Leveraging the success of an established brand can be a great way to start a business. But before committing to a franchise agreement, it is important to carefully consider the fine print of the contract, especially in light of the ongoing litigation against one of the country’s “top” franchises, Cell Phone Repair by Assurant.
Franchise agreements are legal documents that lay out the terms and conditions governing the relationship between the franchisee and franchisor. Understanding the clauses within the contract is essential to protect your investment and ensure a successful partnership.
When evaluating a franchise agreement, potential business owners will review many industry-standard clauses such as franchise fees, training and support documents, termination consequences and more. These contracts could also feature other clauses and conditions that potential franchisees must understand fully before signing a contract. Some, if not considered, can result in negative outcomes.
Territorial Rights
A territory clause outlines the geographic area in which the franchisee has the right to operate. Franchisees should carefully review the territory boundaries to ensure they align with their business goals and market potential.
Most importantly, franchisees should be aware of the possibility of signing up for a non-exclusive territory and competition from the franchisor and its affiliates.
As an example, in the lawsuit against Assurant, the parent company of CPR Cell Phone Repair is being sued for deceitful business practices that benefit the franchisor’s parental entity at the franchisees’ expense. These business owners reported a dangerous cycle in which Assurant offers non-exclusive territories to franchisees and then partners with competitors within the territory assigned in the franchise agreement.
This practice can significantly devalue a business and force a franchisee to sell back to the franchisor at a heavily discounted rate.
Royalties
Separate from a standard franchise fee, which is the initial payment made by the franchisee to the franchisor for the right to use its brand and business model, most contracts also require royalty fees.
Ongoing royalties are typically based on revenue. It’s important to understand the amount of these fees and provisions for increases over time.
Marketing Spend Clauses
In most franchise systems, franchisees are required to contribute a certain amount, called the advertising fee, that is pooled for national and local marketing efforts. These funding agreements are designed collectively to promote and advertise the brand rather than each franchisee choosing how to spend ad dollars independently.
The franchisor is responsible for managing the advertising funds, which should cover fees related to website, search, local listings lock, remarketing, creative assets, television or radio commercials and others. These funds should be separate from royalties and the general sources of revenue. However, some portion of the advertising fees may be allocated to attract new franchise owners rather than to promote the franchisee’s outlet.
In some cases, including the example above related to Assurant, franchisees have reported little to no transparency as to where (or if) the money is being spent for the benefit of the franchisees and allege the fees have acted as a profit center for the franchisor or its affiliates.
It is critical to understand how marketing funds will be used, whether there is room for transparency regarding where the funds are being allocated, and whether the franchisor can provide return on investment results of a pooled fund before signing a contract.
Mandated Suppliers
Similarly, potential franchisees should carefully consider clauses surrounding mandated suppliers for transparency and ethical standards.
Many franchisors have preferred vendors from whom franchisees are required to purchase products or services. While this method can ensure consistency throughout the franchise network, franchisees should examine flexibility in sourcing goods and whether the franchisor is subject to rebates or kickbacks from suppliers.
In some cases, business owners claim franchisors fail to disclose the extent of the relationship between franchisor and supplier. Franchisees should be mindful that alternate suppliers could be less expensive with a superior product compared to the mandated vendors, especially given the group’s buying power.
Renewal Terms
Franchise agreements typically have a set term with provisions for renewal if certain conditions are met. Franchisees should understand the terms for renewal, including any fees or requirements such as increased royalty fees.
Likewise, the contract should outline the circumstances, along with any associated penalties or obligations. if either party decides to terminate the agreement.
For example, if a franchisee falls victim to the cycle mentioned above regarding territory disputes, the franchisee may be unable to continue business because the franchise is no longer profitable and unable to sell the franchise for the same reason. In this instance, the franchisor would react similarly, by buying back the franchise upon time for renewal.
In other cases, franchise agreements will often specify whether franchisees have the right to transfer or sell their franchise to another party. Franchisees should examine the conditions for transfer, including any approval requirements from the franchisor and potential transfer fees. Additionally, the contract should address exit strategies in case the franchisee wishes to sell or exit the business entirely.
Dispute Resolution
In the event of a disagreement or dispute between the franchisee and the franchisor, prospective franchisees should ensure their contract outlines a specific process for resolving the issue. This may include mediation, arbitration or litigation.
Some agreements will include class action and jury trial waivers, which forces franchise owners to proceed with a complaint on their own rather than as a collective. These clauses can essentially halt any franchisee lawsuit, even if there is a legitimate dispute.
Franchisees should have a full understanding of their rights and obligations under a dispute resolution clause and consider seeking legal advice to ensure their interests are protected before signing an agreement. Other relevant clauses in this category include duty of good faith, fair dealing and the statute of limitations.
Franchise contract experts also advise for potential franchisees to conduct independent research on previous claims filed against the prospective company to determine the number of lawsuits filed against the company and the results of those claims.
The bottom line – before signing on the dotted line, franchisees must carefully review the terms and conditions outlined in the agreement. By paying close attention to key clauses related to fees, territorial rights, termination, litigation and other important aspects, franchisees can protect their investment and set themselves up for success.
Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of the AAFD. Information provided on this article does not, and is not intended to, constitute legal advice; instead, all information, content, and materials available on this article is for general informational purposes only.