It Pays to Know Your Franchise Agreement

Scott M. Ratchick

The road to franchise success can be a bumpy one, but knowing what is in the franchise agreement can help franchisees smooth out the ride. Here are five critical legal issues for convenience store franchisees to consider when negotiating the terms of a new or renewed franchise agreement. Of course, a franchisor’s willingness to negotiate varies, so be sure to keep a close eye on these issues.

Jurisdiction & Consent to Venue

If a dispute arises, the franchisor may require you to travel to its hometown jurisdiction to resolve the dispute in court or through arbitration – regardless of how inconvenient or expensive it is for you. Even if your franchise agreement is required by the Petroleum Marketing Practices Act (PMPA) or by state law to be governed by the law of your principal place of business, the franchisor will prefer to make you come to its hometown jurisdiction to resolve the dispute.

Scott A. Augustine

Consider the time and expense for you, your key employees and your witnesses to travel to another state (perhaps across the entire country) to enforce your rights under the franchise agreement. Also, even if an attorney represented you when you negotiated the franchise agreement, you likely would need to engage local legal counsel to assist with the dispute.

As a further complication to a quick resolution, many franchisors require that disputes go through a mandatory non-binding mediation process in the franchisor’s home location before --and as a prerequisite to -- filing suit or arbitration. Be sure to check whether your state’s franchise act (if it has one) requires that disputes be resolved in your home state.

Defined Terms Related to Royalties & Other Fees

Pay careful attention to the defined terms and fees the franchisor can collect from your franchise. These terms can be vague or overly broad, leaving an opening for the franchisor to charge you additional fees in the future – fees not contemplated when the agreement was executed.

Also, make sure that when royalties and other fees are tied to certain revenue sources, those sources are very specifically and if possible, narrowly defined. For example, royalty payments and other fees are often based on a percentage of your overall sales. Make certain that you understand the definition of net sales or gross sales and what sources of revenue are included in or excluded from “sales” Pay close attention to the Franchise Disclosure Document and the disclosure of any franchisees in the organization that pay different royalties or other fees.

In addition, try to determine whether your proposed franchise agreement contains the same or different terms from other franchisees. Some franchisors negotiate fees and other terms to attract or retain certain franchisees. This can be beneficial for the franchisors who successfully negotiate, and a problem for those who don’t and may bear the burden of the franchisor trying to recoup what they negotiated away with others.

Personal Guarantees

Does the franchise agreement require a personal guarantee from the franchisee and if so, for what debts and liabilities? Establishing a corporate structure like a corporation or a limited liability company to operate a franchise will not shield you from personal liability if you sign a personal guarantee. Importantly, you can remain personally liable under a guarantee long after you sell or quit the business.

Your ability to negotiate the application and scope of a personal guarantee may differ depending on whether you are a single-unit or a multi-unit franchisor. Consider asking the franchisor to limit the duration of personal guarantees so they expire after a number of years of ongoing operation in good standing. Also, if you are a multi-unit franchisee, consider asking the franchisor to waive personal guarantees based on the strength of your company’s balance sheet.

Integration or Merger Clauses

Get everything in writing and be leery when the franchisor says, “Don’t worry about...” or “We can deal with that later.” Most franchise agreements include provisions stating that only the written terms of the agreement will be binding, and that nothing previously discussed or promised will be enforced unless expressly built into the franchise agreement.

To help protect yourself in the event of a later dispute, take notes immediately after conversations you have with the franchisor during Discovery Day or in meetings and phone calls leading up to signing the franchise agreement. Your notes of conversations with the franchisor can have a significant, positive impact if a dispute arises with regard to the meaning or application of a vague or ambiguous term in the franchise agreement.

Rights of First Refusal & Other Conditions for Sale or Assignment

You may be required to offer to sell your franchise to the franchisor before you can freely sell it to someone else. This obligation may make your business less appealing to a third-party buyer and thus less valuable for sale. For example, a third-party buyer may have to wait for the franchisor’s right of first refusal period to expire or execute a new franchise agreement that does not include the terms of your potentially more favorable agreement.

Consider negotiating the right to sell to another existing franchisee, or to a member of your existing ownership group, or to a family member. Maintaining maximum flexibility is key.

It is important to pay attention to these issues on the front end of your franchise relationship to help ensure success down the road. And there is no need to go it alone. Consult with legal and financial professionals who have experience with these issues and franchise relationships.

Scott M. Ratchick and Scott A. Augustine are attorneys with Chamberlain, Hrdlicka, White, Williams & Aughtry. Ratchick is a commercial trial attorney and represents franchisees in disputes with franchisors, landlords and employees. Augustine is a business attorney and represents franchisees in franchise agreements, purchase agreements, finance agreements and real estate matters.

Editor’s note: The opinions expressed in this column are the authors’ and do not necessarily reflect the views of Convenience Store News.