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WHAT DOES YOUR FRANCHISE LAWYER REALLY DO FOR YOU?

Written by Business Franchise magazine

By Mark Sherry, Harmans Lawyers

WHAT DOES YOUR FRANCHISE LAWYER REALLY DO FOR YOU?

AND HOW MUCH WILL IT COST?

One of the most enjoyable parts of being a lawyer is that every day is different. Being a lawyer who specialises in franchising, I am fortunate in that I get to meet a large number of interesting people who operate businesses across many sectors.

In New Zealand, there are a huge number of different franchise systems available. Each system brings with it its own subtleties. Just as no two franchises are the same, no two franchise documents are the same. Therefore, when the phone rings and a new client is on the end of the line asking to come and see me about a franchise system, it is very hard to answer the question, ‘How much will it cost me to do this?’

Unlike a house purchase transaction, which has fairly standard procedures to follow, and thus usually commands around the same legal fees, the same cannot be said for a franchise. Therefore, I will categorise the different levels of work involved for different types of franchise transactions. This will help to illustrate the wide variance of costs involved.

An owner operated franchise system with no employees and no premises

A franchise transaction is at its most basic when the person buying a franchise does not intend to employ other people and they do not intend to lease premises to operate from. Often a ‘one-man band’ type franchise like this occurs for a service-based business, such as home services and cleaning franchises. In this case, when a client comes to see a lawyer, there are three main things that need to be reviewed and discussed:

• The first of these is the Franchise Agreement. In every transaction, a Franchise Agreement will need to be reviewed and explained to a client. They are tailored to fit each franchise and there is no ‘one-size-fits-all’ document. Franchisors and franchisees have different needs and obligations in every franchise system, so agreements can vary in length from around 30 pages through to 200 pages or more.

In many instances, franchise systems that have come to New Zealand from Australia will have more complicated documentation to review, as often such documents are largely taken from the highly regulated Australian system and converted to fit New Zealand’s laws. This adds to the complexity and thus the cost of reviewing the paperwork.

Therefore, it is difficult to give an estimate of what the process will cost until the Franchise Agreement has been sighted.

• The second consideration is the business structure. If a franchise system has a sole operator with no employees, the structure can be kept simpler than one that would be required for larger operations having more people involved and higher turnovers.

However, a decision still must be made as to whether a franchisee wishes to operate as a sole trader, a partnership or as a limited liability company. If the partnership or company option is chosen, this will involve further work for the lawyer in either preparing a partnership agreement, or helping to form the company.

• The third item in which a lawyer often has involvement with, in most franchise transactions, is the finance. Unless a franchisee is paying cash to finance their purchase and working capital, there will be a need for a loan. Loan agreements will be prepared and executed and, in many cases, the loan will be secured against the family home.

A lawyer will usually be required by the bank to put the mortgage in place and to provide advice to the franchisee about the loan agreements and guarantees they are signing.

An owner operated franchise system with employees and no premises

This type of franchise involves an extra layer of complexity and this brings with it more complications.

We can assume that because employees are involved, the turnover of the franchise will be higher and, therefore, the return to the franchisee will be higher. In addition to the work under the first scenario, a lawyer may wish to undertake the following tasks:

• First, they should conduct a more in-depth review of the business structure. Whereas under scenario one, a franchisee may have been quite comfortable trading as a sole trader or in a partnership, which employees are involved, the benefits of using a company will outweigh the compliance costs of having one.

The way a franchisee owns their own personal assets, such as their family home and other investments, should also be reviewed. A lawyer will often talk to the franchisee about the benefits of a Family Trust.

• Secondly, the impact of the employment legislation in New Zealand must be considered. It is now a requirement to have a written employment contract in place with every employee of a business.

• Finally, for franchisees who have never been employers before, there is a steep learning curve with things like pay roll systems, tax payments, holiday entitlements and so on.

A prospective franchisee should always heed the advice of their lawyer on such matters, as the costs of getting something wrong can be disastrous for a business.

An owner operated franchise with employees and premises

The introduction of premises adds a further layer of complexity. When a franchise system involves a retail operation, including employment of people and the leasing of premises, it can end up being a reasonably large sized operation.

Agreements for such operations involve more content and take more time to review. Again, it will be important to review the matters discussed earlier. It is most likely that financing will be required and the structuring of the business becomes a very important matter.

In addition to all of this, a lease for the premises must be put in place. In some franchise systems, the franchisor signs the head lease of the premises and then subleases them to a franchisee. However, most franchisees will negotiate directly with a landlord. Many Franchise Agreements contain speci?c terms relating to leases and will require additional clauses to be inserted into the lease. As such, a Franchise Agreement should always be reviewed before a lease is signed.

There are always methods a lawyer can use to try and minimise a tenant’s liability in a lease, including limiting the ongoing liability of guarantors and, where appropriate, trying to ensure the landlord does not undermine the franchisee’s business by leasing other premises they own to competitors of the franchisee.

Commercial lawyers review many leases. They have significant knowledge and skills which can mimimise the risk and maximise the benefits for the franchisee. All too often, a lease agreement is signed before a lawyer is asked to have input. If this occurs, it is usually too late to insert clauses which would have been of real benefit to a tenant.

The most effective time to negotiate with a landlord is before the agreement to lease is signed. Many leases for stand-alone premises use a relatively standard form Deed of Lease, but whenever the premises being leased are in a mall or other large complex, different types of lease forms will often be used.

SUMMARY

The amount of time and effort a lawyer will need to dedicate to a particular franchise venture will depend on the complexity of the Franchise Agreement, as well as the nature of the transaction and all of the accompanying legal elements involved.

Franchisees only get one chance to set things up correctly. Taking proper advice from an experienced franchise lawyer is an integral part of this process. The input a knowledgeable lawyer can contribute will be invaluable.

However, a client should never be afraid to ask a lawyer what a transaction may cost. A lawyer should give a client an estimate for reviewing the Franchise Agreement and producing an initial report.

After the lawyer has done this initial review and the contents of the Franchise Agreement are known, then the extent to which a lawyer will need to be involved will become much more clear. This will enable the lawyer to give a more accurate estimate of what the legal fees will be for the balance of the transaction.

Start-up costs, including legal costs, are often higher in the more complex franchise transactions. Provided they do not come as a surprise, these costs should be seen by a franchisee as an investment in the business and a necessary part of joining the franchise system.

Mark Sherry, LLB (Hons), BCom, is a Partner with Harmans Lawyers New Zealand. He leads the commercial and property team, specialising in franchising, hospitality, rural law, property matters and asset protection.

Harmans is a full service legal ?rm providing excellent service and advice, allowing Harmans to develop long-term, solid relationships with their clients.

For more information please contact: Mark Sherry Phone: 03 352 2293 Mobile: 021 524 890 Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it Web: www.harmans.co.nz

SUCCESSFUL RELATIONSHIPS

Written by Business Franchise magazine

By Ronette Druckovich, Rainey Collins

SUCCESSFUL RELATIONSHIPS

Bob was sold on a franchise that promised to grow and flourish despite the ever-changing economic climate. The franchisor presented Bob with the franchise agreement for signing. He was told that the agreement was the same for all franchisees and no changes would be made to it. Bob read the agreement and had some concerns, but ?gured that as others appeared to be operating and succeeding under its terms, so could he. He signed and his franchise adventure began.

After a number of months, sales were increasing and profit was growing, but larger and larger percentages were being given away - to the franchisor. Under the terms of the franchise agreement, the more successful Bob became, the more value he was required to share with the franchisor. Bob started to feel disenchanted and bitter. He felt cheated out of his hard-earned pro?t. His feelings affected his dealings with the franchisor and their relationship began to breakdown, threatening the future success of the franchise.

How could this happen?

In general, a number of fees will be payable to your franchisor on an ongoing basis. It is generally accepted that this is the very nature of a franchise. These fees most often go towards marketing and royalties, but also provide for the ability to continue systems development and the like. Often these fees are not stated in monetary terms, but are instead outlined as a percentage of gross sales. This means that as sales increase, so do the fees a franchisee has to pay.

Also, if these percentages are not capped in the agreement, franchisors can increase fee percentages as often as they wish and to the extent they desire. This happened to Bob and it left a sour taste in his mouth.

What can be done?

While a franchisor will want to retain as much discretion as possible when it comes to these matters, it is important to remember that the success or otherwise of the relationship is largely dependant on the fairness of the terms of the franchise agreement. Any agreement that is too one-sided can ultimately be counter-productive for the franchisor. Including terms that are likely to create resentment when they come into play, leads to disgruntled franchisees and can reduce the attractiveness of new franchise opportunities. Instead, being open to consider franchisees concerns when finalising the terms of the arrangement can ultimately be in the franchisors best interests.

What does this mean in terms of fees?

From a franchisor’s point of view, it is important to retain flexibility and discretion when it comes to taking a percentage of earnings from franchisees. Franchisors need to be able to make the most of opportunities likely to benefit the franchise as a whole, as and when they arise. They must also have funds to be able to do so. Franchise fees also recognise and reflect the value of the prior and future skill and effort expended on the business by the franchisor. However, they must be fair.

A balance must be struck in order to facilitate a good and constructive working relationship. To help achieve this balance, we recommend providing reasonable parameters within the franchise agreement in relation to fee increases. For example, provide provision for nil increases in the first 18 months of the agreement. This allows the franchisee time to get their business operating well. Further, the parties can agree to incremental increases capped, for example, at a maximum of two per cent of gross sales per annum.

‘Fair’ is good business

At the end of the day, franchise terms should be a true, and not inflated, reflection of the value provided by the franchisor. This is not only in the best interests of the franchisee. It is also a protective measure for the franchisor. Large fees create substantial expectations, and franchisees could rely on these in court as a challenge to the extent of involvement in, and enhancement of, the franchise by the franchisor.

Fair terms and concessions give rise to good working relationships, which are absolutely vital to the success of a franchise. If, like Bob, you accept unfair fee structures at the start, you might find the sour taste it leaves destroys your passion for your business and could ultimately destroy your business itself.

Ronette Druskovich is a Senior Associate with Rainey Collins. Her specialities include franchising, property, leasing and all aspects of business law.

Rainey Collins has been providing quality professional legal services to business people like you since 1919.

For more information please contact: Ronette Druskovich Phone: 04 473 6850 Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it Web: www.raineycollins.co.nz

DEALING WITH FRANCHISE DISPUTES

Written by Business Franchise magazine

By David Foster, Harris Tate Solicitors

DEALING WITH FRANCHISE DISPUTES

The franchise relationship is often referred to as a marriage (whether rightly or wrongly). As we know every relationship, including marriages, have their good times and their bad times. Sometimes people get grumpy with each other for no reason or because of miscommunication or because of well, virtually any reason.

A dispute need not be a big issue in franchising

One of the features of a franchise system that is a member of the Franchise Association of New Zealand (FANZ) is the required dispute resolution procedure. FANZ requires a speci?c dispute resolutions procedure to be incorporated into its member’s franchise agreements, along with various other items designed to promote a better standard of franchising.

In essence, the dispute resolution procedure required by FANZ specifies a mediation if the franchisor and franchisee can not work things out between themselves. Mediation is an established dispute resolution procedure designed to enable the parties to come together and with the help of an entirely independent and experienced person, (the mediator), achieve a resolution of the matter of annoyance between the two parties involved. Legal representation may be required as well during this meeting.

The process is similar to family guidance counselling but on a business level. It provides the following:

a forum to air one’s dispute
an opportunity to hear the other party’s response
a safe environment
a procedure to work out a resolution (with the help of the mediator)
the ability to continue the business relationship – if this is the desired outcome
a formula to terminate the business relationship on a mutually agreeable basis

Greg Nathan, the highly respected international franchise expert and corporate psychologist, has an unsurpassed understanding of the franchise relationship. Greg has written several books on franchise disputes. A number of these are available from the Franchise Association website at www.franchiseassociation.org.nz.

Your franchise agreement (provided you are entering a relationship with a FANZ member) will have a disputes resolution clause containing either the required FANZ wording or a reference to the FANZ required disputes resolution procedure.

If you are not dealing with a FANZ member, matters may be (and more often than not are) quite different. If you are considering contracting with a non-FANZ member, make sure that your solicitor completely understands franchising and the reasons why FANZ membership provides such a bene?t to a franchisee. If your solicitor does not understand this, go and see a solicitor who does. For your own protection, your chosen solicitor should have an expert knowledge of franchising.

Disputes occur for a number of common reasons

1. Poor (or non-existent) franchisor support. Typical of a poorly setup system (from a franchisee’s point of view) is where there is a fee charged for the initial grant and then either no ongoing fees or set fees payable on say a monthly basis. With this scenario, clearly there is no financial benefit for the franchisor to help the franchisee achieve greater sales. So why would he? Will he? More often than not the answer is in the negative to both questions. There are, however, some highly reputable systems that do work on this basis. Complaints often heard in the ‘failure to support’ area generally follow a similar pattern. Franchisee complaints go something like this “He took my money and I have only seen him twice in the last two or three years. I get an occasional email saying my figures aren’t up to scratch.” Ongoing support and training should be a ‘given’ for any franchisee.

2. Poor advertising programmes. National advertising is usually something under the sole control of a franchisor. If national advertising is undertaken, generally it is not cheap. A television advertisement is an expensive thing to put together and to broadcast. Franchisees seeing this expense and no financial return clearly get upset. Similarly, large newspaper/ magazine advertisements, as well as offers of discounts, can be disappointing when they do not pull in the anticipated numbers. If continued advertising campaigns fail, franchisees become disheartened and disgruntled.

3. Not enough money coming in. You can just about bet that the reason for general unhappiness is there being insufficient money or less than expected money. A franchisor who oversells the projected financial performance to a potential franchisee is obviously marching down the route to a dispute. In difficult economic times all businesses suffer, but a good franchisor will be really stepping up their game to help their franchisees at least continue to achieve the same bottom line. Committed franchisors will help their franchisees to increase both market share and profit. There are a number of franchises that are really excelling at the moment. The old saying ‘money sops up the blood’ is very true in any financial relationship. If the returns to the franchisee do not reach those claimed, or if they decrease, then matters which may have irked whilst there was plenty of money sloshing around will soon come to the fore. Franchisors beware!

There are a number of franchise systems that commonly appear on my ‘complaints list’. These are generally run by people who:

have little business franchise experience or knowledge
have not established their system with the appropriate input of professional franchise consultants and experienced franchise lawyers
care little for their franchisees
deliberately churn

Your specialist franchise lawyer will be able to assist you with any concern you have regarding such systems and can advise you as to whether indeed the system you are looking at slips into any of the above categories.

Conflict resolution

One of the benefits of buying a franchise is the amount of advice available from specialists in the franchise community. Such advice can help you make a better business purchase choice.

From a practical perspective, the disputes procedure contained in most franchise agreements (and all FANZ member’s agreements) gives the following bene?ts:

•It is a way of terminating the relationship on terms agreed by the parties, with such agreement being achieved through the mediation process.

• It avoids costly litigation. Under current rules, any application to the District Court will result in the court requiring a compulsory settlement conference as part of the judicial process. It is also likely that the High Court (with jurisdiction above a $200,000 claim) will eventually have a compulsory settlement conference process included in its rules. Having a compulsory mediation process in the franchise agreement does away with the need to issue (or defend) costly court proceedings to get to the same result.

• The process by and large produces mutually acceptable outcomes.

• The process reduces the costs incurred by each party, compared to going through the judicial process.

• Going to court is for most people a very emotional and stressful time. Mediation is a significantly less stressful process.

• Whilst producing an outcome, it is unlikely, and experience tells us this, that the parties will continue their relationship.

A properly prepared franchise agreement will contain a mediation procedure that bene?ts both parties. FANZ requires this procedure in its members’ agreements. When/if disputes arise, the mediation process works well and is an excellent alternative to court proceedings (where you may end up in compulsory mediation anyway). FANZ has a panel of quali?ed mediators with specific knowledge of franchising and the franchise relationship.

Finally, as we know, differences of opinion and/or disputes are part of any ongoing human relationship. With the appropriate clause in your franchise agreement, such matters can be dealt with in the most cost-effective and least stressful manner.

David Foster is a Director of Harris Tate Solicitors. He is the Franchise Association’s Co-ordinator for Waikato and the Bay of Plenty. David is a frequent speaker and author on franchising and regularly appears on television on franchising and business matters.

Harris Tate is a well-established law ?rm. Their knowledge, experience and way of working contribute signi?cantly to the success of their clients.

For more information please contact: David Foster Phone: 07 571 3668 Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it Web: www.harristate.co.nz

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