Common Legal Protections for Franchisors

Franchising is a business model in which one business (franchisor) grants the rights to another business (franchisees) to use the franchisor's established business model. Here are several ways to optimize franchisor's advantages and minimize its risks.

1. Develop a Teachable Model with Clear Legal Standards. Before being able to franchise the business model, you will need to invest considerable time and resources into building it. The business model must not only generate steady revenues but also be teachable and enforceable. This requires that you develop an operational manual, establish standards for each aspect of your business, put it in clear enforceable terms, and include remedies for not following the standards, such as monetary damages, suspension or discontinuance of licenses, injunctive relief, or other remedies.

2. Do Due Diligence in Choosing a Trustworthy Franchisee. Establishing more franchising relationships with other businesses may create a snowball effect on your brand. The more franchises, the more presence, the more brand recognition, the more customers, the better revenues. At the same time, this puts more pressure on you to monitor the quality of the brand and be selective in choosing your franchisees. Being diligent in your search for the right person and team may take time but it will pay off. Finding a franchisee with a proven history of business success or at least a potential for such may enhance the value of your brand. Also checking the potential franchisee for any bankruptcy, judgments, lawsuits, business reputation, and even social media posts is one of the common “due diligence” protections for franchisors.

3. Increase Revenues Safely Through a Clear Fee Structure. As a franchisor, you can receive additional revenues from a “new location” without substantial expenses of opening a new business. You will receive franchising and licensing fees. However, to protect your profits, setting specific rates is not enough. The fee provision in the franchise agreement has to detail, among others, the calculation methods, reporting requirements, and auditing rights. The franchise agreement also must specify your remedies in case of missed or late payments, such as penalties, interest rates, withdrawal of services or licenses, or termination. Additionally, even if you put the fees provision in the agreement, it is important to implement it by regularly checking the franchisee’s numbers.

4. Allocate the Risks of Franchisee’s Mistakes. After establishing the franchisable model and finding a franchisee, you also will need to monitor and audit franchisee’s business to protect your brand from unwise management, deteriorating quality, bad customer service, or other mistakes of franchisees. Some laws may extend liability to franchisors for claims arising out of franchisees’ mistakes (for example, in some cases of employee disputes). Franchisors should wisely allocate the risks of such mistakes and consider including indemnification duties, and monetary and equitable remedies in the franchise agreement to protect their business from the misuse of the brand.

5. Outline Smooth Transition and Termination Rules. To avoid as much as possible discontinuance of a franchise location, it is important to outline what will happen in case of franchisee’s death, disability, or sale of the business. Franchisors typically retain the right of first refusal and the discretion to approve the transfer of business and/or appoint a manager. For the right of first refusal, franchise agreements typically describe how the price is determined and what are the triggers of the right.

In the case of termination, it is important to specify not only the reasons for termination but also the rights and obligations upon termination. For example, the payments owed, distribution of inventory and materials, confidentiality, non-compete, and non-solicitation.

6. Stay Compliant. As a franchisor, you will need to comply with federal and state laws in each state where you franchise your business. Some examples of legal compliance include franchisor registration and disclosure laws and franchise relationship laws. Staying compliant with all these requirements will help your brand to avoid legal troubles and focus on the continuing growth of your brand.

This blog does not constitute legal advice. It contains only general information. To assess legal protections for specific franchise relationships, please consult with an attorney.
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