Emily Wright and Caroline Young stress the importance to any successful franchise of getting the property position right from the start
Some of our most recognisable high-street brands are franchises, particularly in the food and drinks industry, including giants such as McDonald’s, Costa and KFC. It is growing in popularity as a business model, with an industry annual turnover of more than £13bn and nearly 40,000 outlets. Franchisees are attracted by the opportunity to set up on their own, but with the support of an established brand and business model. For brand owners, franchising brings the opportunity to expand their brand without incurring the costs of taking on new premises or setting up distribution channels.
However, the model is not without its risks. From the outset, both franchisees and franchisors need to address all the key issues – including payment structure, use of branding, control and support. For this reason, franchise agreements can run into hundreds of pages – and getting the property aspects right can make all the difference to the success of a franchised business.
If the franchisee takes the lease
Although it might be attractive for the franchisor simply to license the use of its brand and allow the franchisee to deal with the property aspects of setting up and running the business, there are pitfalls to this approach, not least the franchisor’s lack of control over lease terms, which could well affect how the business is run in practice.
The landlord may, where an unproven franchisee is taking the lease, seek additional security by requiring the franchisor to stand as guarantor (cancelling out any benefit for the franchisor) or insisting that a hefty rent deposit is provided, increasing the upfront costs for a franchisee who may have already paid many thousands of pounds. The franchisor also needs to consider what it needs to do to protect its brand and how it will recover the property and preserve continuity of trade if the franchise agreement ends.
Finally, consideration needs to be given to whether the franchisee has the financial and management ability to comply with other obligations that come with letting a property, such as keeping it in good repair and in accordance with health and safety legislation. A property that is run-down or poorly fitted out will not be a good advertisement for the brand.
If the franchisor takes the lease
For these reasons, it is increasingly common for the franchisor to take the lease and underlet to the franchisee, giving increased control to the franchisor and comfort for the landlord of granting a lease to a company with a proven record. However, in this scenario it is even more important that the lease and franchise agreement fit together in a coherent manner.
Any landlord will want to know that all covenants and terms from the lease are included in the underlease and will be met by the franchisee, ideally with the franchisee providing a direct covenant to aid the landlord with enforcement. The franchisor, however, will want to minimise the time and cost implications for itself by requesting that any underlease to a franchisee can be granted without the landlord’s prior consent.
If the franchisor wins this battle, the landlord can try to achieve certainty as to the terms by requiring a form of underlease to be annexed to the lease. The landlord would want to see terms included preventing the underlease being granted to anyone who doesn’t have a current franchise agreement in place, prohibiting any assignment or further underletting, obliging the franchisor not to waive any breach or vary the terms of the underlease, and requiring the premises to be traded under the franchisor’s brand name.
A lease of a shopping centre may also contain a landlord’s right of pre-emption, allowing the landlord a right of first refusal whenever a tenant wants to assign or underlet its unit to preserve tenant mix and help with the active management of the centre. However, the franchisor is not going to want to go through the pre‑emption procedure (which can often last months) every time the franchisee changes. The termination of a franchise agreement (and related underlease) and the grant of new ones should be specifically excluded from this procedure.
At the end of the day
What happens when the franchise agreement comes to an end is also worth considering, whether this be by effluxion of time or because the parties want to get out of the arrangement. The franchisor will need a right to terminate the underlease during the term as soon as the franchise agreement ends, which could be difficult if the underlease is within the protection of sections 24-28 of the Landlord and Tenant Act 1954 (“the 1954 Act”) as any break clause to end the lease will end only the contractual lease; a section 25 notice is needed to end the statutory lease imposed by the 1954 Act, with the available grounds for such a notice restricted by law and the notice periods often longer than those anticipated under the break clause.
If the intention is that the franchise agreement ends at the same time as the lease and the parties then renegotiate the arrangement, the 1954 Act could again cause an issue by allowing any tenant in occupation at the end of the term the right to a new lease direct from the landlord. The safest option is to ensure that both the lease and the underlease are excluded from the 1954 Act, although this does mean that whether the business gets a new lease of the same premises is entirely in the gift of the landlord.
The key to a successful franchising arrangement on both the commercial and property fronts therefore has to be to ensure that as much as possible is thought through and documented at the beginning of the relationship, and that all aspects of how the franchise will be run are given ample consideration.
Emily Wright is an associate and Caroline Young is a solicitor at Cripps
