Are You Negotiating a Franchise Agreement? Do it in Writing

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CH_Scott Ratchick

If you are in the process of negotiating with a franchisor for a new franchise, you will almost certainly encounter the franchisor’s “standard agreement.”

Your soon-to-be business partner may tell you there is no room for negotiation, but that may also just be a “standard” comment. Don’t be dissuaded from trying to negotiate for modified terms that are most critical to your business, whether it’s for a new franchise or a renewal. You may be pleasantly surprised.

While there are several items on which you should focus, we recommend paying particular attention to the following:

  • The defined terms related to royalties and other fees charged by the franchisor;
  • Personal guarantees from the franchisee’s principals;
  • Integration or merger provisions that provide only the written terms of the agreement will be binding (so watch out for any, “Oh, don’t worry about that…” from the franchisor);
  • Rights of first refusal and other conditions for sale or assignment of your franchise; and
  • Franchisor’s right to repurchase your franchise.

Most critically, it is important that your negotiations are documented in writing.

We represented a group of franchisees in the moving and storage business who joined the franchise system fairly early in the history of the company. As is typical in many businesses, this franchise system evolved and changed over time. The company introduced new programs and emphasized its focus on certain segments of the business that were not priorities at the outset, most notably in this case, the “cross-country moves” segment.

Our clients did their due diligence to learn about the business, spoke with existing franchisees to determine what was most important to the operations and what were potentially negotiable terms and spent the time on the front-end negotiating certain terms with the franchisor, such as the definition of “net sales,” to make sure that it was properly protected as the business grew and was not charged royalties on certain revenues.

As the business grew, the cross-country moves segment turned out to be very lucrative. But, despite its agreement, the franchisor charged royalties and fees on that revenue. When our clients confronted the chief executive of the franchisor about the charges and the terms on which they had agreed, the senior executive simply told them that the contract both had signed “…doesn’t work for me.”

The franchisees filed a lawsuit seeking to recover the substantial royalties and fees that had been improperly charged.

The key to victory was being able to present to the court copies of the written communications (emails, letters, red-lined drafts, etc.) between the parties during the negotiation process that spelled out exactly what the parties had negotiated and what was meant by the revised terms of the franchise agreements. We did not have to rely on the troublesome “he said/she said” conflict or argue about who was telling the truth. The facts were in writing, written contemporaneously and exchanged by the parties during the negotiations. It became impossible for the franchisor to walk back from the written understandings and agreements.

It also helped that the in-house legal liaison who handled the negotiations and drafted the agreements for the franchisor ultimately testified in support of the franchisees’ understanding of the contract terms.

However, if the negotiations and agreed upon terms had not been reflected in writing, the company might have been successful in discrediting its employee, as the defendant in our case tried to do by arguing that she both lacked authority and committed scrivener’s error in drafting the agreement.

On the question of the parties’ intent, the court determined that the “extrinsic evidence is overwhelming.”  The record establishes beyond any dispute that the representatives on both sides who negotiated these franchise agreements and attempted to commit their agreements to writing intended to exclude cross-country revenues from the definition of “net sales.”

There are lessons learned and takeaways from the victory.

First, sometimes franchisees don’t assert their rights because they don’t want to get into a fight against a much bigger franchising company that has greater resources. However, this case shows that you can win these disputes when you have the facts and law on your side.

Further, this is a textbook case in how important it is to conduct negotiations in writing. We were able to show exchanges of correspondence between the parties that clearly supported the franchisees’ understanding of what both parties believed and understood they were signing.

Finally, there is real value to including a clause in the franchise agreement allowing the prevailing party in litigation to recover fees. Including the prevailing party clause in a contract makes it much easier for a smaller business to stand its ground when it is right.

Scott M. Ratchick is an Atlanta-based attorney with Chamberlain, Hrdlicka, White, Williams & Aughtry focusing his practice on complex commercial, franchise and securities litigation and shareholder and business disputes. He may be reached at (404) 588-3434 or by email at scott.ratchick@chamberlainlaw.com.