that franchisees do not use unauthorised
advertisements that could bring the franchisor's brand into
disrepute, or be inconsistent with other advertising undertaken by
the franchisor.
Consider adding provisions to cover an obligation on the
franchisee to withdraw any advertising, product or packaging to
which the franchisor has objected.
If there are any specific actions, such as mounting displays,
distributing promotional material, mail shots and so on, that are
likely to be required, they could be included here.
Telephone numbers: clause 13For many franchisors, controlling
the franchisee's telephone numbers will be very important. This
clause gives the franchisor control of the numbers, but requires
the franchisee to reimburse the franchisor for all costs involved.
Consider whether to require the franchisee to enter into a direct
debit or standing order to meet these costs.
If the use of telephones is an important part of the franchised
business because, for instance, the business is advertised through
the Yellow Pages or similar directory service, consideration should
be given to the franchisor subscribing to the telephone number and
being reimbursed telephone charges by the franchisee;
alternatively, the franchisor could obtain from the franchisee an
undated but signed instruction to transfer the franchisee's
telephone numbers to the franchisor, who would only use the
instruction on termination of the franchise agreement.
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Insurance: clause 14The franchisee will be expected to take out
insurance as specified by the franchisor, covering, in particular,
liability for employees and to third parties, damage to property
and loss of profits. The franchisor should ensure that its
franchisees are adequately insured because, as they will be trading
under the franchisor's name and it may not always be clear to the
franchisee's customers that the franchisee and the franchisor are
independent legal entities. The franchisee's customers may seek to
argue that they were, in fact, dealing with the franchisor (who is
likely to be more substantial than the franchisee) and not the
franchisee, but if the franchisee is insured and can meet all
claims from customers, they will not find it necessary to pursue
the franchisor. In order to ensure that the franchisee has adequate
cover, the franchisor should consider having its interest noted on
the policies and requiring the franchisee to supply copies of all
policies to the franchisor.
Ensure that the insurance provisions in the franchise agreement
tie in with the insurance provisions in the Lease.
Premises: clause 15This clause sets out the arrangements for the
Premises.
Note that as the Lease is currently defined, the franchisor is
the landlord and that the Lease will be entered into on the same
date that the franchise agreement is signed.
If this is not the case, then it may be necessary to include
provisions relating to:
The search and selection of premises or a site for the
construction of premises.
The fitting out of premises.
Legal issues
Property
Under Part II of the Landlord and Tenant Act 1954 (LTA 1954), a
tenant occupying premises for the purpose of its business generally
has a right to renew its tenancy at the end of the term. The
landlord can only oppose renewal on certain, limited grounds. The
Regulatory Reform (Business Tenancies) (England and Wales) Order
2003 (SI 2003/3096) enables a landlord and tenant who are intending
to enter into a tenancy for a certain term to agree that sections
24-28 of the LTA 1954 (which relate to continuation) will be
excluded from the tenancy by following one of two procedures:
Advance notice procedure.
Statutory declaration procedure.
If one of these procedures is followed, the agreement will be
valid and effective.
Where the franchisor and franchisee are to enter into a lease,
one of these procedures should be adopted and the appropriate
clause inserted. Note that both procedures require a notice period.
In the case of the advance notice procedure, the tenant should have
sufficient time to ensure that it appreciates that it will be
abandoning its renewal rights by entering into an agreement to
surrender. The prescribed form of warning notice encourages the
tenant to take at least 14 days to consider. Under the statutory
declaration procedure, if the tenant gets less than 14 days notice
before it enters into the agreement to surrender, it cannot make a
simple declaration, but has to make a statutory declaration
instead.
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For this reason, the standard document states that the lease
must be entered into 15 days after the date of the franchise
agreement (see clause 2.2). If the Lease is not executed by then,
this will be a material breach allowing the franchisor to terminate
(see clause 21.2).
For further information, see PLC Property, Practice note,
Business tenancies new procedures for excluding security of tenure
(www.practicallaw.com/8-107-4901).
CRC Efficiency Scheme
See discussion at clause 16.
Negotiating and drafting issues
In some franchises (for example, retail outlets and
restaurants), the premises will be extremely important. If this is
the case, the franchisor will want to have a right to require them
to be maintained and even decorated in a specific manner and to a
specific standard. It may also reserve the right to inspect the
premises to ensure that these standards are being maintained.
The practicality of the provisions set out in clause 15.(a),
(b), (e), (f) and (g), and whether the franchisee can give these
undertakings, should be carefully considered where the franchisee
is to enter into an arm's length lease with a third party landlord,
as they may conflict with the terms of a standard, open market
commercial lease.
Consider whether a requirement to insure the Premises should be
specifically included here (bearing in mind the terms of the Lease,
particularly where it is with a third party).
Clause 15.(e) requires the franchisee to display a sign at the
Premises and may need to be made subject to relevant by-laws or
planning consents (as well as the lease).
CRC Energy Efficiency Scheme: clause 16This clause deals with
the franchisee's obligations under the franchising rules of the
CRC, where it applies. Broadly, in certain circumstances, a
franchisor may be responsible for the energy supplies of its
franchisees, and required to participate in the CRC together with
its relevant franchisees. The CRC treats franchisors and franchises
in a similar way to a corporate group, with the franchisor as the
"parent undertaking" being required to comply and take
responsibility for the energy supplies to its franchisees.
The CRC rules are complex and must be considered for any
franchise arrangement. Broadly, a franchise agreement subject to
the CRC exists where four elements are met:
There is an agreement (whether or not in writing) between two
separate undertakings for the sale or distribution of goods, or the
provision of services.
The franchisee carries out business using the name provided by
the franchisor.
The premises where the franchisee carries out the franchise
business are used exclusively for that business.
The presentation of those premises must have an internal or
external appearance agreed by the franchisor and it must be similar
to that of other premises operating a franchise business under an
agreement with the franchisor.
Franchises which meet all four of these rules are required to
participate in the CRC. There are however certain exemptions and
exclusions, which are not discussed in this drafting note. For
detailed discussion, see Practice note, Franchising: overview, CRC
Energy Efficiency Scheme (www.practicallaw.com/2-107-3749).
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As currently drafted, the definition of Lease assumes the
franchisor is the landlord. However, this standard is silent about
which party is responsible for energy supplies with energy
providers. This is a matter to be clarified during
negotiations.
Where the franchisee is a tenant, and its landlord (who is not
the franchisor) is responsible for procuring the franchisee's
energy supplies on the franchisee's behalf, the landlord will be
responsible for the franchisees energy supplies under the CRC (and
its rules regarding landlords and tenants), not the franchisor. The
same will apply if the franchisee is a licensee and its licensor
procures its energy supplies.
This clause 16 should be included if the franchisee is
responsible for its own energy supplies (see clause 16.6).
Note that the term CRC Franchising Rules is defined to mean the
specific rules applying to franchises under the CRC Order.
See further information about the interaction of the franchising
rules and the landlord and tenant rules, see CRC Energy Efficiency
Scheme: impact on corporate structures: Interaction of the
Franchise rule with other rules of the CRC
(www.practicallaw.com/7-500-5975).
Clause 16 is adopted from Standard clause, Franchise agreement:
CRC Energy Efficiency Scheme (www.practicallaw.com/4-502-8092),
which includes detailed drafting notes and discussion on the CRC as
it applies to franchises.
Clause 16.1
Clause 16.1(a) should only be used if the franchise agreement
(under the CRC) is a renewal of an existing franchise agreement
with a party who was already a franchisee on the qualification day
of the introductory phase (that is, 31 December 2008). If the
franchise agreement did not exist on that date, do not include this
clause.
For more information about the phases and the qualification
years for each phase referred to in clause 16.1(b), see the CRC
Energy Efficiency Scheme: PLC timeline
(www.practicallaw.com/5-500-7843).
Clause 16.2
Clause 16.2(a) requires energy supply information to be provided
by the franchisee, irrespective of whether the franchisor has made
a request. A franchisor should avoid having to request the
information, as the disadvantage of this approach is that if the
franchisor neglects to ask for the information, for any reason, the
franchisee will not be in breach of the clause. Note that the
franchisor must inform the franchisee if it is required to
participate in the CRC.
You should ensure that the date in brackets in the first option
allows sufficient time for the franchisor to comply with its own
obligation to produce its footprint reports and annual report by
the end of July of the relevant year.
In relation to clause 16.2(b), under article 66 of the CRC
Order, the franchisee must provide the franchisor with information
and assistance for it to comply with its own obligations under the
CRC, but does not set a time frame by when such information or
assistance should be provided by the franchisee. Franchisors may
wish to specify a time for franchisees to respond to their
requests.
Clause 16.3(b)
Where a franchise agreement (under the CRC) exists on the
qualification day of a phase (that is the last day of the
qualification year) the franchisor will need to include information
about the electricity supplies to the relevant franchisee
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when assessing if it is required to participate in that phase of
the CRC so it will need to have information about the electricity
supplies to the franchisee for the entire year (paragraph 11 of
Schedule 1 to the CRC Order).
Clause 16.5
As the party responsible for the franchisee's energy supplies
under the CRC, the franchisor will be subject to any enforcement
action taken by the administrator of the CRC (that is, the relevant
regulator) if the information provided by the franchisee is
inaccurate (or not provided at all), so it will want to ensure that
the franchisee is contractually required to ensure that the
information provided is accurate.
From the franchisee's perspective, it does not want this
obligation to be too onerous as it may be relying on information
that it has received from its energy suppliers. A franchisee may
prefer to amend this clause to make it a warranty "to the best of
its knowledge" or a lesser standard, such as "all reasonable
endeavours".
Clause 16.6
As discussed above, the specific franchising rules in the CRC do
not apply where the franchisee is a tenant and his landlord
procures all of the franchisee's energy supplies. In such cases,
the CRC rules regarding landlords and tenants will apply. If the
franchise premises change and the new premises are leased where the
landlord (who is not the franchisor) procures the energy supplies
to those premises on the franchisee's behalf, those supplies will
be the responsibility of the franchisee's landlord under the CRC so
the franchisor would cease to be responsible for those supplies
under the CRC and would want to be informed of that so it could
reflect this change in its next annual report.
Clause 16.7
As the participant in the CRC, the franchisor may be subject to
audits from the administrator, and is required to keep:
All the records required to be kept by Part 7 of the CRC Order
for seven years after the end of the phase to which they relate;
and
Its records regarding its first footprint report and annual
report and its position in the first league table for the first
year of the CRC that the franchisor is a participant for as long as
it participates in the CRC.
A franchisee may want to conduct meter readings to verify the
information provided by the franchisee, and will need access to
meters in order to do so.
Clause 16.8
The franchisor will want to recoup any penalties or fines
imposed upon it due to a franchisee's failure to provide
information, or as a result of it providing inaccurate information
to the franchisor.
The administrator can take enforcement action against a
franchisee itself (although it is not a participant in the CRC),
where the franchisee has failed to provide information to the
franchisor:
If a franchisor has tried to obtain the information it needs to
comply with the CRC from its franchisee, but the franchisee has not
co-operated, the administrator has the power to serve an
enforcement notice on the franchisee and require it to provide the
data to the franchisor.
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If the franchisee does not comply with the enforcement notice,
the administrator can provide the franchisor with the assistance or
information that was required and recover the costs from the
franchisee.
The administrator may waive the penalty that the franchisor
faces for its non-compliance if it is satisfied that the franchisor
has taken all reasonable steps to comply with the CRC Order.
Clause 16.9
Franchisors and franchisees are free to enter into whatever
commercial arrangements they think are most appropriate for them in
relation to the CRC. The franchisor can pass on the costs of the
CRC to their franchisees. A franchisor may decide to require that
its franchisee pay a fair and reasonable proportion of the charges
incurred by the franchisor in registering for and participating in
the CRC.
This clause 16.9 provides a simple clause to deal with these
costs. Note that as an amount has not been included in the clause,
a franchisee may ask for independently audited reports confirming
the accuracy of the amount it has to pay.
Intellectual Property: clause 17This clause sets out provisions
relating to the intellectual property of the franchisor and any
trade marks which the franchisor may license to the franchisee.
Clause 17.1
The franchisee will want the franchisor to warrant that it is
entitled to license any trade marks to the franchisee without
infringing any third party rights, that all application and renewal
fees have been paid and the Trade Marks maintained and protected,
and that no similar trade marks have been registered. Care should
be taken in giving any such warranties, unless the franchisor's
trade marks are registered and have been established for a
considerable period of time. The franchisee may also want the
warranty to be coupled with an indemnity against loss arising out
of any claim that the franchisee's use of the Intellectual Property
in accordance with the agreement infringes the rights of any third
party.
This clause sets out a qualified warranty that the franchisor
does not know of any reason why the licence to use the Intellectual
Property and Trade Marks should not be given and that it is not
aware that use of them would infringe any third party rights.
Clause 17.2
This clause relates to the execution and registration of the
Trade Mark licence. If other forms of intellectual property are
important to the business, then this clause should be expanded to
cover other relevant licences.
The clause allows, in the alternative, for a licence to be
entered into immediately or if and when the franchisor
requires.
Although licences are registrable transactions under the Trade
Marks Act 1994 (TMA), there is no statutory requirement that they
must be registered. However, it is desirable for a licensee to
ensure that the transaction is recorded, since it will otherwise be
ineffective against a third party acquiring a conflicting interest
in the mark. Note that, if a licence is not registered within six
months of the date of the transaction, the licensee has no right to
its costs relating to any infringements occurring in the period
from the date of the transaction to the date of registration of the
licence. Registration would usually provide a statutory right (in
the absence of any contrary agreement) to bring infringement
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proceedings in default of an action by the registered proprietor
(section 30(2) and (3), TMA), but clause 17.6 excludes any rights
that the franchisee has under that section