Where does the franchisor’s duty of care begin?

Many franchise agreements include (sub)lease agreements. In that situation, the franchisor is often the main tenant, and in turn leases the location from the bottom to the franchisee, under an individualized sublease agreement.

The purpose of this construction is, of course, to retain the locations for the franchise organization. This is not only important when the franchisor obtains the place of business upon termination of the franchise agreement and sublease agreement. The interest also lies in the value of the entire chain in the event of the sale of the entire franchise organisation. After all, it is of eminent importance to the prospective buyer of the franchise organization that he has a permanent grip on the locations.

If a franchisor wants to successfully sublet the business space in question to the franchisee, it is important that he is either a subtenant of the point in question or already owns the point of sale in question (for a longer period of time). If there is a situation where the franchisee owns the point, where the franchisee then leases the property to the franchisor, who in turn sub-leases it to the franchisee – for the sole purpose of creating a sublease structure – then this is unacceptable under competition law. It has been ruled in court that in that case there can be a question of a sham construction and that restrictions relevant to competition law are then not possible. In other words: the usual stipulations that depend on a franchise construction (market sharing arrangements, exclusive purchases, maximum price arrangements, (post)contractual non-competition stipulations, internet stipulations, etc.) are then sensitive or are not even allowed at all. There must therefore be a pure sublease relationship.

In addition, the construction only makes sense if there is an adequate link between the franchise agreement and the sublease agreement, in combination with all other agreements, such as financing agreements, purchase agreements, etc. This means that the entire franchise construction must be designed in a way that maximizes the link. The way in which this should take place differs per situation. If this does not take place in an adequate manner, this ultimately reduces (greatly) the grip on the location and the value of the franchise organization is significantly eroded. This also entails that transfer arrangements, any goodwill provisions, financing conditions, depreciation and possible repurchase constructions have a major impact on an adequate link and vice versa.

For example, the transfer arrangement of the franchise agreement must naturally be related to any transfer arrangement of the rental rights. Standard offer arrangements or substitution arrangements are definitely insufficient. An isolated transfer scheme in the franchise agreement, which, for example, entails an offer scheme from the franchisee to the franchisor, is of little use without coherence with an individualized sublease construction and legally permitted specific transfer scheme. Here, too, the individual situation must be carefully weighed up. Since the financing construction alone differs per situation, and as outlined above has a major impact on the legal and ultimately economic consequences of the franchise construction and the value of the entire chain, these themes also need to be streamlined.

Interest of the franchisee, duty of care of the franchisor

Obviously, the value of the franchisee’s business is inversely proportional to all of the above if the franchisor chooses not to set up an individualized sublease construction for the benefit of the franchise organization. After all, in that situation the franchisee automatically acquires more rights, thus gaining more control over the location and, for example, in the event of a takeover, the franchisee will be able to derive many more rights from his situation. It should be clear that this clearly strengthens the value of his company, his negotiating position and his future position. Incidentally, it is part of the franchisor’s duty of care to inform the franchisee in advance about his actual tenancy rights and position – certainly in the case of certain forms of linking the franchise agreement to the sublease agreement. The legal starting point here is that the franchisee may not (eventually) be put in a worse position as a result of the sublease construction. The marketability of the location does not only depend on an adequate link, but of course also depends on a number of other legal subjects to be specified in advance. More about that next time.

Mr Th.R. Ludwig – Franchise Attorney

Ludwig & Van Dam Franchise attorneys, franchise legal advice Would you like to respond? Mail to info@ludwigvandam.nl