Negotiating your franchise agreement

Negotiating obligations
Many franchisees’ spouses who are not involved in the business, except tangentially, are asked to provide a personal guarantee of the franchise for the franchisor or landlord. This is a bad risk that should not be agreed to.

Granted, if a married couple will actively run all aspects of the business as directors or officers with joint ownership, then it would be difficult to convince the franchisor, a banker or a creditor that both spouses shouldn’t provide a personal guarantee. Adding a non-involved spouse as a director, officer or shareholder, however, can put you in a bad position where such guarantees become expected. So, it is not always a good idea to involve your spouse in the business in this way.

An unlimited guarantee of your franchise’s obligations to your franchisor or landlord might make for many sleepless nights, especially if the business runs into financial trouble. One of the most troublesome issues prospective franchisees face when they are asked to sign a personal guarantee for five or 10 years is putting their home and personal savings on the line. It is all too uncertain what the obligations could be.

So, you should try to cap the guarantee in terms of dollar amount, number of years or both. This is almost impossible to do with banks, but franchisors, landlords and other creditors may well entertain the idea.

The franchisor may be prepared to limit your personal guarantee, covenant or exposure to the amount of the initial franchise fee, for example, or another agreed-upon amount you can live with. Indeed, this negotiation may be what gives you the certainty and comfort level you need to jump into the business.

Another provision, which can be found in the termination section of many franchise agreements, can be called the ‘three strikes, you’re out’ clause. There, along with other grounds for default that grant a franchisor the ability to terminate a franchisee if a situation is not remedied, is a provision allowing for termination “if the franchisee has received from the franchisor, during any consecutive 12-month period, three notices of default relating to one or more defaults under the agreement, irrespective of whether or not these defaults were remedied by the franchisee.”

This type of clause can be abused by franchisors. While a franchisor may not normally be able to terminate a franchisee for minor transgressions, if there are three minor defaults—even if notices are given separately over the course of 24 hours and each minor breach is immediately remedied by the franchisee—the franchisor may terminate on the third notice.

One can hope a court would overturn such behaviour, but more often than not, franchisees in this kind of legal dispute—particularly those in non-disclosure jurisdictions, including provinces like British Columbia—will not have sufficient financial resources to fight their franchisor, as legal fees are too high.

So, it is important to watch out for the ‘three strikes, you’re out’ clause, as it means you could lose possession of your business and its location to a franchisor that otherwise would have no grounds to terminate on any single default.

Homework first
There are dozens of other issues prospective franchisees have to consider before making what may be the most important financial decision of their lives. Your questions are therefore just as important as the answers. One of the keys to your success in a franchised business is the homework you do before you pay the franchisor.

Tony Wilson is the author of Buying a Franchise in Canada: Understanding and Negotiating Your Franchise Agreement, head of the franchise law group at Boughton Law in Vancouver, a registered trademark agent, a bencher of the Law Society of British Columbia and an adjunct professor at Simon Fraser University (SFU). His opinions do not reflect those of the Law Society, SFU or any other organization. For more information, contact him at twilson@boughton.ca.