One of the provisions we almost always seek to negotiate into a lease on behalf of franchisor clients is a franchising clause.
Whilst many sophisticated shopping centre landlords now expect this request from established franchise brands, the drafting varies considerably between landlords and, surprisingly often, the issue is overlooked altogether.
Although it may appear to be a relatively minor clause, a well-drafted franchising provision can significantly simplify the day-to-day operation of a franchise network and avoid unnecessary administrative burden throughout the term of the lease.
What is a franchising clause?
Where a franchisor holds the lease directly but permits a franchisee to operate the business under a franchise agreement and licence agreement, the franchisee is not the tenant.
Without an appropriate franchising clause, this arrangement can potentially conflict with standard lease provisions prohibiting assignment, subletting, licensing or parting with possession.
A franchising clause expressly permits the franchisor to appoint a franchisee to operate the business from the premises whilst confirming that:
- the franchisor remains the tenant under the lease;
- the franchisee does not acquire any tenancy rights against the landlord; and
- the franchisor remains responsible for complying with the lease.
For established franchise systems, this has become a relatively common commercial arrangement.
Large landlords often have their own precedent
Major shopping centre landlords generally expect national or growing franchise networks to request a franchising clause.
In many cases, rather than accepting the franchisor’s precedent, the landlord will instead insist upon using its own version.
Whilst these clauses are often perfectly workable, they should still be reviewed carefully. The detail can vary considerably between landlords and seemingly minor drafting differences can have significant practical consequences.
A good clause makes practical sense
One of the biggest advantages of a properly drafted franchising clause is that it allows the franchisee to deal directly with many routine landlord matters.
For example, a well-drafted clause may permit the franchisee to:
- provide the required bank guarantee;
- effect the insurances required under the lease; and
- pay rent, outgoings and other monies directly to the landlord.
From a practical perspective, this makes sense.
Without these provisions, the franchisor can unnecessarily become an administrative gateway for routine operational matters despite not being the party managing the day-to-day operation of the business.
Direct payment still carries risk
Of course, there is another side to the equation.
Where the franchisor remains the tenant under the lease but the franchisee is paying rent and outgoings directly to the landlord, the franchisor ultimately remains legally responsible if those payments are not made.
Accordingly, clear communication channels between the landlord, franchisor and franchisee are essential.
The franchisor should ensure it is promptly notified of any arrears, defaults or other lease issues so they can be addressed before they escalate into more significant problems.
Keep the approval process simple
Many franchising clauses require the landlord’s consent before a new franchisee may be appointed.
Whilst some landlords are prepared to allow appointments without formal approval (provided they receive prior notification), others insist upon a consent process.
Where landlord approval is required, the process should be as simple and efficient as possible.
Ideally, the clause should:
- clearly identify the information the landlord is entitled to receive;
- specify any supporting documents that must be provided;
- require the landlord to respond within a reasonable timeframe; and
- provide that consent must not be unreasonably withheld, conditioned or delayed.
Lengthy approval processes rarely benefit either party and can unnecessarily delay franchise sales and appointments.
Watch out for hidden legal fees
One issue we regularly encounter is a landlord seeking to recover its legal costs simply for considering a proposed franchisee.
Sometimes these clauses go even further, requiring the franchisor to pay the landlord’s legal costs for reviewing the proposed licence agreement itself.
These provisions should be considered carefully.
Whilst it may be reasonable for a landlord to recover legal costs associated with a genuine assignment or significant lease variation, charging legal fees every time a franchisor appoints a new franchisee can become an unnecessary and recurring expense over the life of the network.
Where possible, these provisions should either be deleted or limited to circumstances where the landlord’s involvement genuinely extends beyond a routine review.
The takeaway
A franchising clause is much more than a technical leasing provision.
When drafted properly, it allows a franchise network to operate efficiently whilst preserving the landlord’s legitimate interests and ensuring the franchisor remains responsible under the lease.
However, not all franchising clauses are created equal. Particular attention should be paid to the approval process, the allocation of responsibility for rent and outgoings, communication following defaults, and any recurring legal costs associated with appointing new franchisees.
At Magnolia Legal, we regularly negotiate retail leases on behalf of franchisors across Australia. Although these clauses are becoming increasingly common, careful drafting at the outset can save considerable time, cost and administrative burden throughout the life of a franchise network.