Franchise dictionary. Advertising fees. Alternative dispute resolution. Arbitration

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1 Franchise dictionary Advertising fees Alternative dispute resolution Arbitration Audit Business format Buyback Developer Disclosure Expert determination Franchise Franchise agreement/franchise contract Franchisee Franchising Franchisor Goodwill Intellectual property rights Know-how Master franchisee Mediation Misrepresentation National accounts/clients/customers Operations manual Pilot operation Post termination restrictive covenants Renewals Royalties Subordinated equity agreement System Term Termination Territory Advertising fees To promote the franchise business, both the franchisor and the franchisee including developers and master franchisees will need to undertake advertising and promotional activities. Where the franchisor undertakes international, national or regional advertising, the franchisee is typically obliged to pay advertising fees to the franchisor. These fees can either be a flat, weekly, monthly or quarterly fee or calculated as a percentage of the franchisee s monthly gross turnover. Alternatively the franchisor may provide the franchisee with advertising and marketing materials in consideration for a fee or simply oblige the franchisee to obtain the franchisor s pre-approval to any advertising and marketing materials that the franchisee produces. Advertising fees paid by franchisees may be held in a separate advertising fund by the franchisor. This fund can then be used by the franchisor for marketing campaigns with a right for the franchisees to audit the financial statements relating to the fund. Alternative dispute resolution Alternative Dispute Resolution or ADR is a means of resolving franchise disputes without resorting to court action. The best known method of ADR is Mediation but it also includes Arbitration, Expert Determination and direct settlement negotiations. The UK courts are very much in favour of ADR and parties will often need to show that they have, at the very least, considered ADR before resorting to court action. Arbitration Arbitration is perhaps best thought of as private litigation. The parties to a franchise agreement might agree that in the event of a dispute they will follow the rules of an international arbitration body such as the London Court of International Arbitration or UNCITRAL (the United Nations Commission on International Trade Law). These rules set out procedures very similar to those used by the courts, with exchanges of relevant documents and statements of case in preparation for a trial of the issues in dispute. Arbitration clauses in franchise agreements are not uncommon, although arbitration can be as time-consuming and expensive as litigation at court. Its most pronounced advantage is perhaps that where court proceedings are mostly public, arbitration is usually secret (enabling the franchisor to protect its brand from bad press). In addition, instead of a judge allocated to the case by the court, the parties to an arbitration can often select a decision-maker (the arbitrator, or even a panel of three) with specialist experience of their own market sector as well as a legal background.

2 Audit During the term of the franchise agreement and for a period thereafter the franchisor should be contractually permitted to audit the franchisee s books of account. The main purpose for the audit will be for the franchisor to determine whether it has received the royalties and advertising fees to which it is entitled. Where any such audit reveals any discrepancy in the fees paid or payable to the franchisor; the franchise agreement should oblige the franchisee to redress the discrepancy and in certain scenarios to cover the franchisor s audit costs. Business format This is a set of business systems and procedures which are capable of replication by franchisees. It is those operational elements which define how the franchise business works. Buyback This refers to an option whereby the franchisor has a right to purchase the franchise back from its franchisee. If the option is granted the franchise agreement should set out those scenarios where a buyback is possible usually where the franchisee wishes to sell its franchise business to a third party or on termination of the franchise agreement - and the terms and conditions which apply to the buyback. Developer Where a franchisor wishes to expand its franchise business into relatively large new territories - which may include new regions within a country, or whole new countries - one option is to appoint a developer (another is to appoint a master franchisee). The developer will be granted the non-exclusive or exclusive right to expand the franchised business within its designated territory usually in accordance with a development or roll out schedule. Subject to certain terms and conditions the developer will be granted the right to operate individual franchise businesses within the Territory. The developer will therefore have two roles: i. as the developer for the territory; and ii. as the franchisee for individual outlets/stores/franchise business units. Another term which may be used to describe a Developer is Area Developer. Disclosure Disclosure within a franchise context is where a franchisor provides information to prospective master franchisees, developers or unit franchisees before a franchise agreement (which here includes a master franchise agreement or a development agreement) is concluded. In a number of countries the provision of certain franchise related information - prior to the grant of franchise rights - is a legal obligation on the franchisor. Disclosure is not a legal requirement in the UK but it is recommended best practice. It is also recommended by the British Franchise Association. The typical information which is required to be disclosed includes: details of the franchisor; details of the franchise business; number and location of franchisees; key legal and operational obligations; intellectual property rights which form part of the franchise; and details of any franchise litigation. Disclosure has a different meaning in legal proceedings, where it can refer to the exchange of documents which are relevant to a claim.

3 Expert determination Expert determination is a form of alternative dispute resolution. Whilst it might be most appropriate for a franchisor and franchisee to engage in litigation, arbitration or mediation where they do not agree on the facts or law of a dispute, and need an impartial referee to decide who is right, expert determination is often most useful in very technical disputes where specialist knowledge is vital. The expert will be appointed by the parties to evaluate their position, and the issues at stake, and make a final decision on the issue put to him. An example might be where a franchise agreement contains particularly complex royalty payment provisions and a financial expert is needed to confirm which party has applied them correctly. An expert determination is - like arbitration and mediation - usually private, and will provide a binding decision which might resolve the dispute in its entirety or might help the franchisor and franchisee narrow the terms of the dispute before it is referred to the courts. Franchise A legal and commercial relationship between a franchisor and a franchisee which allows the franchisee to operate a business, under the franchisor s established brand and in accordance with the franchisor s system, know how and business format. Franchise agreement/franchise contract The franchise agreement is the legal document which contractually binds the franchisor and franchisee. It should contain each party s legal obligations, and is the framework within which the franchisee s business must operate (although elements of the business format, know how and system should be described further in an Operating Manual). Franchisee This is the term used to describe a party appointed by the franchisor to run an individual franchise business. Master franchisees will also appoint franchisees. The franchisee s legal obligations and responsibilities will be set out in the franchise agreement. Another term which may be used to describe a franchisee, particularly in a master franchise structure is a subfranchisee or unit franchisee. Franchising Essentially, franchising is a business model where one party (the franchisor hyperlink) has developed a successful product or service and allows another party (the franchisee) to operate under its brand name in accordance with its business methods (which includes the business format, know how and system in exchange for a fee. As a result the franchisee benefits from consumer goodwill towards the franchisor s brand and product(s) or service(s) and access to the franchisor s proven methods of doing business. Franchisor This is the ultimate owner of the franchised business including the intellectual property rights in particular the brand, the know how and the system. It is the franchisor who appoints developers, master franchisees, unit franchisees or a combination of these. Goodwill This refers to the reputation amongst consumers enjoyed by the franchisor as a result of selling its product(s) or service(s) under its brand. In time a franchisee will also develop local goodwill through the operation of the franchised business.

4 Intellectual property rights In a franchise context a franchisor s intellectual property rights typically include unique trade marks, copyright and patents. Typical examples of intellectual property rights include a business logo protected as a trade mark i.e. the brand, a secret recipe protected by copyright and/or a unique product protected by a patent. Know-how A franchisor s know-how is the franchisor s knowledge and experience of how to operate its particular business within the industry sector. The know how forms a key part of the business format and the system. The franchise agreement should expressly grant franchisees the right to use the franchisor s know how. As know how is not intellectual property it does not have the same level of statutory protection as, for example, is enjoyed by copyright or patents. Therefore it is essential that the franchise agreement provides protection for the franchisor s know how, typically by ensuring the franchisee keeps it secret and confidential. Master franchisee Where a franchisor wishes to expand its franchise business into relatively large new territories - which may include new regions within a country, or whole new countries - one option is to appoint a master franchisee (another is to appoint a developer). The master franchisee will usually be granted the exclusive right to expand the franchised business within its designated territory. Subject to certain terms and conditions the master franchisee will be granted the right to appoint its own franchisees in the territory. The master franchisee effectively becomes the franchisor for its franchisees. Another term which may be used to describe a master franchisee is subfranchisor. Mediation Mediation is a form of alternative dispute resolution and is designed to help the parties to a dispute resolve their differences without the cost of time-consuming litigation. Unlike litigation and arbitration, mediation is less a battle of statements prepared by lawyers and more an effort to resolve the dispute by dialogue between the parties. It is relatively informal and, where successful, produces a settlement which is generally not binding until recorded in a settlement agreement. The parties will try to select a mediator who will either discuss the dispute with both parties together or perform shuttle diplomacy between parties who don t see eye to eye. The mediator will not make a formal judgment or decision, but will assist the parties in agreeing a voluntary resolution. Even unsuccessful mediation can be beneficial in helping the parties to a franchising dispute identify the real issues and thus save costs in litigation. Misrepresentation A misrepresentation is a statement of fact made (in the franchise context usually by the franchisor) prior to the signing of the franchise agreement which induces or partially induces the other party (in this case the franchisee) to enter into the agreement and the franchisee later discovers that the statement was not correct at the time it was made. Misrepresentations are often in the form of exaggerations of the estimated success of the franchise, such as unrealistic earnings projections based on assumptions rather than previous data. A franchisee (including developers and master franchisees) which purchased its franchise in reliance on untrue statements may be able to bring a claim against the franchisor for misrepresentation. National accounts/clients/customers The franchisor itself may have built up a portfolio of certain clients or customers for its products or services, which due to the client s/customer s size, geographical coverage or purchasing power, are accorded special status compared with smaller, less frequent clients/customers. Such clients/customers may be termed National Account clients/customers. National Account clients/customers may enjoy preferential terms compared to other clients/customers of the franchise business. These preferential terms are often set by the franchisor for franchisees to follow and adhere to. In some franchise businesses, the franchisor may itself provide the services or products direct to National Account clients/customers even in scenarios where the National Account clients/customers are located in a franchisee s territory.

5 Operations manual The operations manual should contain all the information that is needed by the developer, master franchisee or franchisee (as the case may be) to run its business in accordance with the franchisor s system, business format and know how. Pilot operation Sometimes, before setting up a full network of franchisees, a franchisor might run one or more outlets in exactly the same way as it proposes the franchises be run. The pilot operation is essentially the franchisor s learning or testing ground. The franchisor will appoint one or more pilot franchisees who may, for the term of the pilot franchise relationship, be granted more favourable commercial terms as an acknowledgement that the franchisor is still refining the franchise concept and system. The pilot operation allows the franchisor to develop its operations manual based on the pilot franchisees operating experiences. It also enables the franchisor to test its franchise agreement to see which provisions work and those which do not. Taking this approach means the franchisor might better understand its franchisee s businesses, and might lessen the risk of making statements which misrepresent the truth. Post termination restrictive covenants Many franchise agreements contain a prohibition on the franchisee from being involved in a business which is similar to, or competes with, the franchisor s business for a certain period of time after expiry or termination of the franchise agreement, Such a restriction is, on its face, in restraint of trade and therefore void pursuant to Competition Law. However, the courts have held that the franchisor/ franchisee relationship is similar to a vendor/purchaser relationship, rather than a consumer or employee/employer relationship and a post termination restriction in a franchise agreement is enforceable provided that it goes no further than is reasonably necessary to protect the franchisor s legitimate business interests. Such clauses need to be carefully drafted by an experienced professional to ensure their enforceability as what is and is not reasonable will vary from business to business based on a variety of different factors. Renewal A franchisee (or indeed a developer or master franchisee) will be permitted to conduct business in accordance with the franchise agreement only for a specified period of time. It is only granted the use of the franchisor s brand (hyperlink to intellectual property rights) for that period. Some franchise agreements will contain terms and conditions which dictate what needs to be undertaken by the franchisee and franchisor to allow the franchisee to continue after the original franchise agreement would have expired. These are the terms and conditions for a renewal of the franchise. Royalties As consideration for the grant by the franchisor to the franchisee of the right to use the franchisor s know how, system and brand and in return for ongoing training and support, the franchisee is obliged to pay the franchisor royalties on an ongoing, usually monthly basis. These royalties are often calculated as a percentage of the franchisee s monthly gross turnover. Other terms which may be used for royalties are Service Fees or Management Fees. Subordinated equity agreement A franchisor may decide that it wishes to invest in its operations in new territories. It may therefore look to set up a new company with the developer, master franchisee or unit franchisee in that territory. The parties will enter into a subordinated equity agreement which will govern how the new company is to operate. The new company - which will be partly funded by the franchisor - will then be granted either master franchise rights (via a master franchise agreement), development rights (via a development agreement) or unit franchise rights (via a franchise agreement) from the franchisor.

6 System The system represents the franchisor s methods for conducting the franchised business. The system encompasses the franchisor s know how and the business format. The operational elements of the system should be set out in the operations manual. Term The term of a franchise agreement (or a master franchise or development agreement) is the period of time, usually a specific number of years, for which the franchisee can operate the franchise business. If the franchisee wishes to continue after the term expires, a renewal of the franchise agreement will be needed. Termination Termination describes the scenario where the franchise agreement (and therefore the relationship between a franchisor and its franchisee) comes to an end. Termination may arise in a number of scenarios including: (i) where the franchise agreement has reached the end of its contractual term (also referred to as expiration); (ii) in scenarios where the parties mutually agree to end it early; or (iii) in circumstances where one party has broken its contractual obligations in a way which allows the other party to end the franchise agreement. It is recommended that the grounds for termination, including any opportunity to remedy, are expressly detailed in the franchise agreement. Territory The specific geographical area (whether a city, region or country) within which the franchisee is granted the right to operate. Often a franchisee will be given exclusive rights to a territory (meaning no other franchisee of the business will operate there in competition with it) but in some businesses this is not the case. Contacts Gordon Drakes Associate, London Victoria Hobbs Partner, London Graeme Payne Partner, London e gordon.drakes@ffw.com t +44 (0) e victoria.hobbs@ffw.com t +44 (0) e graeme.payne@ffw.com t +44 (0)