The Anatomy of a Sports Business Franchise Agreement
By Nandan Kamath
Franchising has gained increasing credence as a viable model for companies to expand their business in domestic and international markets. In simple terms, franchising is the practice of starting up a business based upon the intellectual property rights and business methods adopted by corporate entities. A franchisor owns these rights, while a franchisee obtains the right to use the franchisor’s ideas, names and logos. Notable examples of multi-national companies that have used and continue to use the franchise model to develop their business include McDonald’s and Subway. The primary advantages to franchising are two-fold. First, as regards the franchisor, the franchise is a limited risk alternative to investing in and building its own stores. Second, while the franchisor’s success depends on the success of the franchisees, the franchisee has a greater incentive to ensure success of the franchise than a direct employee of the franchisor as the franchisee has a direct stake in the franchised business. Additionally, franchise arrangements allow participants instantly to become part of a larger organisation while retaining ownership of their own businesses.
Globally, the franchise model has found its way into sport and sports related businesses. In India, there is a wide range of ever growing franchise opportunities in sport related businesses – from physical training programs for children to fitness/wellness related services.
This article outlines the structure of a basic franchise agreement for a sports related business, excluding team based franchises as in the case of sports leagues. It outlines some of the key provisions that ought to be documented and their basis. Ultimately each agreement will be personalised in structure and substance based on commercial and other contexts.
The agreement should, at outset, clearly identify all parties to the agreement along with their individual/corporate status, any other identifying information and their registered or mailing addresses.
Definitions and interpretation
The agreement should clearly set out a list of definitions to establish or clarify the meaning of important terms in the contract. As these defined terms appear throughout the agreement, they are usually capitalised. It is advisable to cross-check the meaning of the word in the definitions section each time it is used in the agreement as its entire meaning, inclusive of limitations and exceptions, is imported into the provision in which it is used.
Grant of Rights
Every franchise agreement involves the grant of a license and the right to use either a product trade name or a business format, or both. In the former, the franchisor owns a trade name or trademark and licenses the right to use the name to a franchisee. In the latter, the franchisor and the franchisee enter into an on-going relationship where the franchisor provides a repertoire of products and services including training, supplies and, in some instances, finances.
In this regard, it needs to be clarified whether the grant of rights is exclusive, non- exclusive or ‘sole and exclusive’ in the case of master franchise agreements. Further, the franchise agreement needs to specify whether the franchisee is allowed to operate a franchise at one location, with the opportunity to open more, or is allowed to open franchises at multiple locations. Further, the franchisor usually specifies a list of minimum requirements to be met by the franchisee during the term of the agreement, failure to fulfil which could result in termination of the franchise agreement.
This provision will describe the duration of the agreement, i.e., the length of time that the parties agree to be legally bound. The Term is usually a specified number of months or years. It should be noted that while the agreement expires at the end of the Term, there are usually a number of provisions, such as confidentiality, indemnification, restrictive covenants, cooling-off periods, etc. that will survive the termination or expiry of the agreement for varying periods of time. It is possible that there could be an initial term, which could be renewed through one or more mechanisms, including the notification of one of the parties, the mutual agreement of the parties and so forth. In the case of an extension, the extended term is considered the term of the agreement.
This provision will describe the geographic area within which the agreement is relevant and within which the parties perform their obligations as well as enjoy their rights under the agreement. This can be a particular area, city, state, country, region or even the entire world. Along with the provision on term, the provision on territory places explicit limitations on the tenure, extent and scope of the rights and obligations created under the agreement. For instance, a franchisee may be precluded from admitting students who reside outside the territory assigned to the franchisee.
In the event that the franchisee is permitted to operate the franchise on a non-exclusive basis, the franchisor retains the right to appoint other franchisees within the same territory.
Consideration and Subsidies
The section on consideration must clearly indicate the nature, quantum, method and schedule of payments. A franchise agreement usually involves three kinds of payment. First, a one-time franchise fee that is payable towards the grant of rights by the franchisor. Second, a monthly fee is payable in respect of each franchise operated by the franchisee. Third, a percentage of the monthly revenue generated by the franchisee through the business may be paid to the franchisor as royalty.
The triggers and the quantum of payment associated with such trigger need to be determined mutually. It should also clearly indicate what interest rate will be applicable in the event of late payment.
Generally, to assist the franchisee in operating a sustainable business, the franchisor provides certain subsidies either in the form of finances to help the franchisee in setting up operations or through rebates on the monies paid.
Training, Standards and Startup Kit
The franchisor’s main obligation under the agreement would be to train the franchisee’s personnel in the use and operation of the rights granted and the material provided by the franchisor. Often, the costs for such training are included in the one-time franchise fee that is paid by the franchisee. The franchisee fee also covers the cost of certain quantities of materials, standards and specifications manuals, etc., to be provided by the franchisor.
It is of prime importance for the franchisor to retain the right to inspect the location of each franchise to ensure that appropriate safety equipment and procedures are put into practice by the franchisee at the franchise as well as interact with customers on the manner on which the franchise operates. This is because the franchisor’s role in the direct operation of the franchise is minimal, involves only the finalisation of certain aspects such as fees, schedules, etc., and, ultimately, it is the franchisor’s reputation and goodwill that is at stake in the market. Further, the franchisee may also be required to display adequate branding and signage.
Accounting and Reporting
As part of the consideration payable to the franchisor is dependent on the revenue generated by the franchisee, the franchisor needs to be able to inspect the books, registers and sales records of the franchisee to determine that the franchisor has been paid the correct amount of royalty. The payment of royalty is often accompanied by an audited certificate that is signed by a director of the franchisee, thereby attesting its contents. Nonetheless, the franchisor may conduct an independent audit of the documents and figures provided by the franchisee. Further the franchisee may, from time to time, be requested to provide reports on the operations/finances of the franchisee.
The franchisee is obliged to obtain and maintain at all times during the term general liability insurance policies wherein the franchisor would be named as an additionally insured party. This is to protect the franchisee from any liability that may attach on account of an accident or mishap at the franchise.
This provision generally grants the franchisee a limited right and license to the franchisor’s intellectual property rights and also sets out the fact that each party will respect the other party’s intellectual property and proprietary interests. This is a standard provision in all franchise agreements and must be carefully drafted to avoid any confusion on its scope. There must also be clarity on the ownership of the intellectual property that is created during the tenure of the relationship, which should be owned by the franchisor to ensure continuity of the business in the event of termination of the agreement. The franchisor should also retain the right to approve in advance any promotional material and advertisements. Further, the franchisor usually lists a set of guidelines that the franchisee must adhere to in the franchisee’s use of the franchisor’s intellectual property rights.
This section is important as it often details what the contracting parties agree to do to honour the agreement between or among them. Factors such as the Term, the scope of the services to be provided, the exclusivity of the services, and the consideration usually determine the level of restrictions imposed on the activities of the franchisee. For instance, the agreement may require the franchisee to refrain from undertaking or being part of any other business that competes with the franchisor’s business, from soliciting the franchisor’s/other franchisee’s employees or customers during the term and for a certain period thereafter.
These kinds of restrictions must then be coupled with a clear provision on the consequences of breach, and what damages can be recovered by the company.
This section of the agreement will typically be generic, with the possibility of a few additions depending on the context. It will generally act as an assurance that both parties are acting within their legal capacity to enter into contract, that they indeed possess the rights and ability to grant the rights being granted and perform the obligations being committed to and that they have no conflicting contractual or legal obligations (and will not enter into such contracts or obligations) that could jeopardise the nature and scope of the agreement being entered into.
A representation is defined as an account or statement of facts, allegations, or arguments. Representations present everything from its past to its current status. A warranty generally moves from the present to the future. The warranty obligates both parties to the terms of the contract. Usually, both parties warrant that neither will enter into any such agreement in the future that would hamper their ability to perform their obligations under the sponsorship agreement. When a contract uses the terms “representations” and “warranties” together, they blend the past, present, and future together within terms of the contract. The scope of the representations and warranties can also have an impact on the indemnification rights of the parties.
Termination and its consequences
Every contract will usually set out the circumstances under which it can be terminated prior to the expiry of the term. That is, a contract will generally come to an end when it is considered to be fully performed, or when it has come to the end of its Term. However, usually if there is a material breach of the agreement, the party which breaches the agreement may be considered to have defaulted on its promise. Accordingly, the other party may terminate the contract at will. This may arise if the franchisee does not make timely payment, or if the franchisor does not provide adequate support to the franchisee. Further, the franchisor may also option to retain the right to terminate the agreement if the franchisee consistently fails to fulfil certain performance parameters mutually agreed to.
It is important to lay down the consequences of termination. Often, the consequences include proportionate payment of the monthly fee and/or the license fee, but usually not the franchise fee. In addition, any rights granted by the franchisor to the franchisee stand revoked immediately and the franchisee cannot continue to operate the franchise, associating with the franchisor. In essence, the consequences of termination could also serve as a deterrent to prevent either of the parties to the agreement from terminating the agreement for no good reason. It is also important to note that contract law does not favour ‘penalties’ for breach that are unconnected to the actual loss or damage suffered and therefore the nomination of liquidated penalty amounts, regardless of circumstance, is rarely recommended.
The franchise agreement will list a number of standard miscellaneous provisions that constitute an important part of any contract, including:
(a) Force Majeure: This provision will usually free both parties from obligations or liability when a superior external force affects the performance of the contract. Examples which are commonly listed in a contract include acts of God, war and riot, terrorist attacks, strikes, changes of law, etc. If a force majeure event continues for a certain extended period, the parties may have the right to terminate the agreement and not just suspend their relative affected obligations thereunder.
(b) Indemnification: Each party will generally agree to indemnify the other party for any loss that may occur due to the former party’s negligence, due to inaccuracy of their representations and warranties, or due to their acts of omissions. Indemnification is a key contractual remedy and the scope and procedures for indemnification must be carefully set out. It is also common to limit indemnification for direct (rather than remote) losses and damages and/or to put a commercial cap (e.g., the total consideration payable) on the indemnification obligation of a party so as to limit its total potential liability under the contract. In the case of franchise agreements, it would be prudent on the part of the franchisor to insist on receiving indemnification from the franchisee for mismanagement of the franchise or wrong use of the material provided by the franchisor or any wrongful imparting of the training methods, etc. prescribed by the franchisor, which could potentially expose the franchisor to liability. On the other hand, the franchisee could expect the franchisor to provide indemnification that would protect the franchisee against any third party claim that the franchisor’s intellectual property rights infringe the third party’s rights.
(c) Dispute Resolution: This provision outlines the manner in which the parties will resolve any dispute that may arise out of the contract. Common dispute resolution clauses refer such matters to negotiation, conciliation, meditation, arbitration and litigation. It is common to specify the rules governing each of these and the seat of arbitration, if that is the chosen remedy.
(d) Governing Law and Jurisdiction: This provision will outline the set of laws the parties wish to be bound by. This is particularly important in the event of a dispute as the judge or arbitrator will consider the governing law when making a final and binding decision in terms of which party is liable for any wrongdoing. The jurisdiction provision will set out where the dispute should be heard. Law requires both the governing law and jurisdiction chosen to have a relevant nexus to the parties and/ or the transaction and to this extent the parties’ choice is bounded.
(e) Assignment and Change of Control: This section will generally state that the rights afforded under the agreement may not be assigned to a third party by the franchisee without the franchisor’s prior consent. Similar mutual provisions may relate to continuance of obligations when the other party undergoes a corporate change of control. This is to ensure that either party is not forced to interact with someone they had not originally agreed to work with. However, it is also common that the Franchisor retains the right to assign without consent in order to retain flexibility of their operations.
(f) Confidentiality: Confidentiality is a standard provision in franchise agreements. Parties will agree to keep most finance-related and contractual dealings strictly confidential between them subject to a few standard exceptions. This is on the understanding that the parties will often be in a close relationship where lots of non- public information is shared between them in the course of their dealings.
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