Franchise agreement

In Russian legislation there is no concept of a franchise agreement, and this type of cooperation is formalized by a commercial concession agreement. Let's consider what kind of document this is and what points should be indicated in it.

The franchise agreement is signed between two parties, typically referred to as the Franchisor (the one selling the franchise) and the Franchisee (the one buying the franchise). They agree on the transfer of a package of exclusive rights (IP) from the Franchisor to the Franchisee for a fee. A mandatory condition is the Franchisee's compliance with the standards and rules established by the Franchisor.

The agreement is generally drafted in accordance with the requirements of the Franchisor, as they bear more risks: the actions of the Franchisee can negatively impact not only the Franchisor but also the entire network, which may involve a large number of people working under the same conditions as the Franchisee.

In addition, the Franchisor possesses a well-established, operational, and profitable model. They can afford to be selective in choosing partners and work only with those who are willing to accept their terms.

Before we delve into the specific terms of the franchise agreement, let's discuss the role of a lawyer in the development of your franchise.

A lawyer is one of the key figures in any franchise business. There are several reasons for this:

The company's lawyer is involved in all stages of interaction between the parties. They are present at the negotiation stage and incorporate all agreements into the contract. The lawyer initiates and introduces all changes to the relationship between the parties in the form of appendices to the main contract. They also record all the approvals that the franchisor grants to the franchisee. Any disputes and disagreements between the franchisee and the founder also take place with the participation of a lawyer. And finally, the closing process is also accompanied by a lawyer.
All this means only one thing: the position of a lawyer should be occupied by a qualified specialist who will be with you for a long time and who has experience working with franchises.

Naturally, at the stage of packaging a franchise, the role of a lawyer is secondary, since lawyers do not and should not understand the intricacies of business and technological processes. At the stage of developing a franchise, we come to the lawyer with a detailed technical specification for our lawyer, prescribing exactly which clauses we introduce into the contract for a specific franchise.

We have listed the main risks, now we will consider in detail how the contract should be drawn up so that the listed risks are minimized or eliminated completely. It is worth saying that even the most detailed franchise agreement will not insure against all risks and the most correct method of protection is the correct selection of franchisees. If you and your partner understand each other and live by the same rules and share each other’s views, the agreement will become just a formality.

A commercial concession agreement must undergo state registration at the Registration Chamber. And the contract specifies whose party makes this registration and at whose expense the fee is paid. That is, register every agreement with every new franchisee. It is also necessary to specify what actions the parties will take if registration is denied.

The subject of the agreement is a package of exclusive rights (IP), which includes business methods, design elements, technological standards, and other intellectual property objects.

This package is what is sometimes called the "franchise package." It should contain everything the user needs to start this franchised business and manage it successfully.

This is your business, and you know best what your partner needs to know. Typically, this includes product preparation technology, brand standards, opening standards, staff selection, training, and adaptation rules.

The partnership and launch of a franchise business begins with the signing of a commercial concession agreement by the parties. A well-drafted commercial concession agreement will help to avoid disputes and conflicts in the future, and therefore the agreement should describe all possible scenarios of interaction between the parties and regulate all processes of your business.

Let's go over the main points of the agreement and provide comments on each one.

The trademark is part of the transferred IP, so if you do not have it, the commercial concession agreement cannot be signed. The agreement is usually accompanied by a certificate of registration of a trademark indicating the number of this certificate.

Grantor: The party on the side of the franchise founder who transfers the right to use the IP. This is you, the franchise founder. You transfer all your developments to the franchisee and give the right to act on your behalf. You transfer the right to use your brand and trademark.

User: The franchisee who receives the right to use the IP for a fee and on the terms prescribed by the Grantor.

Geographic territory within which the user is allowed to use the instrumentation. These may be the borders of a city, country, or a specific address of the premises may be indicated, and beyond the boundaries of this address the partner does not have the right to use the instrumentation for his activities.

The agreement can be signed for a period that does not exceed the period of registration of the trademark. The user should be interested in clarifying the conditions under which the contract will be extended.

The agreement can be concluded on exclusive terms, when only this particular franchisee has the right to operate using the IP in a specific region. In this case, the city or country is indicated as the territory within which the user can use the IP.

I had a case when I received a franchise application from the city of Birobidzhan, Jewish Autonomous Oblast. The person wanted to buy an exclusive franchise. Initially, we did not sell exclusives, but I still discussed this request with the founder, because of course the decision is always up to him. We knew nothing about either the city or the region. We had never received requests from there before, and we decided to sell the exclusive franchise at a higher price. And as soon as a point opened in Birobidzhan, I started receiving several requests from this city every month. Entrepreneurs saw a working model and wanted to buy it, but we could not sell, having limited ourselves by the agreement. And our partner did not even open a second point. Thus, he simply cut off potential competitors at the entrance, but did not develop himself. It was enough for him what one point gave.

It is important to understand that franchisees react very painfully to competition. They always want to be the only ones who work under this brand. But this goes against the interests of the franchise itself. It just needs to develop and increase the number of outlets. It is important to find the right balance so that partners understand that their interests are taken into account, and the creators of the franchise can develop their network.

A time-limited exclusive is a consensus option. For example, for a year with the possibility of extension, if during this time he opens another point. So the network grows, and the partner is not offended. It is also necessary to take into account the market capacity. If we calculate the market and understand that there can only be one of our restaurants in the conditional Saratov, then we can safely sell the exclusive franchise, without worrying that the network will suffer. If the capacity of the city is three restaurants, then we set conditions for the partner to open three points within the agreed time, and then he will have unlimited exclusivity.

The Grantor (copyright holder) is obligated to provide the User (franchisee) with the standards and intellectual property (IP) in a convenient and understandable format. The format should be easy for the franchisee to access and use for training their team.

The Grantor also commits to providing ongoing support and consulting services to the User.

The Grantor (copyright holder) transfers the IP to the User (franchisee) on condition that the network's standards are adhered to. Therefore, complying with network standards is the User's primary obligation. Any deviations from the standards must be additionally agreed upon with the Grantor.

The franchisor transfers the IP to the User for a fee, and therefore the User is obligated to make timely payments as prescribed by the agreement.

The User is responsible for everything that happens at the franchised location, and ensuring the proper operation of the establishment is the User's responsibility.

A key right of the franchisor is to monitor compliance with standards and oversee the operation of franchised units by any convenient means.

The franchisor also has the right to improve and supplement the IP (intellectual property) that is transferred to the franchisee. This may include updating standards, providing new training materials, or developing new marketing tools. The franchisor is obligated to share these updates with all franchisees in the network.

In addition to the fact that the user has the right to expect the Copyright Holder to fulfill obligations, the user also has the right to influence the development of the network. As a partner, he can make suggestions that can strengthen the network.

The user is obliged to maintain confidentiality. The confidentiality regime should also apply to the user's team. Your KIP is unique and the user pays a lump-sum fee for the right to receive and use it. If your CIP is freely distributed, it cannot be sold for a fee and there will be no value in it, so it is important to carefully monitor confidentiality.

The transfer of instrumentation is carried out on the terms of payment of mandatory contributions. Payment of a lump sum fee 3 days after signing the contract and regular payment of royalties based on the share of revenue.
In order for the royalty to be calculated correctly, the agreement prescribes a method for controlling revenue. For example, the user gives access to a cash accounting program, in which the copyright holder can see the current financial situation. I wrote more about franchise fees in the article “Franchise Fees.”

The Grantor (copyright holder) transfers the IP (intellectual property) to the User (franchisee) only on the condition that the User will not become a competitor of the network in the future.

The franchise agreement typically includes a non-compete clause that prohibits the User from engaging in similar businesses for a certain period of time after the franchise closes. This period is typically 2-3 years, but it can vary depending on the specific franchise agreement.

The franchise agreement should also prohibit the User from challenging the franchisor's rights to the brand, as well as from creating brands that are similar to the franchisor's brand. This is to protect the franchisor's brand reputation and to prevent the User from diluting the brand's value.

The agreement defines the procedure for conducting inspections and audits. Typically, the copyright holder is given the right to monitor compliance with standards in any convenient and accessible way.
The user, in turn, must not interfere with inspections and provide access to the premises for inspections.
Based on the results of the inspections, an act is formed that contains the identified violations, as well as recommendations and instructions for improving work processes.
I wrote more about franchisee control in the article “Franchisee Control”.

The fines in a commercial concession agreement are usually large. We have already said that violation of standards casts a shadow on all franchisees of the network, and therefore the fines that insure such a serious risk must be appropriate.
Let us list what fines and for what the concession agreement implies.
Primarily for violations of standards. violations of product creation technology, service standards, delivery standards, etc. The consumer must receive a product of the same quality level in all network facilities. Therefore, quality standards are tightly protected by contract.
Any reputational risks are also protected by huge fines.
Violations of confidentiality are subject to fines.
Damage to reputation also involves a fine.
What fine size should I choose? I recommend linking the size of the fine to the size of the lump sum contribution. For example, a third of the lump sum seems like a fair amount of the fine.
You need to understand that fines are not 100% protection against violations. You are unlikely to ever be able to apply the penalties listed in the agreement, because the penalties greatly damage your partnership. The appearance of fines usually leads to a deterioration in relationships and subsequent breakup.
High-quality support for partners, support, early detection of violations and understanding why these violations occur work much better.
Let's consider the procedure for assigning a fine. As a rule, a fine is not imposed without warning. Such a warning is an act of non-compliance, which is sent by the copyright holder to the copyright holder after identifying a particular violation. The user is obliged to eliminate the violation within a specified period. If the violation is repeated or not eliminated, a fine will be imposed. If violations are gross or systematic, closure may follow.

The agreement must also regulate the process of separation of the parties. Naturally, a break in relations can be initiated by either party. The party who decides to terminate the contract must inform about its decision in advance by writing a corresponding letter. In this case, the copyright holder revokes the right to use the instrumentation, and the user, within the prescribed period, removes the sign and stops using all elements of the instrumentation.

Points that are often forgotten, but are the source of serious potential problems in the future. You have to choose and describe in the contract whether you are ready for your franchisee to be a legal entity with equity participation, and whether you are ready for the owners to change in the future. Under what scenario will the assignment of rights occur? Perhaps you care who your franchisee will be and you want to approve and agree on the identity of the future franchisee when assigning rights.