03rj PLC Note - Franchise Agreement

Franchise agreement: drafting note

Resource type: Drafting note

Status: Maintained

Jurisdictions: England, Wales

This drafting note accompanies the standard document franchise agreement.

PLC Commercial (with thanks to John Pratt of Hamilton Pratt)

Standard document: Franchise agreement

Contents

General document notes

Legal issues

Negotiating and drafting issues

Clause notes

Parties

Background

Definitions: clause 1

Clause 1.1

Advertising Levy

Business

Equipment

Financial Package

Gross Monthly Receipts

Initial Fee

Intellectual Property

Lease

Manual

Premises

Products

Services

Start Date

System

Territory

Trade Marks

Trade Name

Interpretation

Rights granted: clause 2

Clause 2.1

Clause 2.2

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Clause 2.3

Term: clause 3

Clause 3.1

Clause 3.2

Clause 3.3

Clause 3.5

Clause 3.6

Fees: clause 4

Clause 4.1

Clause 4.2

Clause 4.5

Franchisor's initial obligations: clause 5

Clause 5(a) and (b) - Premises

Clause 5(d) supply of equipment and products

Clause 5(e) - public relations launch of the franchisee's business

Clause 5(f) - the provision of the franchisor's operations manual

Clause 5(g) - local advertising

Clause 5(h) - provision of the financial package

Franchisor's continuing obligations: clause 6

Clause 6(b)

Clause 6(c)

Clause 6(d)

Franchisee's obligations: clause 7

Employees: clause 8

Training: clause 9

Clause 9.1

Clause 9.2

Anti-bribery compliance: clause 10

Clause 10.1(b): outside the UK

Clause 10.1(c): relevant policies

Clause 10.1(d): adequate procedures

Clause 10.1(e): reporting bribes

Clause 10.1(f): foreign public officials

Clause 10.1(g): monitoring and review

Clause 10.2: supply chain

Clause 10.4: definitions

Accounting records: clause 11

Advertising: clause 12

Clause 12.1

Clause 12.2

Telephone numbers: clause 13



Insurance: clause 14

Premises: clause 15

CRC Energy Efficiency Scheme: clause 16

Clause 16.1

Clause 16.2

Clause 16.3(b)

Clause 16.5

Clause 16.6

Clause 16.7

Clause 16.8

Clause 16.9

Intellectual Property: clause 17

Clause 17.1

Clause 17.2

Clause 17.4

Clause 17.5

Clause 17.6

Sale of business: clause 18

Clauses 18.1 and 18.4

Clause 18.2

Clause 18.4

Clause 18.6

Clause 18.7

Death or incapacity of individual: clause 19

Clause 19.1

Clause 19.2

Confidentiality: clause 20

Termination: clause 21

Clause 21.1

Clause 21.2

Conditions following termination: clause 22

Clause 22.1

Clause 22.3

Clause 22.4

Restrictions: clause 23

Indemnity: clause 24

Individual's guarantee and covenants: clause 25

Entire agreement: clause 26

Further assurance: clause 27

Data protection: clause 28

Assignment: clause 29



Rights of third parties: clause 30

No partnership or agency: clause 31

Force majeure: clause 32

Set-off: clause 33

Default interest: clause 34

Severance: clause 35

Variation: clause 36

Waiver: clause 37

Expert: clause 38

Counterparts: clause 39

Notices: clause 40

Alternative dispute resolution: clause 41

Governing law and jurisdiction: clause 42

Trade marks: Schedule 2

GENERAL DOCUMENT NOTESThe Standard document, Franchise agreement (www.practicallaw.com/9-223-1966) is an agreement which may be adapted according to whether non-exclusive or exclusive rights in a particular territory are to be granted.

This drafting note does not discuss taxation in relation to franchises.

Legal issuesFor discussion of franchising arrangements generally, see Practice note, Franchising: overview (www.practicallaw.com/2-107-3749).

The CRC Energy Efficiency Scheme (CRC), which applies to franchises, came into force on 1 April 2010. For information, see Practice note, Franchising: overview: CRC Energy Efficiency Scheme (www.practicallaw.com/2-107-3749).

A franchise agreement is a typical vertical agreement - that is, an agreement between parties at different levels in the economic supply chain. On 1 June 2010, the new vertical agreements block exemption (Regulation 330/2010) and its associated vertical restraints guidelines came into force (replacing the previous vertical agreements block exemption (Regulation 2790/1999) and its associated vertical restraints guidelines).

Broadly, the vertical agreements block exemption provides a "safe harbour" for vertical agreements that meet certain conditions. Where the market share of the franchisor does not exceed 30%, and the market share of the franchisee does not exceed 30%, the vertical agreements block exemption covers:

The licensing of intellectual property rights in franchise agreements insofar as the licence provisions do not constitute the primary object of the agreement and are directly related to the use, sale or resale of goods or services; and

Vertical restraints (such as selective distribution, non-compete or exclusive distribution obligations) on the purchase, sale and resale of goods and services under a franchising arrangement.



However, to have the benefit of the vertical agreements block exemption, the agreement must not contain certain listed "hardcore" restrictions. The inclusion of any such restraints prevents the entire agreement from obtaining the benefit of the block exemption, not merely the clause or sub-clause in which the restraint is contained: there is no severability for hardcore restrictions. The vertical agreements block exemption also identifies a number of "grey list" obligations that fall outside the scope of the vertical agreements block exemption, even though the market share threshold is not exceeded. Unlike hardcore restrictions, severability does apply to these obligations, so that the inclusion of such an obligation will mean that the benefit of the vertical agreements block exemption is only lost in relation to any part of the agreement from which the offending obligation cannot be severed.

The inclusion of reference to the market share of the franchisee is a key change brought about by the new vertical agreements block exemption (in the previous vertical agreements block exemption (Regulation 2790/1999), the market share of the franchisor was generally decisive (except in the case of exclusive supply obligations)).

For information, see Practice note, Franchise: overview: EU competition law (www.practicallaw.com/2-107-3749) and Distributorships: overview: EU competition law and regulation (www.practicallaw.com/6-107-3648).

This standard is not drafted to fall within the "safe harbour" provided by the vertical agreements block exemption (assuming the parties satisfy the requirements for relevant market shares), as it includes provisions that as drafted do not comply with conditions in the vertical agreements block exemption (see commentary at clause 7). If the parties can and wish to rely upon the vertical agreements block exemption, practitioners should seek specialist competition law advice and amend accordingly. Where the vertical agreements block exemption is not available, specialist competition law advice will be necessary to assess any restrictions or exclusivity in light of Article 101 of the Treaty on the Functioning of the European Union (formerly Article 81 of the EC Treaty). For information, see Practice note, Franchise: overview: EU competition law (www.practicallaw.com/2-107-3749) and Distributorships: overview: EU competition law and regulation (www.practicallaw.com/6-107-3648).

A franchisor owes a duty of care in tort to franchisees and prospective franchisees. In MGB Printing and Design Limited v Kall Kwik UK Limited [2010] EWHC 624 , the High Court held that a franchisor owed a duty of care in tort and gave negligent advice to a prospective franchisee when, at the relevant time, the prospective franchisee was considering buying an existing franchise business as a going concern and the franchisor advised on the cost of refitting the premises to the franchisor's mandatory requirements. It transpired after the acquisition that these costs were significantly lower than the true cost of the refitting works. For more information, see Legal update, High Court holds franchisor owes duty of care to franchisee (www.practicallaw.com/5-502-0180).

The Bribery Act 2010 (BA 2010), effective 1 July 2011, replaces the existing bribery offences and introduces new offences. In particular, it introduces a strict liability offence which may affect franchisors. Under section 7, a commercial organisation (which includes a company or partnership) commits an offence if a person associated with it bribes another person, intending to obtain or retain business or a business advantage for the organisation. A person (A) is associated with a relevant commercial organisation (C) if A is a person who performs services for or on behalf of C (section 8, BA 2010). In certain circumstances, a franchisee may be an associated person to the franchisor: for further information, see the commentary at clause 10.

Negotiating and drafting issuesIn practice, it is the franchisor's solicitors who prepare the franchise agreement. However, as the agreement will be the same one that is used for all franchisees, it will also be part of the package which potential franchisees consider when negotiating the franchise deal. Therefore, although the standard document has been drafted from the



perspective of the franchisor, it is intended to strike a balance between protecting the franchisor's interests and being acceptable to potential franchisees.

A franchisor should not generally vary the terms of its franchise agreements because this may cause strong feelings between franchisees if they discover that some have better terms than others. Disparities in contract terms may also result in a greater administrative burden on the franchisor. The only times at which variations in terms should be considered are at the development stage, where the franchisor may find it expedient to offer better terms to the first franchisees in return for assistance in setting up certain elements of the franchise system and where external circumstances, such as the terms of a third party lease, necessitate a variation.

A franchise agreement should be well set out and contain no typing mistakes, as an agreement that is difficult to follow or written in "legalese" may put off a potential franchisee. A prospective franchisee will have every reason to believe that a poorly presented franchise agreement reflects poor preparation of the franchisor itself.

CLAUSE NOTES

PartiesThe franchisee may be a sole trader, partnership or a limited liability company. This will depend largely on the requirements of the franchisor and the advice concerning the tax and legal implications of carrying on business without limited liability which has been given to the franchisee.

The individual will normally be the majority shareholder in the franchisee, and the standard document is drafted on the basis that there is just one individual. If, however, there is more than one, then references to the individual should be amended accordingly and the agreement should make it clear that they have joint and several liability for all their obligations.

The franchisor will almost inevitably be a limited liability company.

If a franchise is to be given to a franchisee trading as a limited liability company, the franchisor will ideally try to obtain a guarantee of the obligations of the franchisee company from the individual who has set up the company and who will operate the franchise. The reason for this is that franchisee companies are very often newly incorporated with few or no assets, and if the franchisee breaches the agreement, it may not have sufficient assets to meet a claim. However, it is harder for individuals to put their assets beyond the reach of a franchisor. The franchisor should also consider restrictive covenants and undertakings from individuals (such as those set out in clauses 17, 22 and 23) so that they will not transfer their shares in the franchisee.

BackgroundThis section (recitals) sets out the background and purpose of the agreement. It can be used to provide brief details of any master franchise agreement.

Definitions: clause 1

Clause 1.1



Advertising Levy

The Advertising Levy is paid by the franchisee to cover a proportion of the cost of the advertising undertaken by the franchisor on a national basis. Consider whether the franchisee should be required to undertake its own point-of-sale advertising as well as paying the Advertising Levy.

Business

The definition of the Business is crucial to the grant of the franchise and must be as accurate as possible, while allowing for business development. However, as it is used for the purposes of clause 22 (restrictions), it should not be too widely drafted to avoid the risk that a court would refuse to enforce the provisions of that clause.

Equipment

List here (or in a schedule) all of the equipment that will be supplied by the franchisor in order to set up the franchise. This standard is drafted on the basis that the franchisee will buy the equipment from the franchisor on the franchisor's then standard terms.

Financial Package

This refers to the finance and accounting package licensed by the franchisor to the franchisee (see clause 5). This package will help the franchisee be efficient in its book and record keeping, and will also greatly assist the franchisor in ensuring that the information it requires from the franchisees is readily available and in a consistent format.

Gross Monthly Receipts

This term is used in the calculation of the payments to the franchisor, so it is important that it is correctly defined to reflect the intentions of the franchisor.

Consider whether payments are to be made to the franchisor on a weekly or monthly basis. The more frequent the payments, the better control the franchisor will have over its cash flow and the better its view of the franchisee's business will be. However, this may not be practical and so the standard document envisages payments being made on a monthly basis.

It is usual to specify whether this definition extends to sums receivable (which is usual) or only to amounts banked, and which items (such as VAT, income of a capital nature, sales rebates or discounts, credit card discounts or charges, the cost of any marketing initiatives such as free offers, sums received under business interruption insurance and so on) should or should not be included in the calculations.

Initial Fee

The Initial Fee is paid by the franchisee to the franchisor and is intended to cover the start-up costs incurred by the franchisor in relation to the franchisee. Consider whether the franchisor's legal fees should be included in this amount or whether they should be reimbursed separately.

Intellectual Property

The intellectual property which the franchise uses may be limited to a trade name only or a complete suite of intellectual property, including patents and design rights, as well as trade marks and names. Check to what extent these need to be identified and referred to in the franchise agreement. This definition is used in relation to the grant of the franchise, and



so it is important from the franchisor's point of view that only the intellectual property that relates to the Business is included, and not its other intellectual property.

Consider whether the definition should be extended to include intellectual property rights which come into existence, or are registered by the franchisor, during the term of the agreement and which relate to the Business.

For further information, see PLC IPIT & Communications, Standard clause, Definition of intellectual property rights (www.practicallaw.com/1-201-3359) and its accompanying drafting note (www.practicallaw.com/9-201-3360).

Lease

This term is currently drafted for where the franchisee is to take a lease of premises from the franchisor (see Practice note, Franchising: overview: Property (www.practicallaw.com/2-107-3749)).

This may not always be the case (and the franchisee will often take its lease of the premises directly from a third party landlord, as this will involve the franchisor in less risk).

For a case which emphasises the importance to both parties of dovetailing the terms of a franchise agreement into the terms of the lease agreement for the property from which the franchise is to be operated, see Miscela Ltd & Ors v Coffee Republic Retail Ltd [2011] EWHC 1637 (QB), where the High Court held that the failure of a company related to the franchisor to make available the franchise property pursuant to a lease agreement (one of the agreements forming part of the franchise package) did not put the successors to the franchisor in breach of the franchise agreement.

If the franchisee takes its lease directly from a third party, this term and all references to the Lease should be checked and amended to reflect the reality of the situation, for example, the franchisor may require prior approval of the terms of the Lease to make sure that the franchise business can operate effectively from the premises. Other considerations include:

Where the franchisee does not take a lease from the franchisor, the franchisor may require a separate deed of option to be entered into to enable the franchisor to take over the premises at termination of the franchise agreement (subject, of course, to the terms of the Lease).

Additional clauses may be necessary if the CRC applies to the franchise agreement. For background and information, see Practice note, Franchising: overview, CRC Energy Efficiency Scheme (www.practicallaw.com/2-107-3749).

(Note that, under clause 1.13, a reference to the Lease is a reference to it as altered from time to time.)

Manual

The Manual will set out how the franchise is to be run, and is an essential part of the operation. Under clause 7, the franchisee is obliged to run the Franchisee's Business in compliance with the Manual. According to this definition, the Manual may be altered by the franchisor from time to time. This will give the franchisor flexibility and the ability to respond to changing market conditions without having to alter the franchise agreements every time it wants to alter the way in which its franchise outlets are run. (Note that, under clause 1.13, a reference to the Manual is a reference to it as altered from time to time.)

Premises

If the franchisor is not leasing the Premises to the franchisee, it may have site selection criteria. The franchisee must be made aware of these (they could, for example, be incorporated into the Manual). The selection of a suitable site is of



the utmost importance for the franchisee, as it is only allowed to trade from the Premises and nowhere else (see clause 7).

You must also consider the impact of the CRC. For background and information, see Practice note, Franchising: overview, CRC Energy Efficiency Scheme (www.practicallaw.com/2-107-3749).

Products

The list of Products is set out in Schedule 3, or in the Manual which would make the agreement more flexible from the franchisor's point of view, as the franchisor can update Manual without agreement of the franchisee. However, if this is the case, the franchisor must not alter the list of Products in a way that could be unreasonable under the Unfair Contract Terms Act 1977 (UCTA). For further information, see Practice note, Supply contracts: overview (www.practicallaw.com/0-107-3646).

Ensure that all relevant products are listed, including (if appropriate) stationery.

Services

The Services are those which will be used in or supplied by the Franchisee's Business. The list of Services is set out in Schedule 3, or in the Manual which would make the agreement more flexible from the franchisor's point of view, as the franchisor can update Manual without agreement of the franchisee. However, if this is the case, the franchisor must not alter the list of Services in a way that could be unreasonable under UCTA. For further information, see Practice note, Supply contracts: overview (www.practicallaw.com/0-107-3646).

Start Date

It is important for the franchisor to know, having allocated a territory to the franchisee, that the franchisee is going to start trading (and therefore generating income for the franchisor) within an agreed time frame. This date may also be used as the date at which the term begins (see clause 3.1) and the date from which payment of the Management Fee and Advertising Levy are triggered (see clause 4.2).

System

Ensure that the definition of the System is adequate to cover all relevant and distinctive aspects of how the business is run. Details of the System should be contained in the Manual.

Territory

The Territory should be very specifically set out in Schedule 1, using a map if appropriate.

Trade Marks

Consider whether this definition should be extended to include trade marks which are registered by the franchisor, and which relate to the Business, during the term of the agreement.

Trade Name

Where the Trade Name is included as one of the trade marks (as is often the case), delete this definition and all uses of it in the agreement.



Interpretation

For discussion of clauses 1.2 - 1.16 and other interpretation provisions, see Standard clause, Interpretation (www.practicallaw.com/5-107-3795) and its accompanying drafting note (www.practicallaw.com/3-107-3796).

Rights granted: clause 2

Clause 2.1

This clause sets out the nature of the rights granted by the franchisor to the franchisee.

Not all franchise agreements will grant exclusive territories and, indeed, many franchisors are hostile to the grant of exclusive rights.

From the franchisor's point of view, the main advantage of granting an exclusive territory is that it will be easier to sell the franchise.

The main disadvantages for a franchisor are that:

It may cause commercial difficulties for the franchisor who subsequently finds that it has given too large a territory to its franchisee when its franchise proves a success, with the result that the franchisee's territory is not fully developed. (The Body Shop is an example of this. At the beginning of The Body Shop operation no one could predict its subsequent success and, accordingly, exclusive territories were granted for UK cities such as Glasgow, Edinburgh and Nottingham. Franchisees in these territories were only obliged to open one store, but the territories should have had three or four stores. As a result, The Body Shop bought back the territories for sums in excess of 1 million each.)

Terminating a franchise for poor performance may, in practice, be difficult and it may be simpler to put another franchisee into the territory of an under-performing franchisee.

From the franchisee's point of view, the main advantage of exclusivity is that it will be protected from competition from the franchisor and other franchisees. The main disadvantage will be that the franchisor may take a strict approach in enforcing performance criteria in order to ensure that a territory is being properly exploited.

If exclusivity is granted, care should be taken in establishing the territories to be granted. If, for instance, customers for a franchised business are likely to be obtained by way of telephone directories, the territories to be given should be linked to the area covered by the directory.

For more about the competition law implications of granting exclusive or non-exclusive rights, see Practice notes, Franchising: overview: EU competition law (www.practicallaw.com/2-107-3749) and Distributorships: overview: EU competition law and regulation (www.practicallaw.com/6-107-3648).

Clause 2.2

Trade mark licence

Although it is common for the parties not to enter into a separate trade mark licence, it may be preferable for them to do so.

From the franchisor's point of view, as long as the Manual has been carefully drafted to include all the obligations that would normally be contained in a trade mark licence, it can rely on licence terms being incorporated by inclusion in the



Manual. However, if this is to be the case, the Manual must deal with common obligations of trade mark licensees, such as not doing anything to damage the trade marks' reputation or value, notifying the franchisor of any infringements by third parties, and following quality control procedures. It is also very important that the franchisee is provided with a copy of the Manual, and with any revised versions. Even if a separate licence is used, it must incorporate the Manual as part of its terms, so as to be consistent with the main agreement.

If the franchisor has registered trade marks or registered service marks, it may be desirable to require a franchisee to enter into trade mark licences because this would ensure that the franchisee did not claim that the use of the trade marks by him gave him any rights to the trade mark.

There is no statutory requirement that trade mark licences must be registered, although a licensee will want to ensure that the transaction is recorded, since it will otherwise be ineffective against a third party acquiring a conflicting interest in the mark. Therefore, from the franchisee's point of view, filing a copy of the licence and registering it with the relevant trade marks registries ensures that the franchisor cannot sell the registered trade marks free of the licence.

In addition, if a licence is not registered within six months of the date of the transaction, the licensee has no right to its costs relating to any infringements occurring in the period from the date of the transaction to the date of registration of the licence. Registration provides licensees with a statutory right (in the absence of any contrary agreement) to bring infringement proceedings in default of an action by the registered proprietor (section 30(2),(3), Trade Marks Act 1994). For more information on registration of licences, see Clause 15.2 below, and see Practice note, Registration of interests in UK trade mark applications and registrations (www.practicallaw.com/6-201-3390).

Both an exclusive non-revocable licence for consideration and a non-exclusive licence are free from stamp duty.

See also Practice note, Franchising: overview: Trade mark licences (www.practicallaw.com/2-107-3749) and PLC IPIT & Communications, Practice note, Overview of Trade marks: Exploitation of trade marks (www.practicallaw.com/4-107-3668).

For a draft trade mark licence, see PLC IPIT & Communications, Standard document, Trade mark licence agreement (www.practicallaw.com/6-500-6579). This licence is not drafted specifically for franchisee use, but could be adapted.

Lease

In relation to the lease, see comments on clause 14 below.

Clause 2.3

Under this clause, the franchisor itself undertakes not to operate, or license anyone else to operate, the Business in the Territory.

When drafting a franchise or trade mark licence agreement, you must consider the likely effect of the arrangements on competition in the market for the relevant goods or services. A franchise agreement is a typical vertical agreement - that is, an agreement between parties at different levels in the economic supply chain. For information on competition law implications, see Legal issues and Negotiating and drafting issues. For further detail, see Practice note, Franchise: overview: EU competition law (www.practicallaw.com/2-107-3749) and Distributorships: overview: EU competition law and regulation (www.practicallaw.com/6-107-3648). If in doubt, seek specialist competition law advice before finalising the agreement.

Term: clause 3This clause sets out the duration of the franchise.



Clause 3.1

Most franchises are for an initial term of five years. The European Code of Ethics for Franchising requires that the duration of the agreement should be long enough to allow individual franchisees to amortise their initial investments specific to the franchise (a copy of the European Code of Ethics is available on the website of the British Franchise Association (www.practicallaw.com/2-335-0952)).

If the Premises are being leased from a third party landlord, consider whether the term should commence after the Lease has been executed and whether to include a requirement for the franchisor to approve the terms of a third party lease.

See also the rules on trading schemes (and the cooling off period for new franchisees joining trading schemes) - see Practice note, Franchising: overview: Trading schemes (www.practicallaw.com/2-107-3749).

Clause 3.2

The European Code of Ethics for Franchising (see above) requires the agreement to include the basis for any renewal of the agreement. The British Franchise Association Code of Ethical Conduct: Extension and Interpretation states that the basis for contract renewal should take into account:

The length of the original term.

The extent to which the contract empowers the franchisor to require investments from the franchises for relinquishment or renovation.

The extent to which the franchisor may vary the terms of a contract on renewal.

The overriding objective is to ensure that the franchisee has the opportunity to recover his franchise specific initial and subsequent investments and to exploit the franchised business for as long as the contract persists. When drafting this clause, consider whether the franchisee should have the right to renew an indefinite number of times or only once.

This clause includes a timetable for the service of notices and the right to renew is made conditional on:

Payment of a renewal fee.

There being no material breaches of the agreement by the franchisee or the individual.

There being no grounds on which the franchisor can terminate the agreement under clause 19.

The franchisee and individual having performed their obligations to the reasonable satisfaction of the franchisor. This condition allows the franchisor some discretion as to whether to renew or not.

Note that, provided that the conditions set out in clause 3.2(a) are fulfilled, the franchisor is effectively under an obligation to renew the agreement.

From the franchisee's perspective, he will want the right to renew the franchise at the end of the initial term and (if the franchisor will agree) that the renewal can be exercised without further payment. The right to renew should not be lost merely for minor breaches of the franchise agreement.



Clause 3.3

Renewal is effected either by the parties entering into the then current form of franchise agreement, or (more rarely) a simple confirmation in writing. Using the former method allows the franchisor to bring all franchisees into line if there have been changes to the franchise agreements which it uses during the lifetime of the franchise business. This clause is drafted, however, to ensure that the franchisee does not have to pay an initial fee, or fulfil its initial obligations, for a second time. This clause should be considered carefully to see whether it is likely that these obligations should be included or excluded.

Consider also whether the renewal provisions should be included in the renewed term. If they are, then the franchise agreement could be renewed perpetually (assuming all other conditions are met). If this is not the intention, amend clause 3.3(c) by deleting the word "not" which is in square brackets.

Consider adding provisions so that:

Refresher training must be completed by the franchisee and its employees.

The franchisee must pay the legal costs of the franchisor.

The franchisee must refurbish the Premises (although, if this is to be included, note that, under the Lease, the landlord's consent (if it is a third party) is likely to be required).

The franchisee must give up any claims which it may have against the franchisor.

Clause 3.5

This clause states that the agreement will terminate at the end of the Term. At this point, the provisions of clause 21 (consequences of termination) will take effect.

Clause 3.6

This clause addresses what will happen if the parties allow the agreement to run on after the end of the Term, without having gone through the formal process of renewal. Consider whether the subsequent right to terminate the agreement should be exercisable by all of the parties or just the franchisee and the franchisor, and whether the notice periods should be different for each of them.

Fees: clause 4

Clause 4.1

There are two guiding principles concerning the initial fee, which will vary depending on the type of franchise:

It should not contain a profit element for the franchisor. It is aimed only at reimbursing the franchisor's costs in setting up and expanding the franchise. If franchisors were to make a profit (or a significant profit) on the initial fee, the emphasis of their business would be selling franchises rather than ensuring that franchises are profitable.

The "thin air" element, being that part of the Initial Fee which does not relate to the supply of equipment, stock, training or promotional assistance, should not exceed 10% of the total investment which the franchisee will have to make. Ultimately, the amount which can be charged by way of an initial fee will depend on the reputation of the



franchisor, the profitability of his franchise, the term granted, whether it contains an exclusive area, and so on. The average amount is 5% to 10% for a successful franchise.

Consider whether the franchisee should also pay the franchisor's legal fees as a part of, or in addition to, the initial fee. This may help discourage the franchisee from attempting to renegotiate the franchise agreement.

It may be preferable to stagger payment of the initial fee if it is a large amount.

Clause 4.2

This clause sets out the mechanics of the payment of fees under the agreement.

The Management Fee and the Advertising Levy are calculated as a percentage of the franchisee's takings or, more usually, receivables. As both of these are based on a percentage of the Gross Monthly Receipts, it will be important to ensure that they are payable from an appropriate date.

The Management Fee is usually set at around 8%. It reimburses the franchisor for the cost of providing the continuing backup to the franchisee and provides the franchisor with its profit. If, however, a franchisor is supplying products to a franchisee at a profit, the franchisor will not usually charge a full management fee. In such a case, the franchisor's mark-up on products supplied may already contain the franchisor's profit element. If the franchisee is required to purchase products from the franchisor, this may have competition law consequences. See Practice notes, Franchising: overview (www.practicallaw.com/2-107-3749) and PLC Competition, Practice note, Transactions and practices: EU vertical agreements (www.practicallaw.com/9-107-3703) for further information.

The Advertising Levy is usually set at around 2.5% of gross monthly receipts.

Ideally, from the franchisor's point of view, the Management Fee should be paid weekly or monthly, since this will improve the franchisor's cash flow and enable the franchisor to establish a franchisee's ability to pay the fees at an early stage.

Note that time is not of the essence for payment of sums, but that non-payment, after being notified in writing to make such payment, is a ground for termination under clause 20.

Clause 4.5

Include this clause if determination of the Gross Monthly Receipts is likely to lead to dispute. Check the time periods inserted into this clause to ensure that the timing of payments works.

Franchisor's initial obligations: clause 5The purpose of the franchisor's initial obligations is to put the franchisee (who probably has no knowledge of the business to be franchised) in a position to operate the franchised business. Note that additional obligations relating to training are set out in clause 9, to advertising are set out in clause 11, and to the premises are set out in clause 14.

Clause 5(a) and (b) - Premises

Clause 5(a) should only be included if the parties are not entering into a lease of premises between them. Where this is the case, check:



Whether the start date is appropriate, or whether the term should only start once a lease for the Premises has been executed.

The input needed by the franchisee (which may vary), from the selection and refurbishment of existing premises to the construction and fitting out of new premises.

Check the timing of this clause to ensure that it will work where the Premises have not been identified by the time the franchise agreement is entered into.

Clause 5(d) supply of equipment and products

The equipment supplied could include vehicles, machinery, furniture, signage, stationery, IT equipment and software. Each type of equipment should be considered separately to ensure that any specific provisions relating to it are included.

On what basis will the equipment be supplied by the franchisor? Who owns it? If the franchisor is to retain title to it, then the reference to the equipment should be put into a separate clause which should state the terms on which is it loaned and require the franchisor's interest to be noted on any insurance policy.

Where title to the equipment and other products is to pass, incorporate the franchisor's standard terms of sale, either by reference or by setting them out in a schedule, and consider whether payment for them should be included in the Initial Fee.

Clause 5(e) - public relations launch of the franchisee's business

Details of the PR launch should be set out in the Manual or, preferably, in a schedule to the agreement. Consider whether the cost of this will be covered by the Initial Fee, or whether the franchisor will want to allow for any additional costs to be reimbursed by the franchisee.

Clause 5(f) - the provision of the franchisor's operations manual

Note that the provision of the Manual is expressed to be on loan, in order to emphasise that the franchisee does not own the Manual or the intellectual property in it.

Clause 5(g) - local advertising

The parties can agree and insert into this clause the minimum requirements for local advertising, which may specify, for example, a sum to be spent or the number and type of advertisements to be placed.

Clause 5(h) - provision of the financial package

If a Financial Package is being supplied, check the licensing terms applicable to this and whether the training should cover its use.



Franchisor's continuing obligations: clause 6It is advisable to set out in detail the obligations accepted by the franchisor. Franchisees will find it unacceptable to enter into an agreement where the obligations which they will have to accept are extensive, but are limited in respect of the franchisor. If the obligations are too vague, the agreement may fall foul of the European Code of Ethics.

Note that additional obligations relating to training are set out in clause 9, to advertising are set out in clause 11, and to the premises are set out in clause 14.

Clause 6(b)

This clause requires the franchisor to update the Manual and the System from time to time. The aim is to ensure that it tracks changes in the relevant market and in the legislation affecting it. In exercising its rights and obligations under this clause, the franchisor should be cautious and should not act to the detriment of the franchisee.

Clause 6(c)

This clause requires the franchisor to supply the Products on its standard terms and conditions in effect at the time of the placing of the order for those products.

Ensure that these terms and conditions actually exist and, if not, include (preferably in a schedule) the relevant terms of supply (including terms as to the limitation of liability and exclusion of statutory warranties). (See Standard document, Terms and conditions for the supply of goods (pro-supplier) (www.practicallaw.com/9-100-9608).)

If the franchisor does have standard terms of supply, ensure that these are available to the franchisee (perhaps in the Manual) and that all updated versions are made available to the franchisee in a timely manner.

Consider whether the franchisee is to be restricted in the products it can use in the Franchisee's Business. If it is to be restricted to products supplied by the franchisor or specific suppliers, this may have competition law implications.

Note that the vertical agreements block exemption only permits such ties as are necessary if, owing to the nature of the goods, it is not practical to apply objective quality specifications and to protect the franchisor's intellectual property.

If the vertical agreements block exemption is not available, then this sort of provision will need to be assessed in the light of Article 101(1) of the Treaty on the Functioning of the European Union (TFEU) (formerly Article 81(1) of the EC Treaty). It will usually fall outside Article 101(1) if the obligations imposed are necessary to maintain the common identity and reputation of the franchised network, or there is a transfer of substantial know-how. Practitioners should note that the definition of "substantial" in relation to know-how in the vertical agreements block exemption now refers to know-how that is "significant and useful" (Article 1(1)(g), Regulation 330/2010), which represents a lower threshold than that of the previous vertical agreements block exemption (in which "substantial" know-how referred to "information that is indispensable"). This is a useful change for franchisors.

For further information, see Practice notes, Franchising: overview: EU competition law (www.practicallaw.com/2-107-3749) and Distributorships: overview: EU competition law and regulation (www.practicallaw.com/6-107-3648).

Depending on the type of franchise, the franchisor may have to allow the franchisee credit on buying Products, up to an agreed credit limit. If so, include a definition of "credit limit" (which should cover both financial and time limits). However, franchisors should use these limits with caution as indiscriminate use could give rise to a claim for equitable relief if it is shown that the franchisor is withholding supplies from the franchisee, particularly if the



franchisee could not source the supplies from elsewhere (see Sky Petroleum Ltd v VIP Petroleum Ltd [1974] 1 All ER 954).

Clause 6(d)

This clause requires the franchisor to assist the franchisee in procuring such goods and services (other than the Products) as are necessary for the purposes of the Franchisee's Business. If this clause is included, take care that the definition of Products is drafted so that it only includes products supplied by the franchisor. Adapt the wording of the clause to reflect the agreement between the parties as to the type and extent of help offered.

Consider also whether to include additional obligations on the franchisor relating to:

Consultation.

Creation and promotion of credit card schemes (and, if so, allow for appropriate deductions to be made in the turnover calculations).

Staff selection assistance.

Provision of standard contracts.

Continuation of research and development.

Equal treatment of franchisees.

Franchisee's obligations: clause 7In order to maintain the uniform quality of the franchise network and to protect the franchisor's brands, detailed operating restrictions and obligations are imposed on franchisees in franchise agreements and, in relation to day-to-day trading, in the franchisor's operations manual. Obligations and restrictions are imposed on all franchisees for the protection and benefit of franchisees generally, because a franchisee who does not comply with the franchisor's system may have a detrimental effect on the entire franchise network.

This clause sets out the franchisee's obligations in relation to operating the Franchise's Business. Its obligations in relation to employees, training, the Premises and so on are set out in separate clauses.

Legal issues

When drafting these provisions, you must consider carefully the provisions of the vertical agreements block exemption. As drafted, the clause does not comply with the vertical agreements block exemption (see Negotiating and drafting issues). Therefore, where a large organisation (or an organisation conducting its business in a very narrow product market) wishes to franchise, it should consider amending this clause by altering or omitting some sub-clauses, including clauses 7(g), (h), (i), (k), and (n). Practitioners should seek specialist competition advice. For information, see Practice note, Franchise: overview: EU competition law (www.practicallaw.com/2-107-3749) and Distributorships: overview: EU competition law and regulation (www.practicallaw.com/6-107-3648).

The requirement for the franchisee to be registered for VAT must take effect before the start date because nearly all franchise agreements now fall within the scope of the Trading Schemes Act 1996 (which deals with pyramid selling) and must comply with the trading scheme legislation, unless they fall within one of two exclusions:



Single-tier trading schemes under which all UK participants or franchisees operate at a single level except for the franchisor.

Where all the franchisees in the network are registered for VAT (regulation 3(a) and (b), Trading Schemes (Exclusion) Regulations 1997 (SI 1997/31)).

If a franchise agreement falls within the scope of the Trading Schemes Act 1996, a franchisor's freedom of action will be substantially restricted. For further information, see Practice note, Franchising: overview (www.practicallaw.com/2-107-3749).


Clause 7(a) should be considered in the light of MMP GmbH v Antal International Network Ltd [2011] EWHC 1120 (www.practicallaw.com/3-506-0855), where the High Court held that, on a true construction of the clause in question, the franchisor was required to produce evidence of actual damage to its brand caused by the conduct attributable to the franchisee, which it could not. The franchisor's fear or concern of damage to the brand was insufficient. The wording of Clause 7(a) protects the franchisor in this situation, as it includes sufficient flexibility, referring to acts that "could or might" affect the brand, and there is also optional wording which is more in favour of the franchisor. However, a franchisee might request that the words "sole opinion of the franchisor" be replaced by "reasonable opinion of the franchisor".

Clause 7(b) is intended to ensure that the franchisee does not slacken its efforts in relation to the Franchisee's Business. This will be particularly important where the franchisee has an exclusive territory. The clause could be expanded to refer to specifics - for example, requiring the franchisee to offer a minimum range of goods or services.

Clause 7(c) contains a broad obligation on the franchisee to comply with relevant legislation relating to the Premises. This could cover, for example, legislation in relation to planning. The Lease itself is likely to have a detailed clause specifying legislation, where appropriate, as well has containing the general obligation.

Clause 7(g) may take the agreement outside the vertical agreements block exemption where the agreement is not one of minor importance. For further information, see Practice note, Franchising: overview: EU competition law (www.practicallaw.com/2-107-3749) and comments on clause 6(c).

Clause 7(h) is included so that the franchisor can protect the integrity of the franchise network, but may take the agreement outside the vertical agreements block exemption. See Practice note, Franchising: overview: EU competition law: Hardcore restrictions (www.practicallaw.com/2-107-3749).

Clause 7(i) is included so that all franchisees are supplying the products and services to third parties on the same terms.

Clause 7(q) could be used by the franchisor to obtain records of sales as well as other business information, such as customer (and potential customer) lists. Consider specifying the information that is required in the agreement, if it is not included in the Manual.

Clauses 7(t) to (v) allow the franchisor to ensure that anyone dealing with the franchisee knows that the franchisee is a separate entity from the franchisor and to protect its intellectual property.

Clause 7(v) is included to ensure that customers of the franchisee are made aware that they are dealing with a franchisee under licence from the franchisor.

Consider also whether to include additional provisions relating to trading - for example:

Compliance with any credit card scheme that the parties agree should be set up.



Undertaking not to pledge the credit of the franchisor.

Compliance with the franchisor's complaints procedures.

Whether the franchisor be permitted to sell via a website (if it is to have a website, ensure that this is in accordance with the franchisor's requirements). Note that a prohibition on passive sales (www.practicallaw.com/4-107-6978) will take the agreement outside the vertical agreements block exemption. Passive sales generally include internet sales, however the new vertical restraints guidelines now contain guidance on the extent to which restrictions on the sale of products or services over the internet may fall within the scope of the vertical agreements block exemption. See Practice note, Franchising: overview: EU competition law: Hardcore restrictions (www.practicallaw.com/2-107-3749).

Whether any requirements as to the use and updating of software should be included. This will depend on whether the franchisor requires the franchisee to enter into a separate software licence for the Financial Package and any other software.

Whether the franchisee will be required to update old equipment as the franchisor thinks fit?

An obligation to consult with the franchisor as to pricing and not to charge more than a maximum amount. A franchisor may impose maximum resale prices or recommend resale prices, provided neither of these equate to a fixed or minimum sale price. Any form of price fixing or resale price maintenance will take the agreement outside the vertical agreements block exemption and will constitute an infringement of Article 101(1) of the TFEU (See Practice note, Franchising: overview: EU competition law: Hardcore restrictions (www.practicallaw.com/2-107-3749).)

The extent to which the franchisee should be free to sell the products and services which it produces as part of the franchisee's business to third parties will there be any restrictions on selling to third parties, for example, by limiting sales to end users or other franchisees of the franchisor? If it is intended to include this sort of provision, consider the competition law implications. See Practice note, Franchising: overview: EU competition law (www.practicallaw.com/2-107-3749).

Will the franchisee be obliged to pay the franchisor a commission on any sales that it makes as a result of a lead given to it by the franchisor?

Vehicles: if the franchise business is such that vehicles are required, consider including obligations relating to vehicle maintenance, licensing and tax and as to the driving standards of the relevant employees.

Employees: clause 8These obligations are stated to relate to the franchisee's employees, but this should be expanded to cover agents, consultants and sub-contractors if appropriate.

Training: clause 9



Clause 9.1

It is desirable to set out the franchisor's training obligations in some detail. The initial training is usually provided free of charge, but further training during the term of the franchise is usually provided subject to the reimbursement of the franchisor's standard charge. Details of the initial training programme, including the number of people to be trained, the length and location of the training, the cost to the franchisee and payment terms (if any) should be set out, either in this clause, in a schedule to the agreement or in the manual.

If a franchisee "fails" the initial training, the franchisor usually reserves the right to terminate the agreement and return to the franchisee payments which have been made, less all expenses incurred by the franchisor, although sometimes the individuals are given the right to appoint a manager to undergo training in these circumstances (see clause 20.1(c)).

Clause 9.2

This clause sets out the franchisee's obligations with regard to training.

Consider including specific requirements as to assessment of individuals and reporting to the franchisor any problems that arise after, or in connection with, training.

Should the franchisor be entitled to call staff in for training on new developments or changes to the System?

Consider whether the franchisor should be obliged to give training in any improvements to the System which it requires the franchisee to introduce.

Anti-bribery compliance: clause 10Under section 7 of the BA 2010, a commercial organisation (which includes a company or partnership) commits an offence if a person associated with it bribes another person, intending to obtain or retain business or a business advantage for the organisation. A person (A) is associated with a relevant commercial organisation (C) if A is a person who performs services for or on behalf of C (section 8, BA 2010).

Section 7 is a strict liability offence. The only defence available to the commercial organisation is if it can show it had in place "adequate procedures" to prevent associated persons bribing others. The BA 2010 does not set out prescriptive adequate procedures, but the Ministry of Justice has published guidance to assist a commercial organisation putting in place procedures to prevent persons associated with it from bribery (Guidance).

In the context of a franchise arrangement, in most cases it is unlikely that the risk of a section 7 offence arises because:

A franchisee is unlikely to fall within the definition of "associated person", since the franchisee does not (as such) supply services back to the franchisor under the franchise agreement. It simply carries on its own business and pays various fees to the franchisor. In other words, a franchisee performs services for itself, not for the franchisor.

If a franchisee bribes someone (for example, a municipal official in order to obtain planning permission for the franchise premises), the franchisee could not be considered to have the intent necessary for a section 7 offence because its intention would be to obtain or retain business or a business advantage for itself, not for the franchisor.

However, there are two situations where there is a risk of the section 7 offence:



If the franchisor operates a national account work system, so that the franchisee obtains work from the franchisor.

If contracts are entered into directly between a franchisor and its franchisees customers in respect of which the franchisee performs services as the franchisors agent.

Despite what appears to be a low risk of exposure, it is prudent to include an anti-bribery clause in a franchise agreement. This is partly because the wording of sections 7 and 8 is far from clear, and the inclusion of an anti-bribery clause will reduce the risk of exposure arising out of an unexpected future interpretation. In addition, as noted above, some types of franchise agreement may incorporate other legal structures which might provide the context for section 7 exposure, and it is difficult to predict all the situations in which a franchisee might be considered to be acting as agent for or supplying services to the franchisor.

In any event, many franchisors will wish to include an anti-bribery clause for ethical reasons even though the circumstances in which the clause might be legally relevant appear to be limited.

For information on the BA 2010, see Bribery Act 2010: Toolkit. (www.practicallaw.com/9-503-9451)

Clause 10.1(b): outside the UK

If the franchisee (or any of its associated persons) has no "close connection" with the UK and commits bribery outside the UK, then its activities are not caught by the BA 2010, although any such bribery on behalf of the franchisor might result in liability for the franchisor under section 7 of the BA 2010. See Practice note, Bribery Act 2010: Territorial application (www.practicallaw.com/5-500-8692) (section 12) for further information on the territorial scope of the BA 2010 and the meaning of "close connection".

This clause ensures that a non-UK distributor is contractually bound to avoid bribery as defined in the BA 2010, even though the BA 2010 may not be applicable to it. Clause 10.1(a) combined with this clause obliges the distributor to ensure that its non-UK associated persons similarly avoid bribery as per the BA 2010.

If the franchisee is UK based and will not delegate, appoint sub-franchisees or subcontract outside the UK then this clause and the cross reference to it in clause 10.1(d) may be omitted.

Clause 10.1(c): relevant policies

This clause refers to the franchisor's policies, which should be annexed at schedule 9. For advice on creating an anti-corruption policy, see Practice note, Anti-corruption policies (www.practicallaw.com/9-502-3153). In addition, there may also be industry codes that the franchisee should comply with.

The franchisee may have its own anti-corruption policies which conflict with or differ from those of the franchisor. In this case, the franchisor may need to review the franchisee's policies to assess whether they are adequate.

If acting for the franchisee, consider whether the franchisor should bear some of the costs incurred by the franchisee in complying with changes to the franchisor's policies and whether the franchisee should have the right not to comply with changes to the franchisor's policies which it has not approved. If acting for the franchisor, note that this is an issue that is likely to be raised by a well-advised franchisee.

Clause 10.1(d): adequate procedures

The term "adequate procedures" is defined in clause 10.4 by reference to the BA 2010.



Clause 10.1(e): reporting bribes

This clause could be omitted if such an obligation is already contained within either the franchisor's Ethics and Anti-Bribery Policy which the franchisee has committed to in clause 10.1(c) or the franchisee's own such policies, as referred to in clause 10.1(d).

Clause 10.1(f): foreign public officials

Section 6(1) of the BA 2010 creates the offence of bribing a foreign public official. A person is guilty of the offence if his intention is to influence the official in the official's capacity as a foreign public official. A foreign public official is defined in sections 6(5) and 6(6) of the BA 2010 (and for the purpose of this clause is defined in clause 10.4 by reference to such sections). Foreign public officials include, among others, government officials and those working for international organisations. The offence does not cover accepting bribes, only offering, promising or giving bribes. For further information on the offence see Practice note, Bribery Act 2010: Bribery of foreign public officials (www.practicallaw.com/5-500-8692) (section 6).

There is no express restriction in the BA 2010 on employing a public official, or on the ownership of a direct or indirect interest in a company by a public official. The purpose of the notification requirement and the warranty is to flag the issue and elicit information about any relevant foreign public officials. If the franchisee notifies the franchisor of a relevant foreign public official then the franchisor should ascertain the identity of the relevant person and their role within the franchisee, in order to assess the risk of an offence being committed.

However, ideally, enquiries about any relevant public officials should form part of the due diligence conducted by the franchisor on the franchisee, and should also be included as part of any due diligence questionnaire. Contractual warranties are no substitute for proper investigation into a prospective partner.

This clause will not be appropriate if the franchisee is an individual.

Clause 10.1(g): monitoring and review

According to the Ministry of Justice Guidance, organisations should have appropriate monitoring and review mechanisms in place (Principle 6: Monitoring and Review, Guidance). Effective monitoring will, in turn, depend on effective record keeping; for suggesting record keeping clauses, see Standard clause: Anti-bribery clause (long form) (www.practicallaw.com/5-504-3582).

This clause 10 does not include audit rights for the principal; it only requires the franchisee to certify its compliance and provide supporting evidence of compliance on request. For appropriate drafting for a principal to reserve audit rights, seeStandard clause: Anti-bribery clause (long form (www.practicallaw.com/5-504-3582).

Clause 10.2: supply chain

On a strict construction of the definition of associated person, the franchisee's own associated persons (essentially its own franchisees, subcontractors and franchisors) may also be associated persons of the franchisor, with the result that bribery by such persons might result in liability for the principal, unless the principal can demonstrate that it has put adequate procedures in place to prevent such bribery.

As such, where the arrangement includes a supply chain, a franchisor will need to consider how best to mitigate itself from this risk. This clause requires the franchisee to extend the anti-bribery compliance obligations to its own agents and subcontractors, where such persons are performing services in connection with this agreement. This reflects the approach suggested in the Guidance. According to the Guidance:



Where a supply chain involves several entities, or a project is to be performed by a prime contractor with a series of subcontractors, a commercial organisation is only likely to exercise control over its relationship with its contractual counterparty. Indeed, the organisation may only know the identity of its contractual counterparty, and not of those further down the supply chain.

In this situation, it is likely that persons who contract with that counterparty will be performing services for the counterparty and not for other persons in the contractual chain (that is, the ultimate customer), suggesting that a franchisor will not be liable for bribery committed by its franchisee's subcontactors.

The Guidance recommends that the principal way in which commercial organisations may approach bribery risks which arise as a result of a supply chain is by employing the anti-bribery procedures proposed in the Guidance, for example, risk-based due diligence and the use of anti-bribery terms and conditions, in its relationship with its contractual counterparty and requesting that the counterparty adopt a similar approach with the next person in the chain.

In certain circumstances, it may be appropriate to include additional safeguards, for example in high profile transactions in high risk jurisdictions or sectors, or where the principal has itself selected the subcontractors and the franchisee is merely acting as the prime contractor for logistical reasons. In such cases, the principal may wish to implement additional safeguards, see Standard clause: Anti-bribery clause (long form) (www.practicallaw.com/5-504-3582) for more prescriptive supply chain clauses.

Clause 10.4: definitions

For more information on the significance of adequate procedures and associated persons see Legal Background in Anti-Bribery Clause (short form) drafting note. (www.practicallaw.com/9-505-7906).

Accounting records: clause 11This clause details the accounting records the franchisee must keep in respect of the franchise.

The franchisor will usually impose strict provisions concerning accounting and financial information to be maintained and provided by the franchisee where the franchise fee is calculated on the franchisee's turnover.

VAT returns are usually required to be provided because they enable the franchisor to check the financial information provided by the franchisee.

Check that the Manual sets out the form that reports are to take. Consider:

Specifying additional financial information that the franchisee should send, as it can be helpful to have a number of types of report and information so that the franchisor can cross-check the figures that the franchisee sends, for example:

weekly sales figures;

in retail outlets, the provision of till rolls;

profit and loss accounts on a four-weekly basis.

Including requirements for stocktakes.



Including requirements to accept unsupervised accounting and stock control systems as and when introduced by the franchisor.

Requiring the franchisee's financial year end to be the same as the franchisor's. (This may cause difficulties for the franchisor, who may need to vet all his franchisees' accounts in a short space of time.)

Requiring the franchisee to allow the franchisor's accountants to carry out audits and checks on reasonable notice. Some agreements provide for the cost of the audit to be reimbursed by the franchisee if a discrepancy between the audited information and that supplied to the franchisor is discovered.

Requiring the franchisee to appoint a firm nominated by the franchisor as auditors (bearing in mind any potential conflict of interest that firm may have, if appointed on that basis).

Advertising: clause 12

Clause 12.1

Clause 12 sets out the franchisor's obligations relating to advertising the Trade Name and Business nationally and how the Advertising Levy is to be handled. The clause leaves a significant amount of discretion to the franchisor and does not set a minimum amount that must be spent on advertising. This will allow the franchisor to concentrate advertising in one area at a time or to mount a national campaign, as appropriate. Consider specifying that the advertising should take place in newspapers, television or radio and whether the franchisee should be consulted before an advertising campaign is started. The franchisor is not allowed to use the Advertising Levy for any other purpose.

Clause 12.2

A franchisee will be required to undertake advertising strictly in accordance with the franchisor's instructions. A franchisor will wish to ensure that franchisees do not use unauthorised advertisements that could bring the franchisor's brand into disrepute, or be inconsistent with other advertising undertaken by the franchisor.

Consider adding provisions to cover an obligation on the franchisee to withdraw any advertising, product or packaging to which the franchisor has objected.

If there are any specific actions, such as mounting displays, distributing promotional material, mail shots and so on, that are likely to be required, they could be included here.

Telephone numbers: clause 13For many franchisors, controlling the franchisee's telephone numbers will be very important. This clause gives the franchisor control of the numbers, but requires the franchisee to reimburse the franchisor for all costs involved. Consider whether to require the franchisee to enter into a direct debit or standing order to meet these costs.

If the use of telephones is an important part of the franchised business because, for instance, the business is advertised through the Yellow Pages or similar directory service, consideration should be given to the franchisor subscribing to the telephone number and being reimbursed telephone charges by the franchisee; alternatively, the franchisor could obtain from the franchisee an undated but signed instruction to transfer the franchisee's telephone numbers to the franchisor, who would only use the instruction on termination of the franchise agreement.



Insurance: clause 14The franchisee will be expected to take out insurance as specified by the franchisor, covering, in particular, liability for employees and to third parties, damage to property and loss of profits. The franchisor should ensure that its franchisees are adequately insured because, as they will be trading under the franchisor's name and it may not always be clear to the franchisee's customers that the franchisee and the franchisor are independent legal entities. The franchisee's customers may seek to argue that they were, in fact, dealing with the franchisor (who is likely to be more substantial than the franchisee) and not the franchisee, but if the franchisee is insured and can meet all claims from customers, they will not find it necessary to pursue the franchisor. In order to ensure that the franchisee has adequate cover, the franchisor should consider having its interest noted on the policies and requiring the franchisee to supply copies of all policies to the franchisor.

Ensure that the insurance provisions in the franchise agreement tie in with the insurance provisions in the Lease.

Premises: clause 15This clause sets out the arrangements for the Premises.

Note that as the Lease is currently defined, the franchisor is the landlord and that the Lease will be entered into on the same date that the franchise agreement is signed.

If this is not the case, then it may be necessary to include provisions relating to:

The search and selection of premises or a site for the construction of premises.

The fitting out of premises.

Legal issues

Property

Under Part II of the Landlord and Tenant Act 1954 (LTA 1954), a tenant occupying premises for the purpose of its business generally has a right to renew its tenancy at the end of the term. The landlord can only oppose renewal on certain, limited grounds. The Regulatory Reform (Business Tenancies) (England and Wales) Order 2003 (SI 2003/3096) enables a landlord and tenant who are intending to enter into a tenancy for a certain term to agree that sections 24-28 of the LTA 1954 (which relate to continuation) will be excluded from the tenancy by following one of two procedures:

Advance notice procedure.

Statutory declaration procedure.

If one of these procedures is followed, the agreement will be valid and effective.

Where the franchisor and franchisee are to enter into a lease, one of these procedures should be adopted and the appropriate clause inserted. Note that both procedures require a notice period. In the case of the advance notice procedure, the tenant should have sufficient time to ensure that it appreciates that it will be abandoning its renewal rights by entering into an agreement to surrender. The prescribed form of warning notice encourages the tenant to take at least 14 days to consider. Under the statutory declaration procedure, if the tenant gets less than 14 days notice before it enters into the agreement to surrender, it cannot make a simple declaration, but has to make a statutory declaration instead.



For this reason, the standard document states that the lease must be entered into 15 days after the date of the franchise agreement (see clause 2.2). If the Lease is not executed by then, this will be a material breach allowing the franchisor to terminate (see clause 21.2).

For further information, see PLC Property, Practice note, Business tenancies new procedures for excluding security of tenure (www.practicallaw.com/8-107-4901).

CRC Efficiency Scheme

See discussion at clause 16.


In some franchises (for example, retail outlets and restaurants), the premises will be extremely important. If this is the case, the franchisor will want to have a right to require them to be maintained and even decorated in a specific manner and to a specific standard. It may also reserve the right to inspect the premises to ensure that these standards are being maintained.

The practicality of the provisions set out in clause 15.(a), (b), (e), (f) and (g), and whether the franchisee can give these undertakings, should be carefully considered where the franchisee is to enter into an arm's length lease with a third party landlord, as they may conflict with the terms of a standard, open market commercial lease.

Consider whether a requirement to insure the Premises should be specifically included here (bearing in mind the terms of the Lease, particularly where it is with a third party).

Clause 15.(e) requires the franchisee to display a sign at the Premises and may need to be made subject to relevant by-laws or planning consents (as well as the lease).

CRC Energy Efficiency Scheme: clause 16This clause deals with the franchisee's obligations under the franchising rules of the CRC, where it applies. Broadly, in certain circumstances, a franchisor may be responsible for the energy supplies of its franchisees, and required to participate in the CRC together with its relevant franchisees. The CRC treats franchisors and franchises in a similar way to a corporate group, with the franchisor as the "parent undertaking" being required to comply and take responsibility for the energy supplies to its franchisees.

The CRC rules are complex and must be considered for any franchise arrangement. Broadly, a franchise agreement subject to the CRC exists where four elements are met:

There is an agreement (whether or not in writing) between two separate undertakings for the sale or distribution of goods, or the provision of services.

The franchisee carries out business using the name provided by the franchisor.

The premises where the franchisee carries out the franchise business are used exclusively for that business.

The presentation of those premises must have an internal or external appearance agreed by the franchisor and it must be similar to that of other premises operating a franchise business under an agreement with the franchisor.

Franchises which meet all four of these rules are required to participate in the CRC. There are however certain exemptions and exclusions, which are not discussed in this drafting note. For detailed discussion, see Practice note, Franchising: overview, CRC Energy Efficiency Scheme (www.practicallaw.com/2-107-3749).



As currently drafted, the definition of Lease assumes the franchisor is the landlord. However, this standard is silent about which party is responsible for energy supplies with energy providers. This is a matter to be clarified during negotiations.

Where the franchisee is a tenant, and its landlord (who is not the franchisor) is responsible for procuring the franchisee's energy supplies on the franchisee's behalf, the landlord will be responsible for the franchisees energy supplies under the CRC (and its rules regarding landlords and tenants), not the franchisor. The same will apply if the franchisee is a licensee and its licensor procures its energy supplies.

This clause 16 should be included if the franchisee is responsible for its own energy supplies (see clause 16.6).

Note that the term CRC Franchising Rules is defined to mean the specific rules applying to franchises under the CRC Order.

See further information about the interaction of the franchising rules and the landlord and tenant rules, see CRC Energy Efficiency Scheme: impact on corporate structures: Interaction of the Franchise rule with other rules of the CRC (www.practicallaw.com/7-500-5975).

Clause 16 is adopted from Standard clause, Franchise agreement: CRC Energy Efficiency Scheme (www.practicallaw.com/4-502-8092), which includes detailed drafting notes and discussion on the CRC as it applies to franchises.

Clause 16.1

Clause 16.1(a) should only be used if the franchise agreement (under the CRC) is a renewal of an existing franchise agreement with a party who was already a franchisee on the qualification day of the introductory phase (that is, 31 December 2008). If the franchise agreement did not exist on that date, do not include this clause.

For more information about the phases and the qualification years for each phase referred to in clause 16.1(b), see the CRC Energy Efficiency Scheme: PLC timeline (www.practicallaw.com/5-500-7843).

Clause 16.2

Clause 16.2(a) requires energy supply information to be provided by the franchisee, irrespective of whether the franchisor has made a request. A franchisor should avoid having to request the information, as the disadvantage of this approach is that if the franchisor neglects to ask for the information, for any reason, the franchisee will not be in breach of the clause. Note that the franchisor must inform the franchisee if it is required to participate in the CRC.

You should ensure that the date in brackets in the first option allows sufficient time for the franchisor to comply with its own obligation to produce its footprint reports and annual report by the end of July of the relevant year.

In relation to clause 16.2(b), under article 66 of the CRC Order, the franchisee must provide the franchisor with information and assistance for it to comply with its own obligations under the CRC, but does not set a time frame by when such information or assistance should be provided by the franchisee. Franchisors may wish to specify a time for franchisees to respond to their requests.

Clause 16.3(b)

Where a franchise agreement (under the CRC) exists on the qualification day of a phase (that is the last day of the qualification year) the franchisor will need to include information about the electricity supplies to the relevant franchisee



when assessing if it is required to participate in that phase of the CRC so it will need to have information about the electricity supplies to the franchisee for the entire year (paragraph 11 of Schedule 1 to the CRC Order).

Clause 16.5

As the party responsible for the franchisee's energy supplies under the CRC, the franchisor will be subject to any enforcement action taken by the administrator of the CRC (that is, the relevant regulator) if the information provided by the franchisee is inaccurate (or not provided at all), so it will want to ensure that the franchisee is contractually required to ensure that the information provided is accurate.

From the franchisee's perspective, it does not want this obligation to be too onerous as it may be relying on information that it has received from its energy suppliers. A franchisee may prefer to amend this clause to make it a warranty "to the best of its knowledge" or a lesser standard, such as "all reasonable endeavours".

Clause 16.6

As discussed above, the specific franchising rules in the CRC do not apply where the franchisee is a tenant and his landlord procures all of the franchisee's energy supplies. In such cases, the CRC rules regarding landlords and tenants will apply. If the franchise premises change and the new premises are leased where the landlord (who is not the franchisor) procures the energy supplies to those premises on the franchisee's behalf, those supplies will be the responsibility of the franchisee's landlord under the CRC so the franchisor would cease to be responsible for those supplies under the CRC and would want to be informed of that so it could reflect this change in its next annual report.

Clause 16.7

As the participant in the CRC, the franchisor may be subject to audits from the administrator, and is required to keep:

All the records required to be kept by Part 7 of the CRC Order for seven years after the end of the phase to which they relate; and

Its records regarding its first footprint report and annual report and its position in the first league table for the first year of the CRC that the franchisor is a participant for as long as it participates in the CRC.

A franchisee may want to conduct meter readings to verify the information provided by the franchisee, and will need access to meters in order to do so.

Clause 16.8

The franchisor will want to recoup any penalties or fines imposed upon it due to a franchisee's failure to provide information, or as a result of it providing inaccurate information to the franchisor.

The administrator can take enforcement action against a franchisee itself (although it is not a participant in the CRC), where the franchisee has failed to provide information to the franchisor:

If a franchisor has tried to obtain the information it needs to comply with the CRC from its franchisee, but the franchisee has not co-operated, the administrator has the power to serve an enforcement notice on the franchisee and require it to provide the data to the franchisor.



If the franchisee does not comply with the enforcement notice, the administrator can provide the franchisor with the assistance or information that was required and recover the costs from the franchisee.

The administrator may waive the penalty that the franchisor faces for its non-compliance if it is satisfied that the franchisor has taken all reasonable steps to comply with the CRC Order.

Clause 16.9

Franchisors and franchisees are free to enter into whatever commercial arrangements they think are most appropriate for them in relation to the CRC. The franchisor can pass on the costs of the CRC to their franchisees. A franchisor may decide to require that its franchisee pay a fair and reasonable proportion of the charges incurred by the franchisor in registering for and participating in the CRC.

This clause 16.9 provides a simple clause to deal with these costs. Note that as an amount has not been included in the clause, a franchisee may ask for independently audited reports confirming the accuracy of the amount it has to pay.

Intellectual Property: clause 17This clause sets out provisions relating to the intellectual property of the franchisor and any trade marks which the franchisor may license to the franchisee.

Clause 17.1

The franchisee will want the franchisor to warrant that it is entitled to license any trade marks to the franchisee without infringing any third party rights, that all application and renewal fees have been paid and the Trade Marks maintained and protected, and that no similar trade marks have been registered. Care should be taken in giving any such warranties, unless the franchisor's trade marks are registered and have been established for a considerable period of time. The franchisee may also want the warranty to be coupled with an indemnity against loss arising out of any claim that the franchisee's use of the Intellectual Property in accordance with the agreement infringes the rights of any third party.

This clause sets out a qualified warranty that the franchisor does not know of any reason why the licence to use the Intellectual Property and Trade Marks should not be given and that it is not aware that use of them would infringe any third party rights.

Clause 17.2

This clause relates to the execution and registration of the Trade Mark licence. If other forms of intellectual property are important to the business, then this clause should be expanded to cover other relevant licences.

The clause allows, in the alternative, for a licence to be entered into immediately or if and when the franchisor requires.

Although licences are registrable transactions under the Trade Marks Act 1994 (TMA), there is no statutory requirement that they must be registered. However, it is desirable for a licensee to ensure that the transaction is recorded, since it will otherwise be ineffective against a third party acquiring a conflicting interest in the mark. Note that, if a licence is not registered within six months of the date of the transaction, the licensee has no right to its costs relating to any infringements occurring in the period from the date of the transaction to the date of registration of the licence. Registration would usually provide a statutory right (in the absence of any contrary agreement) to bring infringement



proceedings in default of an action by the registered proprietor (section 30(2) and (3), TMA), but clause 17.6 excludes any rights that the franchisee has under that section

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03rj PLC Note - Franchise Agreement

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