Important Legal Considerations in Franchise Agreements and Contracts

Buying a franchise is a big commitment. Here are five of the most important things to understand when signing a legally binding contract or franchise agreement.

By Morgan Wood1851 Franchise Contributor

7:07AM • 08/14/24

After weeks, months or even years of research, many franchisees are ecstatic to sign their franchise agreement and get into business. It’s an exciting time, but it’s important that you don’t get swept away by the excitement before taking an objective look at the commitment you’re about to make. Understanding exactly what you’re agreeing to will make the process smoother for everyone involved and will certainly be helpful in your search for long-lasting entrepreneurial success. Here are some legal considerations you should pay attention to when analyzing your franchise agreement.

Intellectual Property

Intellectual property (IP) is at the heart of a franchise agreement. For a franchisee to get the benefits of the franchise model, they must adopt the franchisor’s intellectual property — operational procedures, marketing strategies, slogans, logos and other branding.

“The most significant IP issue to look out for when considering buying a franchise is whether the franchisor has its trademarks registered on the principal registry of the USPTO [United States Patent and Trademark Office],” said Ryan Whitfill, partner at Culhane Meadows. “If not, then the franchisee is at risk of having to change names/marks at some point if the franchisor’s rights to its name/marks are challenged by a third party.”

Both the franchisor and the franchisee need to have a clear understanding of how and when the IP can be used, as well as what is and isn’t off limits. Giving clear expectations for how a brand’s logo should or shouldn’t be used, for example, helps maintain consistency throughout the system and ensures that the brand is not misrepresented.

“As for IP requirements stated in the franchise agreement itself, virtually all franchise agreements include the same basic requirements, which [are] that the franchisee can only use the marks specified by [the] franchisor, and franchisees can only use those marks in accordance with the franchisor’s instructions and standards/specifications,” Whitfill added.

By explicitly outlining what is and isn’t acceptable in the franchise agreement, franchisors can set their franchisees up for success and protect themselves from any sort of ambiguity defense should action need to be taken later on. Having these guidelines on paper also protects the franchisor’s IP if a franchisee decides to create an independent business.

Territorial Rights

Each franchise agreement should outline the rights a franchisee has within their territory. While a franchise purchase inherently places the new owner within a given territory, that does not necessarily mean that they are the only business of their kind operating in the area.

There are three primary types of territories: protected, exclusive and open. Depending on the model outlined in the franchise agreement, protections can range from a franchisee being the only owner allowed to operate that business in a given geographic area to the franchisor being allowed to open its own unit right across the street and cannibalize the business of the franchisee.

“A franchisee should review the FDD [franchise disclosure document] and franchise agreement territorial protection provisions to get an understanding of the following: (a) Does the franchisor actually grant franchisees a protected area (some do not); (b) What are the specific boundaries of the protected area that will be granted to the franchisee; (c) Does the franchisee have to meet any minimum performance requirements in order to maintain its rights in the protected area: (d) What specific protections are granted to the franchisee within the protected area; and (e) What rights does the franchisor reserve to itself within the franchisee’s protected area?” Whitfill said.

Personal Guaranty

Some franchisors require franchisees (and their spouses, when applicable) to a sign personal guaranty. This means that, if franchisees don’t meet their financial obligations, their home, wages and other assets may be up for grabs if the franchisors choose to recover what they are owed.

“Franchisees may wish to try to avoid signing a personal guaranty, but most franchisors will not agree to execute a franchise agreement unless it is accompanied by a personal guaranty,” Whitfill said.

While creating an LLC or corporation for the business can help owners protect their assets from third-party liabilities, it does not excuse franchisees from their commitment to the franchisor as “virtually all franchisors will require the LLC’s or corporation’s owners to sign a personal guaranty,” Whitfill said.

Non-Renewal or Transfer of Rights

Franchise agreements come with a set time frame, and franchisees have certain obligations should they choose to 1) step away from the business before the end of the term or 2) choose not to renew the agreement at the end of the term.

Again, all franchise agreements are unique. Some franchisors guarantee franchisees an opportunity to renew their agreement should they wish, while others take more of a discretionary approach. Franchisees may also have an opportunity to transfer their franchise to another person (often a friend or family member), giving them the rights and responsibilities associated with the business.

“Franchisees should check to make sure they understand all features of their renewal rights, such as: (a) How many renewal option periods do they have under the franchise agreement; (b) How long each renewal period lasts; (c) What is the required renewal fee payable to the franchisor; (d) What other actions are required in order to be eligible for renewal (e.g. complying with the agreement terms, updating the business, giving the franchisor a certain amount of prior notice of intent to renew, and signing a general release of legal claims are common requirements); and (e) Does the franchisor require the franchisee to sign the franchisor’s ‘then-current’ form of franchise agreement upon renewal?” Whitfill said.

He also pointed out that the majority of franchisors require renewing franchisees to sign the “then-current” version of the franchise agreement, and this agreement can have notably different terms than the original agreement they signed. Before signing their original agreement, franchisees might consider trying to negotiate the right to stay under the original terms should they choose to renew later on.

Disputes Between Franchisee and Franchisor

Many franchisors have little-to-no litigation to report. In other cases, like Subway’s, there are plenty of very public lawsuits. This is another aspect of franchising that, ideally, you shouldn’t have to worry about; the franchisor fulfills its commitments, you fulfill yours and everything goes smoothly. But this isn’t always the case, and it’s important to know how a potential legal issue will be settled should it arise.

Some franchisors require franchisees to go to court in the jurisdiction of their headquarters. Others will only solve disputes through arbitration. No matter the approach outlined in the franchise agreement, it is important that you understand and are comfortable with it.

Investing in a franchise is a major decision, and it’s often recommended that prospective franchisees seek the help of their own legal counsel. An experienced franchise attorney can help you to understand the agreement as a whole and answer any questions you may have about key legal aspects.

“In addition to working with a franchise attorney, all prospective franchisees should read the entire FDD, do their own due diligence and talk to as many existing franchisees in the targeted franchise system (and former franchisees if there are any listed in the FDD) as possible,” Whitfill said. “Those existing and former franchisees are a very valuable source of information.”

With the help and perspective of both legal experts and business owners who have experienced the franchise system firsthand, you can approach the decision with full information and confidence.

For more information on franchise legal issues, check out these related articles on 1851 Franchise: