Lost in Translation

John Pratt, partner at Hamilton Pratt, explains the key legal terms to look out for in your franchise agreement and what they really mean

To the uninitiated, it may sometimes seem as if lawyers do not write in plain English. This is all the more frustrating because it is essential that prospective franchisees read and understand the franchise agreemen that they are required to sign. Here follows a straightforward guide to some of the more commonly used legal terms in franchising:

Exclusivity – Not all franchise agreements grant exclusivity within a particular territory. When exclusive rights are given that means that the franchisor will not appoint anybody else in the territory and will not operate itself in the territory. When sole rights are given all that the franchisor is doing is agreeing not to appoint anybody else in the territory but the franchisor is not excluded from trading in the territory.

Passive Sales – Competition law does not allow franchisors to prevent franchisees from responding to unsolicited enquiries from outside their territory – even when exclusive territories are granted. This is referred to as passive selling. Franchisors can, however, prevent franchisees from looking for customers outside their territory; this is referred to as active selling.

Non-Compete Covenants – It is commonplace for a franchise agreement to include restrictions on the franchisee’s involvement in a competing or similar business during the term of the franchise agreement – as well as restrictions that apply, usually for 12 months, after termination. As part of these non-compete covenants there will be non-solicitation obligations, which mean that franchisees are prohibited from encouraging their former customers to patronise any new business started once they cease to be a franchisee. Solicitation involves an active step.Former customers continuing to do business with an ex-franchisee who has not actively
approached them does not amount to solicitation.

Management Service Fee – Almost all franchise agreements require franchisees to pay a continuing fee to the franchisor. In some franchises no continuing fee is charged because the franchisor receives payment by ay of mark-up on products or services that franchisees purchase on a rolling basis from the franchisor. This continuing fee is usually referred to as a management service fee but can be called a service fee or management fee. It is usually calculated on a franchisee’s gross revenue, which roughly equates to turnover although most definitions of gross revenue in franchise agreements would include sums payable by a franchisee’s customers even if those sums were not, in fact, paid. In addition to the management service fee most franchise agreements require a separate payment for advertising and marketing – this is referred to as a marketing fee or an advertising fee. Again, this payment is calculated as a percentage of gross revenue. On average, management service fees are 8 per cent and marketing fees are 2 per cent of gross revenue.

Indemnity – Increasingly, franchise agreements contain an indemnity whereby the franchisee indemnifies the franchisor for loss the franchisee causes the franchisor. In an ideal world these indemnities should not be widely drafted and should be limited to loss that a franchisee causes a franchisor for being in breach of the franchise agreement or for the franchisee’s negligence. The precise extent of these indemnity clauses will depend on the language used but, in essence, when a franchisee gives a franchisor an indemnity and the franchisor suffers loss as a result of an event listed in that indemnity, if the loss, for instance, is calculated at £1,000, then the franchisee must reimburse the franchisor a sum of £1,000.

Intellectual Property – Intellectual property is what the franchisor licenses to a franchisee and will certainly include the franchisor’s brand that, in an ideal world, will be a registered trademark. It may also include copyright in the manual, trade dress – requirements as to the look and feel of a franchise outlet – and other elements such as the franchisor’s know-how. The agreement should set out the precise terms of what is included in the definition of intellectual property.

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