Purchasing a franchise is a significant investment.
For many prospective franchisees, the Franchise Agreement is the single most important document they will sign. Yet surprisingly, many people sign without obtaining independent legal advice or fully understanding the risks hidden within the agreement.
At Magnolia Legal, we regularly review Franchise Agreements across a broad range of industries and franchise systems. Whilst every franchise is different, certain issues arise time and time again.
Here are ten of the most common red flags we look for when conducting a franchise agreement review.
1. Clauses Allowing the Franchisor to Recover Legal Costs
Many Franchise Agreements contain provisions requiring the franchisee to reimburse the franchisor for legal costs incurred in connection with the franchise relationship.
Whilst this may sound reasonable at first glance, the Franchising Code of Conduct places limits on the circumstances in which a franchisor can recover legal costs from a franchisee.
As a general rule, franchisors are entitled to charge their initial documentation fee and certain other fees properly disclosed in the Disclosure Document. However, we occasionally encounter provisions seeking to recover broader legal costs incurred throughout the relationship.
These provisions should be carefully reviewed to ensure they are consistent with the Code and current market practice.
2. Broad Indemnities Without Appropriate Carve-Outs
Most Franchise Agreements contain indemnities in favour of the franchisor.
The issue is often not the existence of the indemnity itself, but its scope.
We regularly encounter indemnities that effectively require the franchisee to indemnify the franchisor against all losses, regardless of whether those losses were caused by the franchisor’s own conduct.
In our view, appropriately drafted indemnities should contain reasonable carve-outs, particularly where loss arises from the franchisor’s negligence, breach of the agreement or unlawful conduct.
3. Personal Guarantees That Go Further Than Necessary
It is common for directors of a franchisee company to provide personal guarantees.
However, some guarantees extend well beyond what is reasonably necessary to protect the franchisor’s legitimate interests.
The practical effect can be that business risks become personal risks.
Where guarantees are required, prospective franchisees should understand precisely what obligations are being guaranteed and whether the scope of the guarantee is commercially reasonable.
4. PPSR Security Over All Present and After-Acquired Property
One increasingly common issue involves Personal Property Securities Register (PPSR) provisions.
Some Franchise Agreements permit the franchisor to register security interests not only over the assets of the franchisee entity, but also over all present and after-acquired property of individual guarantors.
This can have significant implications for directors and business owners.
Whilst security over the franchisee entity may be commercially justifiable in some circumstances, we will often seek to limit PPSR security interests to the franchisee entity rather than extending them to personal assets.
This issue arises most commonly in higher-investment franchise systems or where the franchisor supplies goods on credit or extended payment terms.
5. Future Royalty Claims Following Termination
Some Franchise Agreements contain provisions that seek to make the franchisee liable for royalties, marketing fees or other recurring payments that would have been payable for the balance of the franchise term following termination.
Whilst each clause must be considered on its own terms, these provisions often raise questions regarding enforceability and whether they are consistent with the general legal obligation to mitigate loss.
Where a franchise agreement contains a broad liquidated damages clause, it should be carefully scrutinised before signing.
6. Restraint Clauses That Do Not Fit the Industry
Many franchisors utilise precedent documents that have evolved over many years or have been adapted from entirely different franchise systems.
The result is that we frequently encounter restraint of trade provisions that bear little relationship to the actual business being operated.
For example, a restraint that may be appropriate for a specialised professional services franchise may be entirely inappropriate for a home services business or retail operation.
A restraint clause should be tailored to the nature of the business and the legitimate interests being protected.
7. Excessive Documentation, Transfer or Administration Fees
Most franchisees expect to pay an Initial Franchise Fee.
However, Franchise Agreements often contain a range of additional fees, including:
- documentation fees;
- transfer fees;
- renewal fees;
- training fees;
- technology fees; and
- administration charges.
Whilst these fees are not necessarily problematic, they should be assessed against current market practice.
Recently, we reviewed a franchise arrangement containing a documentation fee of approximately $8,000!!!. Whilst not unlawful, it was materially higher than the level commonly encountered in comparable franchise systems.
Understanding whether a fee is market standard is often one of the most valuable aspects of obtaining independent legal advice.
8. Weak or Non-Existent Territory Protection
Territory protection remains an important issue in many franchise systems.
However, the position varies significantly depending upon the industry.
In some sectors, exclusive territories remain common. In others, particularly those involving online sales or mobile service delivery, exclusive territories are becoming increasingly uncommon.
The key issue is not necessarily whether a territory is exclusive, but whether the franchisee clearly understands:
- what rights they are receiving;
- what rights the franchisor is retaining; and
- whether the territory arrangements are commercially appropriate for the business model.
9. Unfettered Franchisor Discretion
Many Franchise Agreements contain provisions granting the franchisor broad discretion in relation to operational matters.
Examples include decisions concerning:
- suppliers;
- marketing;
- system standards;
- products and services;
- technology platforms; and
- operational requirements.
Whilst some degree of discretion is unavoidable in a franchise system, clauses that provide the franchisor with unlimited discretion should be carefully reviewed.
The good faith obligations imposed by the Franchising Code of Conduct provide some protection, however overly broad discretionary powers can still create significant commercial risk for franchisees.
10. “No Reliance” Clauses Where Significant Discussions Have Occurred
This is one of the most common issues we encounter.
Prospective franchisees often spend months speaking with franchisors before signing. During that process there may be discussions concerning:
- likely turnover;
- customer demand;
- growth opportunities;
- territory potential;
- fit-out costs;
- staffing requirements; or
- business performance generally.
Yet when the Franchise Agreement arrives, it frequently contains a clause stating that the franchisee has not relied on any representation, statement or promise not expressly set out in the agreement.
Whilst such clauses are not necessarily determinative, they can create significant evidentiary difficulties if a dispute later arises.
Where important representations have been made during pre-contract discussions, franchisees should consider asking that those matters be confirmed in writing before signing.
One of the most common warning signs we see is a franchisor making significant statements during negotiations but refusing to reduce those statements to writing when requested.
The Value of Independent Franchise Legal Advice
The purpose of a franchise agreement review is not simply to identify legal issues.
It is to help prospective franchisees understand:
- what they are agreeing to;
- what risks they are assuming;
- what provisions can potentially be negotiated; and
- whether the agreement is consistent with current market practice.
Many of the issues discussed above are not immediately obvious to someone reviewing a Franchise Agreement for the first time.
An experienced franchise lawyer can help identify those risks before they become expensive problems.
Need a Franchise Agreement Reviewed?
At Magnolia Legal, we regularly advise prospective franchisees on Franchise Agreements, Disclosure Documents, franchise due diligence and related commercial arrangements.
If you are considering purchasing a franchise, obtaining advice before signing can help ensure you understand exactly what you are committing to and whether the agreement reflects current legal and commercial standards.