New York Franchise Law Blog : Franchise Lawyer & Attorney Charles N. Internicola, Providing National Representation of Franchisees and Franchisors

For the start-up and established franchisor alike, as your franchise system evolves continuous consideration must be given to your franchise agreement and "the legal rights that you reserve for your franchise system".  That is, basic to every franchise agreement are the "reservation clauses" identifying and  establishing alternative channels of distribution and legal rights  that are not granted, conveyed or licensed to your franchisees.  These reserved rights typically address alternative channels of  distribution and markets that are expressly reserved to the  franchisor.  Examples include internet sales, mail order sales, captive market accounts and licensed products sold through alternative sales channels.

Chances are that your "existing franchise agreement" contains reservation clauses.  However, have you recently reviewed these legal provisions?  Are the reservation clauses contained in your franchise agreement generic, or do they account for your future plans for expansion? When evaluating your franchise agreements and future plans for expansion, discuss with your franchise attorney and staff:

• Potential distribution and sale of private label products;
• Potential expansion and development of alternative franchise systems;
• Licensed distribution and sale of signature products and services through non-franchised outlets; and
• Your current and future plans for internet and/or mail order based sales.

There are other points but they are all based on the fundamental fact that you must be constantly evaluating your franchise agreement to ensure that it matches where your franchise is today and where it may be ten years from now.  Avoid the generic.

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Has the United States economy changed?  Are we in a "new economy"?

Yes, undoubtedly yes.   In fact there are so many new facets to our economy - some good, some questionable and some bad - that you don't need me to tell you that the economy has changed.  Ultimately, where our economy "ends up" is still undecided and, in large measure, will be decided by political and economic factors yet to be determined. But, no matter where we end up, one thing is clear: our economy has been and will remain fundamentally altered. 

So, what are some of the characteristics of this evolving "new economy" and what do franchisors need to know?

• Opportunity Still Exists - Although there are elements of economic turmoil - opportunities still exist.  For the start-up franchisor the current  level of economic instability may indeed constitute a competitive advantage and opportunity to level the playing field and compete with the "big players".   More than ever, technology is abundant and relatively cheap. Competitive tools such as the internet, automated database systems, point of sale systems and social networking have created the opportunity for small competitors to compete at the highest levels and take on much larger competitors who may be distracted by franchisee defaults, litigation and over leveraged balance sheets.

• A Renewed Focus on Franchisee Profitability is Critical.  Prior to the current economic cycle (and the 10 years prior to that) capital was abundant with consumers and prospective franchisees being afforded access to easy credit.  In many instances, franchise system sales and franchisee investments were, in large measure, fueled (or at least inflated) by consumers and franchisees who simply spent more than they could afford.  System growth was focused on the incremental "gross sales and royalties" generated by franchisee expansion.  Insufficient resources were placed on franchisee profitability (compared to gross sales) and, in the current economic cycle, franchisee default rates are increasing at a substantial rate. A renewed focus on franchisee profitability (even if it comes at the expense of gross sales) is more critical than ever as consumers and capital markets remain in retreat. 

• Other Factors. As you are well aware, there are many other facets to this "new economy", including the impact of the declining credit markets on franchisee financing.  In our future and continuing posts about franchising and the new economy we will discuss franchisee financing and other issues that franchisors are confronting.   

This story is evolving rapidly...

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There are many reasons why, for many, the purchase of a franchise makes sense. However, buying a franchise may not be right for you. I was, again, reminded of this "obvious and basic fact" during a conference call today with a client considering a substantial investment in a multi-unit franchise. The investment was sizable and, quite frankly, there was plenty of opportunity in the deal.  After a substantial legal review (where everything looked good and substantial negotiating points were achieved) he decided that "becoming a franchisee was not right for him" -  so he walked away from the deal. 

I think the right decision was made.  Not for any particular legal reason, but, because sometimes, becoming a franchisee is just not right.  When your "gut" tells you its not right - then walk away. The reverse, however, should not be applied.  That is,  if, your "gut" tells you that a potential franchise opportunity "is right for you", then your next step is not to just sign a franchise agreement but, rather, to engage in a thorough "due diligence" evaluation to ensure that you are acting on solid information.

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In a comment to a recent post - "5 Things to Know before Buying a Franchise" - the Franchise King, Joel Libava, raises the critical issue of maintaining "uniformity" in franchise agreements.  That is, the insightful Mr. Libava, challenges the propriety of promoting negotiated modifications to franchise agreements.  The point raised by Mr. Libava is a legitimate and genuine issue that must be evaluated by both franchisors and prospective franchisees.  

From a franchisors perspective uniformity is a critical factor that must underly the franchisors  legal relationship with its franchisees.  Similar to the uniform standards and procedures inherent in franchise systems, franchise agreements must also maintain consistent levels of uniformity.  Such uniformity will, at a minimum, serve to reduce litigation exposure and foster a consistent platform for the management and growth of the overall franchise system.  

From a franchisee's perspective, uniformity in franchise agreements may be a positive factor (i.e., a franchisor committed to its franchise agreement and systems) if the proposed franchise agreement is "balanced" and the franchisor possesses a substantive track record.  So how do you determine if the franchise agreement is "balanced" ?  You do your research, review the franchise agreement and FDD with a qualified franchise lawyer, speak to qualified franchise consultants and conduct the necessary due diligence.  Chances are that there will be "imbalances" in your proposed franchise agreement - there always will - but you must honestly evaluate the impact of this relationship.

So how do I put all this together, i.e., "franchisors perspective", "franchisees perspective", "balance", "imbalance"? Here are my thoughts:

1.  If you are a franchisor, focus on the development of a balanced franchise agreement that fosters the maintenance, protection and growth of, both, your franchise system and business interests of your franchisees.  Once this is achieved - really achieved - then stick to your franchise agreement and be prepared to "walk-away" from potential franchise sales;

2. If you are a prospective franchisee and you have viable questions or concerns about a potential franchise investment (after you have conducted the necessary due-diligence and evaluated the legal implications of the franchise agreement) then be prepared to "walk away" . 

The real issue comes down to a "third scenario" involving  a "franchisor not prepared to walk-away" or a "franchisee not prepared to walk away".  These are the situations where negotiations and targeted franchise agreement modifications come in.  For that prospective franchisee I would much rather obtain targeted franchise agreement modifications that I know will have a substantive impact on the prospective franchisees rights.   I think that Mr. Libava's position would be that  there should not be a third scenario?

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