Understanding the Franchise Agreement vs. the Franchise Disclosure Document
By Michael Seid, Managing Director, MSA Worldwide
It’s unfortunate, but some franchisees do not read or understand their Franchise Agreement before signing on the dotted line - and then discover, after the fact, that the deal they are now legally bound to is not quite what they thought they were getting. Franchise Agreements are generally long and complex documents written in legalese which may put the average person to sleep - but reading and understanding your Franchise Agreement before you sign it is critical.
Often, once a prospective franchisee has muddled through reading the Franchise Disclosure Document (FDD) - a long and complex undertaking - they may think they understand the deal thoroughly, and only superficially scan the subsequent Franchise Agreement. They may assume that franchise agreements are nothing more than adhesion contracts filled with a bunch of boilerplates, and therefore they need not concern themselves with what the agreement contains. This can be a tragic mistake.
- The purpose of the Franchise Disclosure Document (FDD) is to describe the relationship between the franchisor and franchisee, provide the franchisee with the information they need to begin to understand the franchisor and its offering and be used by the prospective franchisee as a basis for then conducting due diligence on the opportunity.
- However, it is the Franchise Agreement - the written, binding contract between the franchisor and franchisee - that legally governs the relationship between franchisor and franchisee.
Franchise Agreement Defined
A Franchise Agreement is a legal document that binds franchisor and franchisee together. This document explains what the franchisor expects from the franchise in running the business. The Franchise Agreement is designed to ensure that all of the franchisees within an organization are treated equitably.
The expectations must be uniform throughout the system; however, agreements with new franchisees may differ somewhat from the agreements the franchisor has with existing franchisees.
Differences from the Franchise Disclosure Document (FDD)
The Franchise Agreement is a document that is signed by both parties upon completion of the deal to do business together. In contrast, the FDD is presented prior to the final agreement in order to provide the potential franchise with the opportunity to review the information in the FDD before making a final determination about whether or not to become a franchisee with the organization.
The FDD entails comprehensive details about the company's background and history. Included is the disclosure of any lawsuits or bankruptcies that have occurred within the franchise organization; a host of financial data; and distribution channel information. Any confidentiality restrictions are also disclosed, as far as what a franchisee may and may not discuss with others.
Elements in the Franchise Agreement
Contract Explanation - The contract explanation is the part of the agreement that outlines the type of relationship a franchise is entering into with the franchisor.
Operations Manual - The Operations Manual is the section of the agreement that details the guidelines that the franchisee must legally follow in operating the business as outlined by the franchisor. From time to time amendments may be made and the franchise must be prepared to adjust operations accordingly. The franchise needs to be aware that the contents of the document are confidential.
Proprietary Statements - Proprietary statements outline how the franchise name is to be used, as well as the marketing and advertising procedures in place that the franchisee will be required to follow. Also, the franchisor documents how much the franchisee will be required to contribute toward national advertising efforts.
Ongoing Site Maintenance - Ongoing site/location maintenance is another item outlined in the agreement. Included are the types and timeframes of various maintenance and upgrades that must be made to the franchisee's location.
While reviewing the Franchise Agreement, you and your attorney should be asking:
- Are there any promises the franchisor made to you verbally that you are relying upon in making your decision to invest in the franchise? If those promises are not in the franchise agreement, they won’t be part of the legal relationship, and the franchisor may not be required to provide them to you.
- Are the franchise agreement and the disclosure document consistent? Usually, this will not be a problem, but sometimes you’ll find items you thought you understood in the disclosure document that isn't quite the same or as clear in the franchise agreement. Make certain the deal you sign up for is the deal you thought you were being offered.
- Are there areas of the franchise agreement that your lawyer believes are not proper based on state laws? If so, it is better to have those terms eliminated or modified before you sign the agreement?
- Does the franchise agreement require you to sign a personal guarantee? Does it include family members who will not be involved in your business or which your attorney thinks is too broad? Discuss modifying the guarantee with the franchisor.
- Are there any additional services you think the franchisor should consider providing you? Extra training, additional field support during the opening period, or changes to the time required to open your business are all possible if you make your case to the franchisor that they are required.
Find a qualified franchise lawyer to review the Franchise Agreement
It is strongly recommended that you have a qualified franchise attorney review the Franchise Agreement before you sign it so that you are certain you have a clear understanding of all its contents.
If you’re working with a franchise broker, don’t rely on them for legal advice. While most franchise brokers are honorable people and knowledgeable about franchising, they get paid by the franchisor. Even if they have been friendly and helpful in getting you together with the franchise system of your dreams, they only get paid when you sign the Franchise Agreement, and that is too great a conflict for you to ignore.
Franchise law is a specialty; the local attorney you used to close on your house or prepare your will probably won’t have the practical franchise experience required to be of any real assistance. They may not understand why certain issues may be negotiable and why others aren’t. They won’t be able to flag something in the agreement that is unusual and possibly unfair. They won’t know enough to ask for the basis of the franchisor’s Item 19, Financial Performance Representation, or to help you review whether the franchisor’s operations manuals are well developed for the type of business being offered. They won’t have the background, knowledge or industry intelligence to effectively understand or compare the franchisor to other possible franchise opportunities. For experienced counsel, you need a qualified franchise lawyer. One good source is the International Franchise Association, www.franchise.org or (202) 628-8000; ask to speak with someone in membership. Another is the ‘Mainly Franchisee’ section of Chambers USA: chambersandpartners.com/uk/Editorial/42656.
Don’t ever sign a franchise agreement you do not understand. This is especially true when it comes to the sections at the end of the agreement dealing with defaults, terminations, and what happens when the relationship between you and the franchisor ends.
- In time, all franchise relationships end: be especially wary of what happens to the equity you will have built in your business. Will you have the opportunity to maximize the equity you have built if you choose to sell your business before the end of the franchise term? Will the purchaser of your business get a full term, which will maximize your selling price, or will they only get the remaining term of your existing agreement?
- How frequently will you need to remodel your location? Will that remodeling requirement be enforced if you only have a few years left on your agreement and likely will not have the time to amortize the additional investment before you leave the system? If you remodel in the eighth year of your agreement in anticipation of renewing, will the franchisor require you to remodel again as a condition of renewal in the tenth year?
Clarify the issues you don’t understand, try to negotiate those points that don’t fit your needs, and rely on an experienced franchise attorney to assist you in making your franchise decision.