What Is a Security Retention Clause in a Franchise Agreement?

When it comes to franchising, clarity and protection are key—for both franchisor and franchisee. One clause that often flies under the radar but can be incredibly useful for franchisors is the security retention clause. While not as universally recognised as other provisions, this clause can play a critical role at the end of the franchise relationship, especially when it comes to covering costs, mitigating risks, and ensuring a smooth transition out of the network.

So what exactly is a security retention clause, and why should franchisors consider including one in their agreements?

A Simple Definition

A security retention clause is a provision in a franchise agreement that entitles the franchisor to withhold or require payment of certain monies from the franchisee when the franchise agreement ends—either by expiry or termination. In essence, it operates like a form of financial insurance for the franchisor, giving them a reserve of funds to draw on in the months following the end of the relationship.

The withheld amount is typically held for a finite period—commonly six months, though this can vary depending on the agreement. During this time, the franchisor may apply the retained funds towards outstanding liabilities or costs associated with the winding down of the franchisee’s business.

Why Do Franchisors Use It?

For franchisors, security retention clauses offer a practical safety net. When a franchise agreement ends, there are often a number of loose ends that need to be tied up—some of which come with financial obligations. These might include:

• Outstanding rent or make good obligations owed to landlords (especially for fixed-premises franchises).

• Unpaid supplier invoices for goods or services ordered under the franchise system.

• Employee entitlements, where staff are employed directly in the franchisee’s business.

• Costs of debranding, removing signage, or transitioning the site or territory for re-franchising.

• Legal fees or enforcement costs, particularly in cases of disputed exits or non-compliance.

• Damages or indemnity claims arising under the franchise agreement or connected contracts.

Rather than pursuing the former franchisee for each cost item individually—which can be costly and time-consuming—the franchisor can apply the retained funds directly, within the parameters set out in the agreement.

Validity and Drafting Considerations

To rely on a security retention clause, it must be clearly and validly drafted in the franchise agreement. This includes:

• The amount or method of calculation (e.g., a fixed dollar figure, or a percentage of average monthly fees).

• The permitted use of the retained funds—for example, to pay creditors, landlords, employees, or the franchisor and its associates.

• The time period for which the funds may be retained.

• The process for reconciling and returning any unused amount to the franchisee.

It’s critical that the clause is reasonable and not punitive in nature. A court or regulator (such as the ACCC) may take issue with a clause that appears excessive, vague, or lacks a genuine commercial rationale. Transparency is key.

How Much Should Be Withheld?

There’s no one-size-fits-all amount when it comes to security retention. The appropriate figure will depend on the nature and risk profile of the business.

• Fixed premises franchises—such as retail, hospitality, or bricks-and-mortar service businesses—often face larger end-of-term liabilities. Rent, fit-out make good obligations, and staffing costs can quickly add up. In these cases, retention amounts of $10,000 to $25,000 or more are not uncommon.

• Mobile or service-based franchises, with fewer overheads and simpler setups, may justify a lower amount—often in the low thousands.

Franchisors should also consider factors such as the average size of transactions, supply chains, and the likelihood of needing to re-enter or clean up a site before re-franchising.

Practical Tips for Franchisors

If you’re a franchisor (or an advisor working with one), a few best practices apply:

1. Build it into the agreement from the start. It’s difficult to introduce this kind of clause later, particularly once the relationship is established.

2. Be transparent with franchisees. Explain the purpose and operation of the clause, and ensure it’s not buried or ambiguous.

3. Use a clear, consistent process for holding, applying, and reconciling the funds. Ideally, keep the retention amount in a separate trust or escrow account.

4. Tailor the amount to your business model. One franchise system’s retention figure won’t fit another’s. Make sure it’s commercially justified.

Conclusion

While not every franchise agreement includes one, a well-drafted security retention clause can be a valuable tool for franchisors. It ensures that you’re not left financially exposed at the end of a franchise relationship, and provides a practical mechanism to deal with outstanding liabilities without resorting to legal action.

At Magnolia Legal, we regularly work with new and growing franchisors to structure franchise documents that are clear, compliant, and commercially sound. If you’d like guidance on whether a security retention clause makes sense for your system—or need help reviewing your current franchise agreement—we’re here to help.