Despite being prevalent throughout New Zealand, there is no legislation that governs or regulates franchises, with the result that there is no requirement for the terms of a franchise to be fair and reasonable.
What is a Franchise?
Every franchise should be a replica of the Franchisor’s business, therefore giving customers of the franchise a consistent experience.
The Franchisee gains the benefit of the franchise’s reputation, goodwill and intellectual property instead of having to develop this from scratch. A franchise business will often cost more to purchase than an equivalent independent business – the theory is that a Franchisee pays a higher up-front fee and pays on-going costs, in exchange for lower economic risk.
In general, a franchise involves:
- A Franchisor
- granting a Franchisee the rights to use its intellectual property and systems;
- providing training, know-how, ongoing marketing, business or technical assistance.
- A Franchisee
- establishing and operating a business selling the Franchisor’s products or services;
- being required to follow the Franchisor’s systems, procedures and instructions;
- paying fees (royalties) to the Franchisor;
The Franchise Agreement regulates the business operation and the franchise relationship. The relationship is contractual and encompasses multiple areas of law such as taxation and intellectual property.
Franchise Agreements are invariably long and complex documents that favour the Franchisor and, to protect the integrity of the franchise, Franchisees will not be able to negotiate changes to it. Some say that all Franchise Agreements are unfair, unreasonable and one-sided when considering the balance of rights and obligations – an easily missed word or clause can have a significant ongoing impact through the term of the franchise.
It therefore follows that extra care and attention must be given prior to entering into a franchise.
It is important to separate out the “sales pitch” from the nitty gritty of the Franchise Agreement. The “sales pitch” will focus on the benefits etc. however the benefits are only one aspect of the arrangement – what is most important is understanding what it really means to be part of the franchise which can only be uncovered by considering the Franchise Agreement in detail.
During due diligence a prospective Franchisee should obtain focussed advice on the terms and implications of the Franchise Agreement. If you are not fully informed as to the details or you do not appreciate the significance of a provision then you may be disappointed, disheartened and ultimately suffer losses as a consequence.
Fees, Levies or Royalty Payments
As part of the franchise arrangement, the Franchisee would typically be required to pay a number of fees:
- An initial (lump sum) franchise fee to compensate the Franchisor for development costs and as a licence fee;
- On-going service or royalty payments for the on-going:
- use of the system and trade name;
- support and assistance of the Franchisor.
- An advertising or marketing levy (an advantage of the system is that a Franchisee obtains the benefit of the franchise’s advertising albeit that the Franchisor chooses how to advertise or market the franchise).
Other terms to consider
- The length of the initial term;
- If and how the franchise can be renewed and the fees associated with a renewal;
- The territory in which the franchise will operate and any rights to exclusivity in that territory;
- How the franchise can be terminated and obligations on termination; and
- Restraint of trade.
Franchise Association of New Zealand
While there is no government regulatory body for franchises, the Franchise Association of New Zealand (FANZ) is involved throughout the country and sets standards for best practice among its members.
Franchisors that are members of FANZ are required to follow its Code of Practice, which should reassure potential Franchisees that the Franchisor is serious and has undertaken to practise in a fair and reasonable manner.
By way of an example, FANZ requires its members to:
- publish a disclosure document to maximise the information available to prospective Franchisees, so that they can make a sound business decision whether or not to proceed
- insist that each Franchisee has independent legal and accounting advice
- use agreements that contain a minimum of a 7-day cooling off period.