Retail leasing and franchising – watch your step!
There are some important considerations about leasing to be aware of when you are poised to buy a franchise.
Inherently the value of a business is tied to the term of its lease that is called security of tenure. There are often issues that arise in franchising, depending on who holds the lease.
In many cases the franchisor will hold the head lease and then grants a license to occupy to the franchisee. In many other franchise models the lease is negotiated directly with the franchisee as head tenant, subject to the lease and site being approved by the franchisor.
Ideally the franchise term will start and end on the same date as the lease agreement. This is often not the case particularly with shopping centre leases.
From a franchisee's perspective, having your lawyer review the lease is as important therefore as reviewing the terms of the franchise agreement.
You need to ensure there are no conflicting terms between the lease and the franchise agreement.
A key issue where the terms do not align is that a franchisee may be left with a franchise business with no premises from which to operate or the franchise term ends with no premises to operate from.
Both of these scenarios are not only uncomfortable but can involve a franchisee in unnecessary financial exposure and stress.
Most franchise agreements which involve the lease of premises will be caught by the Retail Leases Act legislation subject to specific state and territory legislation.
Who should hold the lease?
In many cases it is the shopping centre that will determine who will hold the lease, as many do not want to deal with individual franchisees.
Where a franchisee enters into a lease with a third party and is obtaining funding to acquire a business there can be priority conflict issues between the franchisee’s bank, who may wish to take a mortgage over the lease and franchisee’s assets in priority, to the rights of the franchisor if the franchisee defaults.
This does not occur were the franchisor holds the lease. By holding the lease the franchisor is however primarily liable if the franchisee abandons the business and or is in default.
If the franchisor is also the landlord then the lease and franchise agreement should be aligned. There can however, be conflict between the provisions of the franchise agreement giving the franchisor the right to approve a purchaser and the landlord’s right to refuse an assignment under the Retail Leases Act which need to be considered.
Where the franchisor leases the premises as head tenant and sub-leases to the franchisee there is no contractual relationship between the landlord and the sublease (franchisee).
The franchisor passes on all leasing costs and obligations to the franchisee.
This can create problems for a franchisee if the franchisor gets into financial difficulty and fails to pay the rent as head tenant to the landlord.
The franchisee in that case has acted properly paying its rent and outgoings however if the franchisor has failed to remit those to the landlord, the landlord can terminate the head lease and therefore the sublease. The franchisee’s business is therefore exposed to huge risk.
The franchisor as head tenant may not question many of the costs imposed by the landlord or shopping centre and simply pass them on to the franchisee without question for payment.
Where the franchisee leases the premises directly from a third party then is often the issue that the terms do not coincide between the franchise and lease term. Issues also arise in relation to a franchisee who might exercise its option under the franchise agreement when there is no option under the lease.
Other issues to consider
Each state and territory has its own retail leasing laws, while these are similar in many respects there are differences, the key one being how retail premises are defined.
In Victoria the definition of a retail premises is very broad covering unspecified goods and services provided by retail from premises.
In NSW the Retail Leases Act 1994, definition includes all premises in retail shopping centres as well as all business not in retail shopping centres which are of a type of business specified in the schedule, which are primarily selling goods not services.
What are the risks of relocation and redevelopment?
A franchisee who is a subtenant or licensee may be at the control of the landlord in relation to the relocation/redevelopment of a shopping centre which may be costly and disruptive to the franchisee’s business.
There is also a risk that the head lease may contain a demolition cause which the franchisee may not be aware. The retail leases legislation gives some protection to tenants by requiring landlords to pay compensation however the cost and inconvenience usually far outweighs by the compensation offered and or negotiated.
The obligations to make good the premises at the end of the lease should be carefully reviewed. This can be a costly exercise for the franchisee as the obligations may be passed onto them under the sub-lease or license agreement.
Franchisees should not only review any lease agreements they are holding as a sub-lessee or a licensee but also ensure that they have a list of the possible outgoings so that they are aware of all the fixed operating costs and can properly budget for those costs in their cash flow projections.
Often the base rent is one indicator however there can be contribution to outgoings, owner’s corporation fees and contributions to advertising and marketing campaigns.
There may also be shopping centre rules. the obligations of which are passed onto the franchisee, which may impact on the franchise business for example in respect to signage, playing music and lighting which may be contrary to the intended business activities.
Franchising, like retail leasing, is highly regulated.
Ensure you obtain expert legal advice in respect to not only the obligations under the franchise, but also under any lease or licence arrangement.