The main provisions of a franchise contract

A sound franchising contract can promote the efficient running of franchise operations and prevent the occurrence of disputes. This article analyzes the main provisions that such a contract should contain in order to achieve these objectives.

Trademark licence

A characteristic of franchising is the licensing of the franchiser’s trademarks and other marks symbolizing its business to the franchisee. The contract should specify the marks to be licensed, that the franchiser is the owner of such marks, that the franchisee may not apply to register such marks or similar marks in any country, that the franchisee may not modify such marks in the course of their use, that the franchisee may not use the marks for a purpose other than the ones specified in the agreement, and that the franchisee is required promptly to notify the franchiser if it discovers that the validity or ownership of the marks has been infringed or any unauthorized use of such marks has occurred. The franchiser may choose to execute a separate trademark licence agreement with the franchisee.

Establishment and operation

A franchise store should be established and operated in accordance with uniform standards provided by the franchiser. The contract should provide in detail for such standards.

The name of the franchise store should be specified. The contract should also stipulate that the franchisee may not use the name for purposes other than the operation of, publicity for, advertising of, or other promotional activities in connection with, the franchise store, and may not register the same as his own trade name or trademark.

The franchise store’s trade dress, specifications and fitting out should be completed in accordance with the standards provided by the franchiser, and the date of opening of the franchise store should be expressly specified in the contract. If the franchisee fails to open for business on schedule, the franchiser has the right to terminate the agreement and require the franchisee to bear liability for breach of contract.

Authorized territory and term

The territory within which the franchise operations are to take place should be expressly specified. The contract should also specify the term of the franchise and the method of, and conditions for, renewal upon its expiry.

Purchase of stock and sales

As the franchisee is required to purchase merchandise, raw materials, packaging and other items from the franchiser over the long term, the contract should specify that the franchisee is required to order such items from the franchiser or the suppliers designated by it, and that the franchiser is required to provide the franchisee with a long-term and stable source of goods. It should also provide for the prices, types and transaction terms of the merchandise.

Advertising and promotion

For the purpose of creating an overall image for the franchise system, the franchiser will generally adopt standard methods of advertising, publicity and promotion. These, however, should not preclude the franchisee from himself conducting advertising, publicity and promotional activities. Accordingly, it is generally provided in the contract that all of the franchisee’s advertising, publicity and promotional activities should be conducted through the media and in the types and forms permitted by the franchiser, and should comply with the objective standards and requirements set forth in the franchiser’s operating handbook or other written document. If the franchisee is to carry out adverting, publicity or promotional activities himself, he is required to give the franchiser advance written notice thereof and secure its consent.

Franchise fees

Franchise fees typically include initial franchise fees, deposit, royalties and other charges. The initial franchise fee is a one-off charge that the franchisee pays the franchiser for securing the franchise right and as consideration for use of the franchiser’s intangible assets. Accordingly, it is generally specified in the contract that this is paid in one lump sum and is non-refundable.

The franchise deposit is the deposit that the franchisee pays to the franchiser. Once the franchisee has performed his contractual obligations and the contract terminates, the franchiser is usually required to refund the deposit to the franchisee. If the franchisee, in the course of performing the contract, fails to pay the royalties or other charges as agreed, the franchiser has the right to deduct the corresponding amount from the deposit and the franchisee is required to make up the difference in the deposit.

Royalties are the amounts paid on a regular basis by the franchisee to the franchiser at a fixed rate or certain percentage in the course of his use of the franchise right. In general, it is specified in the Contract that the franchisee is required to pay royalties on a regular basis to the franchiser as a fixed amount or a certain percentage of his business turnover.

Transfer, confidentiality, buyback

Given that the franchisee, after the training by the franchiser, has absorbed the business philosophy closely associated with the franchiser and has mastered significant operating know-how, the franchiser will typically specify in the contract that the franchisee may not transfer his rights and obligations under the Contract without the prior written consent of the franchiser.

As the disclosure of its trade secrets could cause irreparable material losses to the franchiser, the contract should expressly provide for the confidentiality obligations of the franchisee and his employees.

The contract should specify that for a specific period of time after its termination, the franchisee may not engage in business activities identical or similar to those of the franchiser, so as to prevent the spread of the franchiser’s proprietary technology or the occurrence of the unauthorized used thereof.

It should be specified in the contract that after the contract is terminates, the franchiser has the right to buy back the franchise store at the price agreed upon by the parties.

Termination and breach

The circumstances under which the parties can terminate the contract early and the liability that the parties should bear for breach of the agreement should be expressly provided for in the contract.

Harry He is a partner at AllBright Law Offices. His main practice areas are foreign direct investment, M&A and labour disputes