Core Terms That Should Be in Every Franchise Agreement

A franchise agreement is a legally binding contract between a franchisor (the owner of a brand and its operating system) and a franchisee (an independent business owner). It governs the use of the franchisor’s intellectual property, business methods, and support systems by the franchisee, in exchange for payments such as franchise fees and ongoing royalties. 

The franchise agreement is not to be confused with the Franchise Disclosure Document (FDD), which is a pre-sale disclosure document. The Federal Trade Commission mandates that a prospective franchisee be provided with comprehensive information about the franchisor and the terms of operation at least 14 days before signing any agreement or paying any money. Although it must be consistent with the FDD, the franchise agreement is the binding contract that delineates each party’s rights and obligations.

The following clauses are essential to every franchise agreement:

1. Franchise fees and royalties — This includes the upfront payment for entry into the franchise system and ongoing royalties, which can be a percentage of gross sales or a fixed fee, paid to the franchisor for ongoing support and continued use of the brand. It may specify what contributions franchisees are required to make to the franchisor’s advertising and marketing.
2. Territorial rights — This states whether the area in which the franchisee operates is exclusive (no other franchisees or company-owned outlets in the area), protected (limited restrictions on competition) or non-exclusive. It also states the franchisor’s rights, if any, to open additional units nearby or to compete directly within the territory.
3. Duration and renewal — This sets the length of the franchise term and provides for how the agreement can be renewed, the criteria (like performance requirements) and associated fees.
4. Operational guidelines — This sets standards for branding, product offerings and services. It also covers approved suppliers, mandatory training and compliance with operational policies.
5. Training and support — This outlines the franchisor’s obligations to provide training, support resources, operational manuals, technology platforms and marketing materials.
6. Intellectual property rights — This gives the franchisee the right to use trademarks, logos and proprietary systems and prohibits misuse, alteration or unauthorized actions.
7. Termination — This clause enumerates the specific grounds for franchisor termination. It also clarifies post-termination obligations, such as ceasing use of IP and confidential information.
8. Dispute resolution — Specifies procedures for handling disputes, often requiring arbitration or mediation. Defines legal jurisdiction, forum, and governing law.
9. Compliance and reporting — Requires regular financial reports, audits, and other documentation to monitor performance and compliance.
10. Transfer and sale rights — Sets conditions for selling or transferring the franchise, usually requiring franchisor approval and the payment of transfer fees.

It is vital for franchisees to have an experienced franchise attorney draft, review and negotiate the agreement. An attorney’s advice is essential in avoiding costly mistakes, ensuring regulatory compliance and facilitating a fair, sustainable business relationship.

The Law Offices of Donald W. Hudspeth P.C., in Phoenix assists Arizona business clients in legal matters relating to franchise purchase and operation. Call us at 866-696-2033 or contact us online for a consultation.