Franchisors - Getting Your Leasing House in Order

Dean Claughton

Many franchisors are involved with leases (mainly retail leases) in some way, shape or form. Some franchisors choose to be the tenant under the lease, and then subsequently licence the premises to the franchisee, while some franchisors are happy for the franchisee to be the tenant under the lease, as their liability is limited if the franchisee’s lease is terminated. There are positives and negatives for both sides, and set out below is a list of these considerations to take into account.

If the franchisor is the lessee (and subsequently licenses the property to the franchisee)

  1. If the franchisee defaults and is subsequently ejected from the premises, then the franchisor remains liable to the landlord for the remainder of the term of the lease. The upshot of this scenario is that you retain control of the premises, and you can then decide whether to seek a new franchisee, who will hopefully be more successful, or you can operate out of the premises yourself;

  2. It may be important for the franchisor to be able to licence the premises to franchisees without the consent of the landlord. Although most landlord’s will want to retain some control, this should be the franchisor’s starting position in lease negotiations; 

  3. Normally, the landlord will want to see a copy of the franchise agreement before they agree to consent to a licence. As this is a confidential document which illustrates the structure of your company, this should be resisted; 

  4. Even though the licence will likely pass on the make good obligations to the franchisee, if the franchisee defaults and the licence is terminated, these obligations will then fall on the franchisor; 

  5. It may also be important that the proposed franchisee provides the bank guarantee/security deposit and the relevant insurances. At the beginning of the transaction, this should be made clear by the franchisor, so as to avoid any protracted negotiation after the lease has been issued. 

  6. Most leases will have a default period of between 7-14 days, and if rent is not paid within this timeframe, then the landlord has the option to terminate the lease, without notice. It is vitally important to ensure that if the franchisee defaults in their rental obligations under the lease, both the franchisee and the franchisor are notified of this, and both parties have the option to rectify the default. In the past, there have been situations where a franchisee has defaulted under the lease, and the lease has been terminated without the franchisor knowing about it. If the franchisee only licenses the premises, then the landlord will pursue the franchisor for damages following termination of the lease. 

  7. If personal guarantees are required by the landlord, then franchisors should ensure that these guarantees are provided by the directors of the franchisee company, rather than the directors of the franchisor. Again, a landlord may not agree to this, but it should be your starting point in lease negotiations. 

If the franchisee is the lessee

  1. If the franchisee defaults under the lease, then the franchisee remains liable to the landlord for the remainder of the lease. In this regard, the franchisor has no obligations to the landlord. The downside of this is that you would lose the premises and it may result in you not having a franchise in a geographical area which is important to your company; 

  2. The franchisee will be responsible for the payment of the security bond/bank guarantee, and must also maintain the relevant insurances; 

  3. The franchisee must make good the premises at the end of the lease, which can be a very expensive exercise. However, the trade off is that the franchisor loses control of the site, which may be important to the franchisor if the location of the premises is vital for the goodwill of the company; and

  4. The franchisor should try and include a ‘step in’ clause into the lease or side agreement. Essentially, this means that if the franchisee’s lease is terminated, the franchisor may ‘step in’ to the premises and either continue the business or licence the premises to another franchisee. This will ensure that the landlord cannot re-enter the premises and result in the franchisor losing the site, which is very important to all franchisor’s goodwill. 

All of the above points should be taken into account when deciding whether to have the lease in the franchisor’s or franchisee’s name. In our experience, most franchisors choose the first option because they prefer to have the premises locked up for a certain timeframe, and if one franchisee is ejected from the premises, then the franchisor retains the premises and can always find a new franchisee in the future.

For further advice on leasing options for your franchise business please contact our experienced property lawyers:

Andrew Grima, Principal
Phone: + 61 2 9895 9271

Dean Claughton, Lawyer
Phone: +61 2 9895 9276