Structuring a Unit Franchise Relationship

• Author: Rupert M. Barkoff, Andrew C. Selden
• Pages: 51-93

51

Structuring a Unit Franchise Relationship

CHAPTER 2

Stuart Hershman and Andrew A. Caffey

Contents

I. Types of Franchise Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 2

A. Unit Franchises . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

B. Area Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

C. Subfranchising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

D. Development Agencies/Area Directorors or Representatives . . . . . 5 5

E. Development Quotas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

F. Advantages and Disadvantages . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 6

G. Legal Documentation of the Franchise Relationship . . . . . . . . . . . 57

II. Structuring a Multiple Outlet Relationship . . . . . . . . . . . . . . . . . . . . . 57

A. Territory, Term, and Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

B. Fee Structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

C. Development Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58

D. Effects of Transfer and Termination . . . . . . . . . . . . . . . . . . . . . . . . 5 9

III. Structuring a Unit Franchise Relationship . . . . . . . . . . . . . . . . . . . . . 59

A. Term and Renewal of the Franchise . . . . . . . . . . . . . . . . . . . . . . . . 60

B. Reservation of Rights . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

C. Territorial and Customer Rights and Restrictions . . . . . . . . . . . . . . 63

D. License to Use Trademarks, Service Marks, and Trade Dress . . . . 66

E. Control of the Franchisee’s Business Premises . . . . . . . . . . . . . . . . 67

F. Developing the Franchisee’s Business Facility . . . . . . . . . . . . . . . . 6 8

G. Training Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

H. Operating Assistance or Guidance . . . . . . . . . . . . . . . . . . . . . . . . . 75

I. Supplying Franchisees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76

J. Advertising and Marketing Programs . . . . . . . . . . . . . . . . . . . . . . . 78

K. Maintenance of Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 9

L. Upgrading and Refurbishing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 0

M. Protection of Trade Secrets and Non-competition Provisions . . . . . 81

N. Sources of Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

1. Initial Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82

2. Continuing Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

3. Advertising Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

4. Miscellaneous Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 4

52 Fundamentals of Franchising

This chapter outlines program design considerations to be taken into ac-

count in structuring a typical business format franchise system. It will focus on the

legal and contractual aspects of structuring rather than on issues of the desirabil-

ity, from a business standpoint, of the different structures.

The first part of the chapter gives an overview of some of the more typical

types of franchise structures. This discussion is followed by more detailed analysis

of the single-unit franchise structure, the type most widely used.

I. Types of Franchise Structure

A franchise program can be structured in several different ways. Two common

types of franchise relationships are individual, or “unit,” franchises and area fran-

chises. While these and other names are arbitrary, the terms used are those most

commonly associated with these various structures for franchise programs.

A. Unit Franchises

Individual or unit franchises are those in which a franchisor grants a franchisee

the right to develop and operate one outlet at a specific location or within a de-

fined territory. Rights to acquire additional franchises may be granted, within a

defined area, subject to performance criteria and structured either as options or

rights of first refusal. Rights of first refusal, however, will make it more difficult

for the franchisor to attract other qualified candidates for locations that are subject

to such rights due to the uncertainties attendant upon tendering proposals to the

holder of the first refusal rights.

O. Modification of the System . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

P. Transfer of the Franchise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

Q. Termination by the Franchisor . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 7

1. Grounds for Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87

2. The Franchisee’s Obligations upon Termination or

Expiration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

3. The Franchisor’s Option to Purchase the Business . . . . . . . . . 89

4. The Franchisor’s Obligations upon Termination or

Expiration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

R. Boilerplate Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

1. Interpretation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

2. Judicial Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

3. Integration Clause . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91

4. Relationship of the Franchisor and Franchisee . . . . . . . . . . . . 9 1

S. Arbitration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 2

IV. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 3

Chapter 2 Structuring a Unit Franchise Relationship 53

Unit franchises may also be offered as an incentive for growth with existing

franchise owners, with additional franchises granted to successful franchisees.

Franchisors should exercise caution in assuming any sort of contractual obligation

to grant additional unit franchises. Most companies simply adopt company-wide

policies regarding the incentive program. An individual or unit franchise is most

often used with a service business or business requiring an owner-operator, in which

the expertise of the franchisee is critical to the success of the operation. Examples of

service businesses often franchised on a unit-by-unit basis include foodservice, lodg-

ing, real estate, home inspection, and automotive service businesses.

B. Area Development

Unit franchises are often sold in “bundles” under some type of multiple unit de-

velopment plan that grants a single franchisee the right to develop a scheduled

number of single franchised businesses, usually within a defined territory or search

area, subject to a development quota, with each business being governed by a

separate unit franchise agreement. These are not subfranchising deals of the type

discussed below: the investor in an “area franchise” is expected to develop and

operate the franchised businesses for its own account.

Area franchises use multiple outlet franchises or area development agree-

ments. Under these arrangements, a franchisee may be granted the right to de-

velop and operate two or more outlets within a defined territory, ordinarily under

a master agreement called an “Area Development” or “Multiple Unit Develop-

ment Rights Agreement,” which anticipates the issuance of separate unit franchise

agreements for each separate location. The significant elements of an area devel-

opment agreement are:

1. Territory definition and exclusivity rights and exceptions;

2. The number of outlets to be developed;

3. The time frames for development;

4. Franchisor assistance in development;

5. Fee obligations;

6. Site selection and approval responsibilities of the parties;

7. Transferability of the development rights apart from the franchised busi-

nesses; and

8. Termination and its consequences: The effect of termination of the devel-

opment agreement on existing individual unit franchises and the effect of

termination of unit franchises on the development agreement and other

unit franchises.

These contracts all presuppose and should require that the franchisee develop

and operate the retail businesses for his or her own account and not for the

purpose of resale to others. While individual unit franchises can be transferred