FRANCHISING THE ROLE OF THE LAWYER

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1 FRANCHISING THE ROLE OF THE LAWYER Both a potential franchisor seeking to develop a franchise and a franchisee looking to purchase a franchise opportunity will need advice from an experienced franchise lawyer. The proactive client involves their lawyer on a constructive value-added basis, which generally results in the client having better informed control of their own business and a more beneficial relationship with their lawyer. Background In the New Zealand context, since the early 80s, the economic and commercial climate has changed markedly with greater emphasis on consumerism and competition. The result has meant legislation has developed rapidly reinforcing the free market while also providing consumer protection. It is essential in that environment that commercial clients are well protected and clients involved in franchising are no exception. This is particularly pertinent if one remembers that the franchisee is a consumer and purchaser of a licensed business opportunity which they risk their capital to acquire. Franchise Industry Experience In the context of franchising, the value of a lawyer is greatly enhanced by the lawyer s own knowledge, experience and understanding of the franchise industry. There are some complex factors involved in franchising and experienced legal advice is valuable. It is also important that the lawyer understands and assists in preserving the all important franchise relationship. The traditional adversarial approach by lawyers is generally inappropriate (there are exceptions e.g. protecting intellectual property from a rebellious franchisee). Too often lawyers can polarise the parties positions rather than facilitate the development, survival and ongoing success of that relationship when difficulties arise. The consequences of failure to achieve objectives in this area can be very serious for both Franchisor and Franchisee. Pre-Contractual Evaluation The franchise lawyer as well as the accountant can assist the franchisee at the pre-contract stage of evaluation. The right questions need to be asked and the appropriate inquiries made beyond the pure legal documents in order to satisfy potential franchisee clients as to the credibility of the franchisor and the franchise system. Is the franchise a vehicle for success or a vehicle for exploitation? Is the client s capital to be risked in a franchise investment of quality and value long term? The achievement of profit is fundamental but it can be undermined by many factors in a franchise relationship including excessive legal liability exposure.

2 Franchising The role of the Lawyer 2 Tough But Fair Documents For a franchise relationship to successfully mature, it is important that mutual trust is established at an early stage. This is cultivated by the legal obligations and responsibilities of each party being clear and fair. For instance franchise agreements are often perceived as significantly favouring the franchisor and are generally not negotiable on terms. There is generally good reason for this when the franchisee uses the franchisor s system under a common brand name. Many controls are essential if the integrity of the franchise system is to be maintained. This benefits everyone. There is also a strong desire for uniformity within the network. But the documentation should still be fair and be perceived as fair. An experienced franchise lawyer will usually have a greater appreciation of what is fair and acceptable in the particular circumstances of the franchise. They can greatly assist the client to understand why certain tough terms are included, rather than simply moving into attack mode and possibly de-stabilising relationships. It is their franchising experience and knowledge that assists a franchise lawyer to discern the line of what is fair and what is not in each case. Managing Risk Exposure The lawyer can assist in establishing legal liability risk management strategies and procedures for both franchisors and franchisees in order to minimise their vulnerability to claims. Aggrieved franchisees in particular will often venture into misrepresentation claims where early expectations have not matched reality. The nature of franchising makes it particularly vulnerable in this area especially where business opportunities are being sold rather than existing businesses. It is currently the greatest area of franchise disputes. From a franchisee s perspective, an experienced franchise lawyer can also assist in evaluating the vulnerability of the franchisor to liability in this high risk area. It should be remembered that it only takes one dissatisfied franchisee (justified or not) to monopolise the franchisor s focus and resources to possibly cause the collapse of the whole network. That can then affect everyone including the innocent. What an Experienced Franchise Lawyer Can Do This paper briefly (it is not exhaustively) identifies some of the more important issues where lawyers have a role to play (either for franchisor or franchisee) as part of the overall team of advisers assisting the franchisor or franchisee. The points noted are grouped into three phases of a typical franchise transaction ie: pre-contract/contract/post-contract. There is also a summary included of the more significant documentation that a lawyer should be involved with as appropriate, when dealing with a franchise transaction. Pre-Contract: Assist in the due-diligence evaluation of the franchise opportunity (both of the franchisor and the franchise system). Franchise lawyers usually have extensive check lists available for this purpose.

3 Franchising The role of the Lawyer 3 Assist in developing the appropriate structure for the franchise acquisition. Review and advise on all relevant legal documentation for completeness, accuracy, fairness and consistency with the franchisee s expectations (refer to document list below). Complete a legal audit of the existence and protective soundness of the fundamental intellectual property assets upon which the franchise is based. Assist in negotiation of the franchise opportunity. Ensure the contracts cover the franchisees expectations and document the promises. Assist in implementing the franchise transaction (e.g. finance securities, purchase and settlement). Assist in evaluating the appropriateness and feasibility of franchising to realise the client s objectives. Assist in developing and structuring the franchise system. Assist in protecting the fundamental intellectual property asset (e.g. trade marks, copyright, confidentiality etc) within the designed structure. Ensure intellectual property protection is secured overseas (where relevant) well in advance of actual trading. Assist in structuring and protecting dual or multi-party arrangements including co-branding agreements. Prepare franchise agreement and other related documents (refer below). Review supply and other ancillary contracts. Carry out legal audit of client s ability to prove compliance of franchise system and franchise agreement (e.g. Commerce Act and Consumer Guarantees Act). Carry out legal audit of franchise manuals to ensure comprehensive and accurate legal compliance as the franchisee ultimately will rely upon them (e.g. Health & Safety issues). Carry out legal audit of offering and advertising material (e.g. Fair Trading Act considerations). Assist in due diligence inquiry of insurers, lenders, suppliers and purchaser. During the Contract: Assist as appropriate, in providing advice on implementation of legal responsibilities e.g. terms of trade arrangements, employment contracts, supply contracts. Ensure business legal compliance of the franchisee s independent business. Provide dispute resolution assistance (including mediation) where appropriate.

4 Franchising The role of the Lawyer 4 Provide assistance for ongoing legal review of documentation and particularly the disclosure documents, franchise agreement, manuals and ancillary trading documentation. Provide guidance in formulating risk management training and strategies to ensure franchisees businesses are legally compliant and that franchisee is perceived as independently operated (this area is often compromised by franchisors becoming too involved in operating the franchisee s business). Assistance in enforcement of intellectual property rights against third party competitors. Providing guidance on risk management policies and procedures for the franchisor s business. Assist with dispute management and resolution. Post Contract: Assist in protecting residual assets to be retained or sold by franchisee. Review and advise on legal restraints placed upon the franchisee. Advise and assist on termination procedures, documentation and consequences. Assist in asset recovery including intellectual property rights. Assist in enforcement of legal restraints on franchisee (e.g. intellectual property, competition). Documentation Issued by Franchisors in relation to Franchise Transactions The package of documentation should be complete before any attempt is made to sell or buy a franchise and there should be full legal compliance. The documents may include the following: 1. Franchise Application Form (e.g. Human Rights Act and Privacy Act compliance). 2. Confidentiality agreement. 3. Franchise brochures and advertising material legally compliant (e.g. Fair Trading Act compliance). 4. Prospectus or Offering documentation (e.g. Fair Trading Act compliance). 5. Franchise Purchase Agreement (a valuable instrument for both parties). 6. Disclosure document (not essential in New Zealand law but highly desirable as a risk management tool, Fair Trading Act and FANZ Code Compliance). 7. Representation deed (a helpful risk management tool). 8. Deeds of personal covenant (provides for personal liability where appropriate. Also strengthens protection of intellectual property, trade restraints and confidentiality obligations). 9. Franchise Agreement (fundamentally holds everything together). 10. Franchise Development Agreement (applicable where multi-unit development or area development arrangements exists).

5 Franchising The role of the Lawyer Manuals (an integral part of the franchise legal commitment and should be comprehensive and legally compliant). 12. Dual or co-branding agreements. 13. Master Franchise Agreement (applicable where greater geographical division or overseas parties involved). 14. Franchise Advisory Council rules and procedures. 15. Site development documentation. 16. Premises occupation documents (e.g. leases, sub-leases, licences - essential that franchisor and franchisee both protected). 17. Finance documentation (should not conflict with franchise agreement). 18. Employment and related agreements (critical to establish individual responsibility of franchisor/franchisee when operating under one brand). 19. Ancillary contracts (e.g. supply contracts, software licences, association membership rules). 20. Terms of Trade. Summary If anyone wants to successfully move into the innovative world of franchising they need an experienced franchise lawyer. The lawyer can assist in ensuring expectations and promises are realistic and documented. The controlled use of a lawyer can also extend beyond documentation to areas of evaluation, risk management, compliance and dispute management., the pro-active use of a lawyer can add real value to the franchise system., the use of an experienced lawyer is essential to assist them in making the right purchase decision and to assist in protecting their investment for the long term. David Munn is a leading franchise lawyer and partner with the Auckland law firm Gaze Burt. He has many years experience representing both franchisors and franchisees and is listed in the International Who s Who of Franchise Lawyers. Visit our website or contact David Munn or Michael Bright on