Starting a Franchise Part 3: International Franchise Agreements

This post is the third in a series on starting a franchise, by Edward (Ned) Levitt. He is a Certified Franchise Executive, a partner at Dickinson Wright LLP, and provides legal services to international clients on all aspects of franchise law. Read parts 1 and 2.

Getting Started

When should you begin to draft and negotiate an international franchise agreement? Most people in charge of international franchise expansion would say you should have an interested candidate who is ready willing and able to sign. In reality, the work should begin when such an expansion is in the planning stages.

A franchisor intending to be a serious player on the international franchise stage needs the input of its franchise attorney from the very beginning. Proper planning for such a development should include not only what legal structures are available, but what the pros and cons are of each vehicle. Such input should extend to the appropriateness of one structure over others, by specific country or region.

The choice of structures will influence many of the business decisions. Things like franchisor capital requirements initially and ongoing, the speed of expansion what human resources are needed, what jurisdictions and when, and much, much more.

The Goal

The primary goals of drafting an international franchise agreement are for the franchisor to end up with a legally enforceable agreement, which protects the desired economic return for the franchise. Everything else about the initial planning will make these goals significantly more attainable.

Which Markets for Starting a Franchise, and When?

The choice of expansion markets, the order, and the timing will have a profound impact on the resources needed by the franchisor. Equally, these factors will impact the choice of legal structures and the content of the franchise agreements needed to support the expansion.

Master franchising, with its downloading of most of the responsibilities to the master franchisee for the expansion of the system in the target market, might be the optimum approach for more distant and less familiar places.

Unit franchising, area development, and area representative arrangements might be more effective for the franchisor when the market is close and more familiar. Master franchise agreements are some of the most tailored agreements in the international franchise marketplace. Consequently, they are the most expensive to produce. Unit franchising development and representative agreements tend to be more consistent across jurisdiction, and are less likely to be negotiated.

Know the Rules of the Area

The cultural norms and legal systems of the target market will have an impact on the drafting and negotiation of an international franchise agreement. For example, a franchisor may not be comfortable with the laws and judicial system of a target market and therefore may wish to have any future disputes adjudicated in its home jurisdiction and by the laws of that home jurisdiction.

Letters of Intent

The value of a non-binding or partially binding letter-of-intent as a precursor to the drafting and negotiation of an international franchise agreement cannot be overstated. In a domestic franchise program, the deal is pretty much carved in stone before the franchisee is presented with agreements to sign. But international franchise agreements, as mentioned above, tend to be more specific to the particular parties and localities. Further, franchising and less familiar jurisdictions bring a much greater likelihood of misunderstandings from the time the deal is struck in principle, to the time when an agreement is presented for signing.

Thoughtfully prepared letters of intent can go a long way in avoiding extensive redrafting of documents. By using such letters, the franchisor can also avoid the very costly waste of money and time that comes with an otherwise worthy candidate bolting at the last minute because they were surprised by the content of the ultimate agreement.

Significant Deal Points

Some of the business terms of any international franchise deal will be obvious. Some examples are front-end franchise fees, length of the term, territory, revenue-sharing, performance criteria, the source of products and supplies and operational considerations at the unit level. However, some not so obvious matters, which often do not show up until an agreement is drafted, could sink an otherwise propitious deal such as:

• The currency of payments to the franchisor
• Crucial events of default
• The requirements of the franchisee to post security
• Personal guarantees
• What happens to existing operations on termination
• The extent of the initial term renewal terms and conditions to renewal
• Conditions to assignment by the franchisee and fees charged by the franchisor for consent and
• Control of parallel marketing channels

Avoid Costly Surprises

Identifying these potential problem areas early in the process will go a long way to avoiding unpleasant surprises. However, even if even if such items are inserted in a letter of intent, prospective franchisees may not have the expertise to fully understand their impact and it is their lawyer who sounds an alarm, only after the letter is signed. Often, the lawyer will have a significant impact on the time it takes to negotiate an international franchise agreement. It is best to encourage the prospective franchisee to involve its legal advisor early in the process and to choose a lawyer who is familiar with franchise matters.

Laws of the Target Jurisdiction

It is wise for the franchise lawyer to select a capable local council at the earliest stage possible in the drafting and negotiation of an international franchise agreement. Knowing what the impact of specific local laws will be on the agreement will avoid costly delays in finalizing the agreement and provide the franchisor with a more realistic picture of what powers it can reserve and rely upon in the event of a default, renewal, assignment or expiration.

Conclusion

Successfully drafting and negotiating an international franchise agreement is dependent upon the ideal mix of expertise, experience, local knowledge, planning, and patience.

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