What Is a Franchise Agreement?


Written by: Rachel Vanni
Legally Reviewed by: David Curle and Jennifer Tsai

November 9, 2020

4 minute read

A franchise agreement is a legally binding contract that dictates the terms, circumstances, and obligations between a franchisee and a franchisor. The power dynamic between the franchisee and franchisor is different than a typical contracting relationship. Often, franchisees have little to no room for negotiation when purchasing a franchise. Whether signing or drafting a franchise agreement, it is vital to understand the contract components.

Terms of a Standard Franchise Agreement

When entering into a franchise agreement, the franchisee agrees to abide by certain obligations and regulations to use a proven business model; each section of the contract lays out these provisions. Understanding the terms and what they mean is vital to a smooth franchise partnership. Some key terms of franchise agreements are outlined below.

Grant

Once a party enters into a franchise agreement, the franchisor grants them restricted use of select trademarked images such as logos, slogans, images, and other items associated with the brand. A party is also allowed to use the franchise’s operating procedures laid out in detail within the agreement. This grant does not provide unbridled use, so the limitations and expectations must be clearly stated within the contract.

For example, a Chipotle franchise owner may be allowed to use images and logos to run specific promotions on social media but not to create custom apparel for the location.

Territory limits

This term lays out the franchisee’s territory in a specific area. If a franchisor has multiple locations close to each other, the franchisor needs to clearly define territory limits for a franchisee choosing a brick and mortar location.

For example, some franchised fast-food chains have in-mall locations as well as a freestanding restaurant outside of the parking lot. The owner of the mall location may be allowed to place signage only within the mall’s interior while needing corporate approval to place signs in the parking lot near the freestanding location.

Infographic: Franchise Agreement 101

Time period and renewal

Most franchise agreements expire within a dictated length of time after signing. The contract stipulates renewal rights for those who wish to be bound by the arrangement long term.

Safety of proprietary data

One of the most valuable assets any company owns is their intellectual property and proprietary data. While the franchisor grants a temporary license for the franchisee to use intellectual property, the agreement should state specific language that protects the dissemination of confidential data and other trade secrets.

For example, a franchise owner usually receives privileged information about operating procedures, customer information, or other potentially sensitive data in the course of their job. The agreement should bar the owner from distributing that information to those outside the franchise.

Defaults, damages, and criticism limitations

Franchise agreements often stipulate strict regulations forbidding the franchisee from criticizing the brand. The agreements also lay out a framework for handling breaches. In some cases, breaches could result in an immediate termination of the contract with no reimbursement to the franchisee.

Sometimes criticism takes a form not related to the brand itself but involving the company’s political stance. For example, many customers recently criticized Wendy’s after a franchisee made a controversial political campaign donation. If a brand wants to avoid political controversy, it may forbid franchisees from making campaign donations or large investments without approval.

Franchisor’s right to first refusal

If a franchisee decides to sell or transfer their business, the franchisor will have the right to purchase the enterprise first. They may choose to exercise their right of first refusal or allow the franchisee to transfer their interest.

For example, if a McDonald’s franchise owner decides to sell, they would need to give McDonald’s the offer to purchase the franchise before seeking other buyers.

Indemnification

One of the most important terms within a franchise agreement is an indemnification covenant. This term states that a franchisee will reimburse the franchisor for losses relating to negligence or wrongdoing. A franchisee must understand the expectations and adhere to safety regulations relating to operation.

For example, imagine that a franchise owner continually serves food past its expiration date, and sick customers sue for damages. The franchisee would need to reimburse the franchisor for any losses they experience due to the franchisee’s negligent oversight. Many franchise owners purchase indemnity insurance to help cover these potential losses.

Non-Compete Clause

It is common for a franchise agreement to contain provisions relating to non-competition. A non-compete clause prohibits a franchise owner from opening a similar business within the industry within a certain distance of the franchise and/or for a specified amount of time. The level of restriction of a non-competition clause varies from state to state.

Termination

Every franchise agreement should contain a termination clause that dictates how the parties can end their contractual relationship. It will include key terms relating to the timing of notice, the procedure that must be followed, and how any damages from early termination may be handled.


Conclusion

Franchise agreements can be complicated. Any individual entering into a franchise should thoroughly review the contract and direct questions to qualified legal counsel.