Franchising Agreement: key features and what to look out for when entering into one
Franchising: what this contractual model represents
Franchising—or a franchise—what associations arise when we hear these words? Naturally, one immediately thinks of a successful and profitable business model. And often that is indeed the case.
Franchising is a form of relationship between commercial entities which grants entrepreneur-users (franchisees) the right to use various intellectual property assets in their business activities—specifically, the trade name, trade mark, confidential commercial information, business reputation, know-how, software, brand books, designs and other intellectual property owned by the rights holder (franchisor)—in return for remuneration.
Under the law, a comprehensive business licence agreement (or franchising agreement) is an agreement under which one party (the rights holder or franchisor) undertakes to grant the other party (the user or franchisee), for remuneration, for the term set out in the franchising agreement or without a fixed term, a licensing bundle (licensing complex) that includes the right to use the rights holder’s trade name, other intellectual property specified in the franchising agreement, as well as undisclosed information, in the franchisee’s business activities.
Put simply, franchising entails the right to operate under another company’s brand, to use its business model and technologies, brand books and corporate identity, rules of operation and customer service, and sometimes material resources.
A franchise is a complex contractual model that has certain features both at the level of legislative regulation and outside the legal sphere, and at times has its own specifics in each separate jurisdiction. The parties do not always understand these complexities and features and sometimes make mistakes that can affect both the effective conduct of business and their business relations.
Let us consider the principal advantages and risks of a franchising agreement
Advantages
Franchising has a number of advantages for both franchisors and franchisees. The key ones include:
- A ready-made business plan
Franchisees receive a ready-made business plan, which significantly simplifies launching the enterprise. This allows them to focus on operational tasks, bypassing the lengthy process of developing and testing a business model.
- Rapid business expansion
Franchising allows companies to expand their brand into new markets and territories significantly faster than through traditional development methods. This enables companies to strengthen their presence and recognition among a wide audience.
- Joint marketing activity
Franchising removes the need to prepare advertising materials independently, as the franchisor and franchisee can cooperate in conducting joint marketing campaigns, which helps increase brand awareness in the market.
- Assistance with recruitment and training
Franchisors often offer help in searching for and selecting personnel. Moreover, the franchisor provides the franchisee with comprehensive training, enabling them to start the business with the necessary knowledge. This is important not only for a successful start but also for maintaining quality and standards of work.
- Arrangements with suppliers
Most often, when purchasing a franchise, the franchisee receives a ready list of reliable suppliers with whom cooperation has already been established.
- Minimisation of investment risks
For companies wishing to start their own business, franchising is a safer option. Investing in a successful and proven business model allows many initial difficulties and uncertainties to be avoided.
- A well-known brand name
Franchisors are most often large companies that have earned customer trust, recognition and loyalty.
Disadvantages and risks
When entering into a franchising agreement, the following nuances must be taken into account:
- Restrictions on creativity and autonomy
Within a franchising system, franchisees are required to follow established standards, methods of operation and design, which may limit the entrepreneur’s creative freedom and autonomy.
- Dependence on the franchisor
Franchisees rely on the franchisor’s support and resources, which may create dependency. If the franchisor fails to fulfil its obligations or changes strategy, franchisees may find themselves in a vulnerable position.
- Financial obligations
Joining a franchising system requires financial investment, including licence fees, royalties and other expenses. This may be inaccessible to many entrepreneurs, especially at early stages of development.
Moreover, franchisors often set prices for the entire network, so the user (franchisee) is deprived of the opportunity to raise the price of any product in order to increase profits, or to lower the price to attract additional customers.
- Strict control procedures
Franchisors usually strive to maintain high product or service quality, which may result in detailed and strict control procedures. This can place additional pressure on franchisees and complicate rapid decision-making.
- Intellectual property risks
Franchisees may face the risk of intellectual property infringement, especially if rights to the brand and methods of operation are weakly protected or if the franchisor fails to exercise control over their use.
- Reputational risks
Improper actions by one franchisee may affect the reputation of the entire network. Cases of poor service or low product quality can undermine trust in the brand.
- Transfer of knowledge and experience
It is not uncommon for franchisees, having obtained everything possible from the franchisor—knowledge and experience, development and capital—to wish to spin off into an independent network, sometimes even colluding with competitors, which leads to losses for the franchisor. To avoid such situations, it is advisable to set out clear restrictions on competition and the use of undisclosed information, including after the cooperation ends.
Franchising has many advantages, but the disadvantages must also be considered. It is important to analyse all aspects carefully and to consult experienced lawyers in advance before making a decision in order to avoid mistakes and, at the initial stage, to structure and think through the operating strategy properly.
The most common mistakes made by the parties when concluding a franchising agreement
The most frequent mistake is a failure to understand the essence of the agreement, when franchising is confused with other types of contracts—most often with a trade mark licence — or when any transfer of rights to an intellectual property asset is loosely referred to as a franchise. There is even the erroneous view that a licence agreement is a simplified version of franchising.
Although under Belarusian law the full name of a franchising agreement is a comprehensive business licence agreement (franchising), it is nonetheless a more complex contractual model than a mere trade mark licence.
The main difference is that a licence agreement is aimed at the use of only individual intellectual property assets (for example, it may include one or several trade marks), whereas the subject matter of a franchising agreement is an entire complex of exclusive rights—to a trade name, trade mark, patent, design, trade secret (know-how) — and may also include copyright works, computer programs, databases, etc.
In addition, within franchising the rights holder exercises stricter control over the use of its brand, as all users operate within a common system. The rights holder provides technical and commercial documentation, instructions and rules on brand use, monitors compliance with all adopted standards, and may control the location of the office and its fit-out, advertising and promotion, as well as business operations as a whole. The user is very limited in autonomy, since the principal business issues are decided by the rights holder, or such issues must be agreed with the rights holder.
A franchising agreement may also contain a number of restrictions on the user’s rights, for example a prohibition on engaging in activities competing with the rights holder and on selling competitors’ goods, setting prices for goods and services sold, and limiting the territory of business operations.
Another difference is that, when concluding a franchising agreement, the rights holder bears additional (subsidiary) liability for the quality of goods and services offered by the user.
In addition to all of the above, the cost of a franchise is usually higher than a licence, which is due to the fact that what is effectively obtained is a ready-made business rather than simply the right to use trade marks.
Accordingly, the distinguishing features of franchising include the following:
- it is a special type of business transaction,
- under which a licensing complex is granted (including mandatory objects and other intellectual property),
- whose parties may only be commercial entities,
- concluded for the purpose of granting a bundle of rights for carrying on business activities,
- which presupposes particular relationships between the parties.
Another significant omission is failing to take account of regional specifics in the regulation of such agreements.
Based on the statutory requirements of each particular country, the licensing complex transferred under a franchising agreement must include certain intellectual property assets.
For example, in the Republic of Belarus, mandatory assets that must be included in the licensing complex are the trade name and undisclosed information. Other assets, such as trade marks and patents, may be included in the licensing complex but are not mandatory elements.
Under the law of the Russian Federation, the essential elements of a commercial concession agreement (the analogue of a franchising agreement) are a trade mark and undisclosed information. The trade name is generally not included in the licensing complex.
This difference in approach is a key issue when concluding, for example, a master franchise, since all local legal nuances in this field should be taken into account in advance.
Given these differences and legislative requirements, rights holders from other countries often face the need to adapt their standard forms of agreements to Belarusian law if they wish to grant rights to use their licensing complex in Belarus.
Failure to register the agreement may also become a significant problem for the normal conduct of business and the use of this contractual model.
The legislation of the Republic of Belarus provides that a franchising agreement must be concluded in writing and is subject to registration with the patent authority in the manner prescribed by law.
At the same time, the legislation also emphasises that, if such agreements are not registered with the patent authority, they are considered invalid and do not entail legal consequences.
Furthermore, it is important to remember that not only the franchising agreement itself is subject to registration, but also any amendments and supplements to it, and even its termination.
The legislation does not set a specific period within which the agreement must be registered after it is signed by the parties; however, in practice, registration should be carried out before the parties begin performing their obligations under the agreement (for example, obligations to pay remuneration, etc.).
It is not uncommon for the parties to limit themselves to merely signing the agreement or an addendum to it, which may not comply with legal requirements and, accordingly, will not duly formalise the parties’ legal relations.
An agreement signed by the parties without registration may function for some time, but only until a conflict arises—when the terms of the agreement cease to be performed, mutual claims appear and may lead to litigation—where the situation with an ineffective agreement then comes to light, which may result in the claim being rejected, non-performance by the other party, a rupture of relations, penalties and other adverse consequences.
Therefore, one must check legislative requirements and register the agreement in due time if the law so provides.
Unfortunately, the parties to the agreement do not always verify the status of counterparties and the intellectual property assets being transferred.
A lack of such verification may lead to negative consequences, including refusal to register the agreement and the impossibility of implementing the provisions and obligations laid down in it.
As noted above, the parties to a franchising agreement may only be commercial organisations and individual entrepreneurs. A natural person—even if they are the owner of, for example, a trade mark—cannot be a party to a franchising agreement.
Moreover, if under a franchising agreement, in addition to the mandatory elements of the licensing complex (undisclosed information and the trade name), other intellectual property assets are transferred, including those subject to registration (for example, trade marks, inventions, industrial designs, etc.), then those assets must be specified as clearly and concretely as possible (the text of the agreement or its schedules must include details from the relevant title documents or registers, the registration certificate number, and other data allowing the asset to be identified).
It is also important to check the term of validity of the title documents (it must not expire before the term of the agreement, unless there is a separate stipulation), the territory in which they are in force (for example, a trade mark of the Russian Federation does not have effect in the Republic of Belarus and vice versa), the rights holder’s actual lawful authority to grant the right to use such assets, the existence of any previously concluded agreements regarding the same assets in the same territory, and to verify that there are no conflicts with them.
In conclusion, note that the decision not to engage lawyers to prepare or review and correct a draft agreement may also prove a fatal mistake when seeking to structure business relations effectively.
The parties to an agreement do not always have the knowledge and experience to draw up a practical, workable agreement that genuinely formalises their relations and lends them legal force, rather than merely serving as a meaningless stack of paper.
As is clear from all of the above, franchising is a complex and one of the most complicated types of agreement, which contains a number of mandatory provisions—even if the parties consider their inclusion to be non-essential.
The law clearly defines the subject matter of the agreement, which is the grant of a licensing complex mandatorily including the trade name and undisclosed information, in addition to other intellectual property assets.
The agreement must contain a description of the undisclosed information being transferred. It is not necessary to disclose the substance of this information in detail; however, it must be described in general terms and it must be ensured that the information transferred truly constitutes undisclosed information.
The agreement must also contain such basic terms as the territory in which it applies and its term, as well as provisions on the rights holder’s liability for claims brought by consumers against the franchisee.
In addition, the agreement must contain an obligation on the user to ensure that the quality of the goods, works or services produced, performed or provided by the user conforms to the quality of analogous goods (works, services) produced (performed, provided) by the rights holder. Incidentally, this requirement also applies to trade mark licence agreements, for example.
The agreement must also contain provisions to prevent consumers from being misled as to the fact that the licensing complex is being used under a franchising agreement.
It is certainly important to check the agreement for any conflicts with previously concluded agreements regarding the same intellectual property assets in terms of the form of rights transfer, the scope of rights granted, the term and the territory of the agreement.
The presence of any conflict in the agreement may serve as a ground for refusal to register it, which in turn will lead to the loss of the state fee paid for examination of the agreement and to the invalidity of the agreement itself, even if signed by the parties.
With due care and compliance with all the features considered, as well as timely legal assistance, you can indeed obtain a quality, ready-made business model and reliable partners with whom you can jointly develop the business. The main thing is not to take a careless or thoughtless approach to formalising all rights and obligations in the agreement.
Authors: Pavel Klementsov.
Contact a lawyer for further information
Contact a lawyer
