Chapter 5: Franchise Legal Considerations

Understanding key legal components before going into franchising can set both brands and prospective franchisees up for success. 

Before diving into the world of franchising, it is important to understand the complex landscape of franchise legal considerations. From franchise agreements and disclosure documents to intellectual property protection and compliance with local regulations, understanding the legal framework surrounding franchising is essential for both franchisors and franchisees. 

1851 Franchise spoke to industry experts to explore the key legal considerations that should be at the forefront of your mind as you embark on your franchise journey, ensuring a solid foundation for a successful and legally compliant franchise operation.

Most Important Things to Look for in an FDD

A franchise disclosure document (FDD) is one of the most important tools a prospective franchisee has to evaluate a franchise brand. Serving as a comprehensive resource, FDDs provide crucial insights into every aspect of a franchise operation that franchisors are legally obligated to disclose to investors. FDDs serve as the primary, and sometimes sole, place to find potentially damaging information about the brand that could affect franchisees. Franchisees should carefully examine all of the information provided, but there are key areas that they should examine even closer. 

Item 20, which includes information about outlets and franchisees, is one of these areas, said Tom Spadea, a founding partner at Spadea Lignana Franchise Attorneys.

“Nothing is going to teach you more about the culture of the system, or whether the franchisor fulfills their brand process, as much as talking to the franchisees,” said Spadea. “Every professional that you meet, whether it's the salesperson or the executives, will have a vested interest in you signing. Talking to franchisees is where you learn the most. Don’t skip that step or try to shortcut it by sitting on some sort of group conference call or reading about it.” 

Item 3, or Litigation, is another key area to review. This is where a franchisor is required to disclose certain current and past lawsuits that the franchisor or its predecessors, affiliates, parents or individuals on the leadership team were involved in or subject to. In one example from Spadea, if a 2,000-unit brand has a couple pieces of litigation, that could be reasonable. But a 50-unit brand with three pieces of litigation is a red flag. 

“Having substantial litigation certainly tells a story,” added Kim Ellis, vice president of Franchise Development & Legal at Bruster's Real Ice Cream. “If you don't have any litigation, it tells me that the franchise works hard on maintaining and building a strong franchisee franchisor relationship.” 

Ellis also noted that Item 2, The Leadership Team, is something to pay attention to. Prospective franchisees can learn about whether the team has experience in running a franchise and whether they have experience in a specific industry.

Best Practices for Drafting and Negotiating Franchise Agreements

The franchise agreement serves as a legally binding contract between the franchisee and the franchisor. It outlines the expectations and responsibilities of both parties and includes the franchisor's specific requirements from a franchisee. When it comes to drafting and negotiating, Spadea recommends both franchisees and franchisors not go into it expecting to change much. 

“You shouldn't be expecting to come in as a franchisee and change things,” he said. “A franchisee that gets a franchisor to change too much is probably buying into the wrong system. It is okay to include a few important and personal requests, not systemwide requests. And from the franchisor perspective, franchisees who ask for too much are probably not the right ones.” 

Ellis even goes as far to say that there should not be negotiating. 

“My advice would be not to negotiate,” she said. “The more versions of an agreement you have out there makes it very hard to track who got what and it puts a strain on the support system. If a franchisee signs a regular agreement and finds out someone else got a better deal, how does that look? I want to be able to look everyone in the eye and say they got the same deal.” 

Ensure Compliance with Federal and State Franchise Regulations 

It is important for franchises and franchisees to be sure they are complying with all regulations at the state and federal level. The best way to do that is by working with a franchise-specific attorney, said Ellis. 

“Having a franchise-specific attorney is going to make your franchise organization stronger because the state and federal laws are always changing,” she said. “We have to make sure that our registration documents are up to compliance with those changes.”

Additionally, Spadea recommended having a system in place that ensures a brand knows where they're registered, when those registrations expire and that they're properly disclosing this to candidates in a timely manner. 

“Brands shouldn't be depending on Word documents or a chart in the FDD that shows where they are registered,” he said. “They should have some sort of system that is attached to a calendar app that tells them when they're registered and when they will expire. It's very easy to disclose someone on the wrong or stale document.”