What does your franchise lawyer really do for you?
And how much will it cost?
This article was written by Mark Sherry and was first published in the Business Franchise Australia and New Zealand magazine, and has been reviewed and updated in April 2020.
One of the most enjoyable parts of being a franchise lawyer is that every day is different. Being a lawyer who specialises in franchising means that I get to meet a large number of interesting people who operate in businesses across many sectors.
As anyone can see from the listing of different franchise organisations in New Zealand, there are a huge number of different franchise systems that are available for people to join. Each system brings with it its own subtleties. No two franchise agreements 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 that they are interested in buying into, it is very hard to answer the question “How much will it cost me to do this?”.
Unlike a house purchase transaction which has largely standard procedures to follow so that a relatively accurate price range can be given at the start of a transaction, the same cannot be said for a franchise. During the course of this article, I will attempt to set out different levels of work involved in different types of franchise transactions to illustrate why this is the case.
1. An Owner Operated Franchise System with no Employees and no Premises
As one might imagine, from a legal perspective a franchise transaction is generally at its most basic when the person buying a franchise does not intend employing other people and they do not intend leasing premises to operate from. Often a “one man band” type franchise like this occurs for a service based franchise, such as home services and cleaning franchises. In that 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. Further, the Franchise Agreement for every system is different. Franchise Agreements are tailored to fit each franchise and there is no “one size fits all” Franchise Agreement. The reason for this is that franchisors and franchisees have different needs and obligations in every franchise system. Franchise Agreements can vary in length from 30 odd pages through to 200 pages. It is a generalisation, but in many instances franchise systems that have come to New Zealand from Australia will have more complicated documentation to review, as often such Franchise Agreements are largely taken from the highly regulated Australian system and are just converted to fit New Zealand’s laws. By and large, Franchise Agreements that come from Australia are considerably longer because of the Australian obligations that they must comply with.
Therefore, if a client rings up to have a Franchise Agreement reviewed, it is very difficult to give them an estimate of what it will cost to do this until the Franchise Agreement has been sighted. At the very least, the range would be quite large.
Secondly, regardless of whether a franchisee is going to be a one man band or not, a lawyer should talk to their client about the business structure that they wish to operate under. Often, when a franchise system has a sole operator with no employees, the structure can be kept simpler than a structure that would be required for larger operations that have more people involved and higher turnovers. However, there still needs to be a decision made as to whether a franchisee wishes to operate as a sole trader, or in a partnership or as a limited liability company. If the partnership option or the company option is chosen, this will involve further work for the lawyer in either preparing a Partnership Agreement, or helping to form the company. Each option has its pros and cons.
The third item that 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 often be a need for a loan to be raised. At that time loan agreements will be prepared and executed and, in many cases, the loan will be secured against the family home. In all likelihood a lawyer will be required by the bank to be involved to put the appropriate mortgage in place and to provide advice to the franchisee about the loan agreements and guarantees that they are signing.
2. An Owner Operated Franchise System with Employees but without Premises
The second scenario is not much different from the first one, but it involves an extra layer of complexity and this brings with it more complications. One could reasonably assume that because employees are involved, the turnover of the franchise will be higher and therefore the return to the franchisee will be higher. Therefore, in addition to the comments made under scenario 1 above, there may well be reason for the lawyer to undertake the following tasks. First, they should take a more in-depth review of the business structure. Whereas under scenario 1 a franchisee may have been quite comfortable trading as a sole trader or in a partnership, it is more likely that when employees are involved that the benefits of using a company will outweigh the compliance costs of having one. There may well also be good reason to review the way a franchisee owns their own personal lifestyle assets, such as their family home and other investments. A lawyer will often talk to the franchisee about the benefits of a Family Trust.
Secondly, the other obvious implication of involving employees is the impact of the employment legislation in New Zealand. There is now a need to have a written Employment Contract in place with every employee of a business. There are also subtleties involved if an employer wishes to obtain the benefit of the 90 day trial period when hiring new employees. If the correct procedures are not followed, then you can lose the benefit of that trial period. Finally, for the franchisees that have never been employers before, there will be a steep learning curve to come to grips with things like pay roll systems, tax payments, holiday entitlements and so on. A prospective franchisee should never be concerned about taking advice from the lawyer on such matters, as the costs of getting something wrong can be disastrous for a business.
3. An owner operated franchise with employees and premises
Just as when employees are introduced into the mix, the introduction of premises into the mix adds a further layer of complexity. It would be fair to say that when a franchise system involves a retail operation, the employment of people and the leasing of premises, that it can end up being a reasonable sized operation. Franchise Agreements for such operations tend to involve more content and therefore are longer and take more time to review. Again, it will be important to review the matters discussed earlier. In particular, it is more likely in such scenarios that financing will be required. Also, the structuring of the business becomes a very important matter.
In addition to all of this there is also the need to put in place a lease for premises that the franchisee wishes to operate from. Some franchise systems will have the franchisor taking the Head Lease of the premises and then subleasing them to a franchisee. However, most franchisees will negotiate directly with a landlord. Many Franchise Agreements contain certain specific terms relating to Leases and clauses that they require to be inserted into those Leases. Therefore, a Franchise Agreement should always be reviewed before a lease is signed. Further, there are always methods a lawyer can use to try and minimise a tenant’s liability in a Lease. Such areas include limiting the ongoing liability of guarantors and, where appropriate, trying to ensure that the landlord does not undermine the franchisee’s business by leasing other premises they own to competitors of the franchisee.
Commercial lawyers review a lot of leases and have significant knowledge and skills that should be harnessed before an Agreement to Lease is signed. All too often an Agreement to Lease is signed before a lawyer is asked to have input, and at that stage it can be 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. It should also be noted that not all leases are the same. A lot of 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 then different forms of Lease will often be used that are again more complex and involve more time for a lawyer than the simple standard form.
As can be seen from the different scenarios above, a lawyer’s involvement can vary to a great extent, depending not only on the complexity of the Franchise Agreement, which they will have to review in every case, but also on the nature of the transaction and the other legal elements involved.
Franchisees only get one chance to set things up the right way at the outset. Taking proper advice from an experienced franchise lawyer is an integral part of this as the input they can give will be invaluable. Equally however, a client should never be afraid to ask a lawyer what a transaction may cost. At the very least, a lawyer should give a client an estimate for reviewing the Franchise Agreement and reporting back on it once they have had an opportunity to view the agreement. After that has occurred and the contents of the Franchise Agreement are known (whether good or not so good), then the extent that a lawyer will need to be involved in the balance of a transaction will become clearer. That will enable the lawyer to give a clearer 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 that they do not come as a surprise, then they should be seen by a franchisee as an investment in the business and a necessary part of joining the franchise system.