For Franchisor, Franchisee and Landlord: Ways a Franchise Agreement and Commercial Lease May Conflict (Part 1 of 3)

By Barbara I. Berschler

FOR FRANCHISOR, FRANCHISEE AND LANDLORD:

WAYS A FRANCHISE AGREEMENT AND COMMERCIAL LEASE

MAY CONFLICT

Part 1 of 3

From the Franchisee’s Point of View

Many franchise business models require use of commercial real estate.  The franchised business may be operated out of a store in a strip shopping center, regional mall, office complex or a stand-alone structure.   In most instances the space is leased by the franchisee from a third party—the landlord, thereby involving at least three major players:  the franchisee who is also the tenant, the franchisor and the landlord.

Each player has high expectations of protecting its own interests.  By understanding these interests, those negotiating the transaction will be more successful at arriving at a mutually satisfactory arrangement.  This three-part blog will examine some overlapping issues from the perspective of each of the parties and will start from the point of view of the franchisee.

Among the three players, the franchisee comes to the project with the least bargaining power, yet it is the party most affected by the obligations imposed by the others.  To counter this effect, an important tool for the franchisee to have is a clear understanding of the relationship between the franchise agreement and the lease.   

Even before any thought of securing leased premises arises, the franchisee, while it is doing its due diligence, should become thoroughly familiar with the franchise agreement, which sets forth the relationship between the franchisor and franchisee. Among the various obligations required of the franchisee under that agreement, there will be terms that can affect the franchisee’s relationship with its future landlord.  If the franchisee also understands typical provisions that will appear in a lease, it will be better able to raise the potential conflicting issues with the franchisor while it evaluates the franchise agreement.  The following discussion covers some issues which can overlap in a franchise agreement and a lease.

TERM OF FRANCHISE AGREEMENT VS TERM OF LEASE:

 

A major issue where the franchise agreement and lease intersect concerns the length of time that each relationship exists; in other words the “term” of each agreement.  If, for example, a ten-year term imposed by the franchise agreement begins upon execution of that document, much of the time could be eaten up before the franchisee has identified a commercial location, entered into a lease, built out the premises and opened for business.  Yet the lease will have its own independent term of existence.  What happens to the franchisee/tenant when the franchise term has expired but the lease still has a year or more to run?  Knowing that such a situation likely will occur, the franchisee can raise the matter and negotiate a suitable method for calculating the term of the franchise agreement.

ADVERTISING EXPENSES: 

Another area where overlap may occur concerns the advertising expenses that the franchisor and landlord expect the franchisee/tenant to shoulder.  In most franchise agreements, a franchisee is asked to contribute not only a certain percent of its gross revenues to a general marketing/advertising fund administered by the franchisor but also to spend a minimum amount for local advertising. 

While advertising is an important business expense, if the franchisee’s premises are in a shopping center, the lease may also require tenants to make comparable contributions to the landlord’s shopping center marketing fund and local advertising.  Without some relief, the franchisee may be faced with further erosion of both the monies it needs to run its operation and its bottom-line profit.  In this situation, a franchisee is well advised to build into the franchise agreement a suitable formula to calculate its overall advertising expense.  Whether or not the franchisor makes concessions in this matter, the franchisee should also raise the matter with its prospective landlord.

SIGN CRITERIA: 

A third area of conflict can arise with respect to the identification signage which will appear at the entrance of the premise or at other locations in the shopping center.  Obviously, the franchisor has expectations of the use of its logo and may have a standard sign package it wants to see installed.  However, the package may contravene the landlord’s sign criteria for its project.  When the franchisee is evaluating a particular location for its premises, it will be able to see how the landlord handles signage in general.    If it appears that there could be a conflict in expectations, the franchisee should raise the matter early in lease negotiations with its prospective landlord.

These are just a few areas of overlap between a franchise agreement and lease.  The savvy franchisee should know what they are so it is in a better position to raise them while negotiating with its franchisor and its future landlord.