Starting a franchise is not as easy as it may look. It is a concept that is vulnerable to abuse and demands a high degree of cooperation from both the franchisor and the franchisees. The failure of a franchise can be disastrous not only to the franchisor but also to the franchisee. It is therefore important that for a franchise to succeed, the basic concept must be sound, the legal roadmap must be well-defined and the franchise must be properly managed.
Myriad legal issues need to be considered before starting a franchise. However, because of the budgetary restraints that new franchises face, it pays to know which legal issues need urgent attention. A road map will help you focus on the areas of risk first and consider the legal issues, which don’t cost much now but may be expensive down the line if not tackled immediately.
In this article, we will be taking an in-depth look at some of the legal issues that need to be gotten right to ensure a successful new franchise.
1. Corporate Structure
A Franchisor may choose to operate a sole proprietorship, a partnership or a limited liability company. Each corporate structure entails a different responsibility.
Sole Proprietorship and Partnership: this type of structure does not offer protection from individual liability, thus any liabilities or claims brought against the franchise would strictly be the obligation of the franchise owners. This might however be a huge turn-off to investors or equity partners. This type of structure is however not without benefits as they offer some level of tax relief as compared to a limited liability company. This structure also affords complete access to the profits made by the business.
Limited Liability Company: the advantages of this type of structure in a franchise are numerous. For instance, LLC as a separate legal entity is distinct and different from the promoters of the company. In other words, the death of a shareholder does not terminate the existence of a franchise. Also, the liability of the promoters of this type of structure is limited to their individual subscriptions in the company’s share capital. A limited liability company can easily raise funds for expansion purposes through the public issue of shares.
As promising as this looks, this structure is also not without its cons. For instance, any profit declared is subject to corporate tax, and for a sizeable profitable company, this could run into millions or billions of naira. Also, the operations of a company with this type of structure are usually restricted to the objects in its memorandum of association, hence it might be difficult to venture into other kinds of business if it’s not provided for in its MEMART.
2. Intellectual Property Rights Protection
Trademarks: Ensuring that strong trade mark protection is in place is essential at the onset of any new franchise, not only because it is a legal requirement of most franchising agreements but also because it ensures that each party can protect their respective interest.
When you franchise your business, you grant specific licenses to your franchises, allowing them to use your trademarks. Franchisors must ensure that they own all other intellectual property in logos, materials, company websites, and business operating systems. In the licensing and transfer of intellectual property rights in a franchise agreement, necessary steps and measures must be taken to better protect certain proprietary intangible rights from unauthorised uses and exploitation by franchisees. For instance, A franchisor needs to be able to prevent any unscrupulous ex-franchisee from unfairly competing against him/ her and possibly against other franchisees. When continuing to trade, an ex-franchisee may use some or all of the franchisor’s trademarks or other IP.
If a franchisor were to be faced with this situation, he/she could apply to a court to seek to prevent the ex-franchisee from continuing to trade. However, a crucial remedy for a franchisor is to ask the court to prevent the continued use of his/her registered trade mark or unregistered brand name. If the trade mark is registered, it is likely that a ‘stop-order’ or injunction to stop the unscrupulous ex-franchise from continuing his/her use of the franchisor’s trade mark and/ or other IP, can be obtained. However, if the brand name is not registered as a trade mark, the franchisor has to rely on the tort of passing off.
Copyright The starting point for an entrepreneur setting up a franchise is usually to record a description of the business format model that they have developed. This will, naturally, involve drawing up new documentation – franchise operations manuals or training material, terms and conditions of sale, and other legal documents. These are subject to, and protected by copyright law. Having drawn up these documents, the franchisor would be able to prove the date of their creation, and this may assist in any action against a competitor who has allegedly infringed the franchisor’s copyright.
Patent Patents protect the technical and functional aspects of products and processes. All patents must be registered in each country where the protection for franchisors is required. If a franchise business is dependent on a computer program or any other type of equipment or machinery, that technology may be patentable.
3. Franchise Agreement
Franchise agreements incorporate the rights and obligations of the franchisor and the franchisee and set standards and expectations around performance. These include internal policies for recruiting and dealing with franchisees, policies around poorly performing franchisees and termination.
When considering termination, franchisors must ensure there are solid grounds. If the breaches are not clear-cut, it can come down to establishing a chain of evidence illustrating the franchisee’s poor performance over time. That can be a difficult and laborious process but will be avoided if the franchise agreement sets out the parties’ obligations and rights to terminate (if any). A well-executed franchise agreement will protect the franchisor’s brand and ensure that the franchisee avoids pitfalls.
4. Employees
Well-drafted employment contracts are critical to a successful franchise business. Their most important function is to attract and retain key employees, but including appropriate clauses (such as restraints of trade, intellectual property protection and confidentiality) to protect your business’ assets is equally critical in maintaining an advantage over your competitors.
5. Operations Manual
In its simplest form, an operations manual is effectively the instruction manual for running a franchise business. It includes information and guidance on all aspects of what a franchisee must do to run their business.
The franchise agreement governs the franchise relationship between the franchisee and the franchisor. Once a franchise agreement is signed, it cannot be altered (without agreement from both parties) for the term of the agreement. However, the operations manual can typically be changed at the discretion of the franchisor, depending on the terms of the franchise agreement.
Given this, the operations manual is a critical tool in influencing the behaviour and operations of the franchisee over time. It provides a franchisor with a level of control and ability to enforce desired behaviour and actions within the operation of a franchisee’s business, to uphold and protect the brand, but also provides the flexibility and freedom to be able to change and adapt the system to changing customer needs as well as new technologies and systems.
6. Registration with regulatory authorities
There are no specific laws regulating franchising in Nigeria, however, there are several regulatory provisions that affect franchising. For instance, the National Office for Technology and Acquisition Promotion (NOTAP) Act regulates the transfer of foreign technology in Nigeria. The NOTAP Act provides that all agreements between a foreign transferor and a Nigerian transferee must be registered with NOTAP. Section 4 of the NOTAP Act states that such agreements are to be registered if they are regarding: the use of trademarks; use of patented inventions; supply of technical expertise in the form of technical assistance of any description whatsoever; supply of detailed engineering drawings; supply of machinery and plant; provision of operating staff, managerial assistance, and the training of personnel.
However, if the franchise arrangement is to be executed between two local entities, there would be no need to register with NOTAP.
7. The Franchise Disclosure Document (also known as the FDD)
To set up a successful franchise business, a franchisor has to prepare an FDD. The purpose of the FDD is to provide prospective franchisees with information about the franchisor, the franchise system and the agreements they will need to sign so that they can make an informed decision. In addition to the disclosure part of the document, the FDD includes the actual franchise agreement as well as other agreements the franchisee will be required to sign, along with the franchisor’s financial statements. The FDD is designed to give you some of the information you need to make an informed decision about investing in a particular franchise.
Conclusion
Every seemingly insignificant decision goes towards laying the groundwork for success, and poor choices can come back to bite. Common mistakes include setting up a company without proper legal advice and implementing agreements involving your intellectual property (IP) that fail to properly protect your interests. Ensuring that you are legally protected is crucial to creating a new franchise.
Olawunmi Ojo heads the Corporate and Commercial law practice group at the Trusted Advisors
The Trusted Advisors is a leading Nigerian full-service law firm providing cutting-edge and timely legal solutions and services to its clients.
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