A lease is a critical piece of the puzzle for a franchisee considering the acquisition of a franchise. The success of a franchise may depend on one major factor: location, location, location. The premises of the franchise is where the franchisee will establish its business and create key relationships within the local community. As such, a lease should include certain terms to adequately protect the franchisee.
In this blog, we assume that the franchisee is not entering into a sublease with the franchisor but is instead signing a direct lease with the landlord, which has become the trend as franchisors attempt to limit their liability.
There are a number of issues that a franchisee should be alert to and consider in any review of a direct lease with a landlord. The following is a non-exhaustive list of these issues.
Who is the franchisee?
In the early stages of acquiring a franchise, the franchisee may not have incorporated a corporation to act as the franchisee. Often times, the individual franchisee will sign a lease as the tenant personally. This is an oversight that exposes the franchisee to personal liability – if there is a default of the tenant’s obligations under the lease, the landlord can take legal action against the individual tenant. If a corporation has not yet been incorporated, the franchisee should sign in trust for a corporation to be incorporated (for example, John Smith, in trust for a corporation to be incorporated). Once the franchisee corporation has been incorporated, the tenant name can often be easily be replaced. Assuming there is no personal guarantee or indemnity provided by the individual, the franchisee corporation will then be liable for all tenant obligations under the lease.
What is the term?
To the extent possible, a lease term should coincide with the term of the franchise agreement. Suppose that a franchise agreement has an initial term of 10 years, but the proposed lease has a term of 5 years without any right or option to renew. In such case, the franchisee will be forced to relocate the franchise to new premises after the fifth year – obviously, an undesirable and expensive result. Therefore, the franchisee should negotiate with the landlord to increase (or decrease) the term of the lease to coincide the term of the franchise agreement.
How long is the fixturing period?
When acquiring franchise rights for a new or existing location, there may be significant construction or renovation required. Failure to open for business by the set commencement date may subject the franchisee to significant costs and liability. A franchisee should consult its construction team to confirm that the required construction can be completed within the time frame provided by the landlord, and if necessary, negotiate with the landlord for an extended fixturing period.
Is there a redevelopment or demolition clause?
Some leases contain what is referred to as a redevelopment or demolition clause, especially leases for premises in the downtown Toronto area. It is one of the most critical issues in a lease and poses concern for both the franchisee and the franchisor. A demolition clause allows a landlord to terminate the lease, usually at any time, if it intends to demolish or redevelop the premises. Should the landlord exercise this right, the franchisee will be left in the cold. If the landlord refuses to remove the redevelopment or demolition clause, it may be best for the franchisee to walk away from the negotiating table, especially since a franchisor may not approve of a lease containing a demolition clause. However, if the premises are so important to the success of the business such that the franchisee wants to proceed, and assuming the franchisor approves, the franchisee should insist upon a reasonable notice period for redevelopment or demolition to allow the franchisee time to find, negotiate and sign a lease for new premises.
What are the conditions to acceptance?
As touched on in the above issue regarding demolition clauses, it is usual practice for a franchisor to require final approval of any direct lease signed by a franchisee. If a franchisee fails to insist on the lease being conditional upon the approval of the franchisor, it may find itself in the position of being committed to lease premises without a business to operate. To avoid this situation, the lease should be conditional upon the franchisor’s final approval.
These are just five points to consider in a lease review for a franchise location. There are many other issues to consider, and Morrison Brown Sosnovitch LLP is well-equipped to help franchisees negotiate a lease agreement with terms which protect the franchisee’s interests.
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