When you start a franchise, it will generally involve a commercial lease. The terms and the structure of that lease are extremely important and are more complicated than a typical commercial lease, as there are three interested parties involved, rather than just two.
The Interested Parties to a Commercial Lease Involving a Franchise
Typically, a commercial lease will be between two parties:
- The commercial landlord who owns the premises, and
- The company that wants to rent it for their business.
When the company is a franchise, though, there are three interested parties:
- The commercial landlord,
- The franchisee that will be operating the business on the premises, and
- The franchisor behind the franchisee.
That extra party means that there are additional ways to structure the lease. How the commercial lease is structured can make a big difference on the risks, obligations, and requirements of the franchise arrangement, itself.
How Franchises Often Handle Commercial Leases
The most common way to set up a commercial lease for a franchise is for the franchisor to lease the property from the landlord and then sublease it to the franchisee.
Under this arrangement:
- The franchisee pays the landlord rent in exchange for legal rights to occupy the property,
- The franchisee pays the franchisor the normal fees and royalties in exchange for equipment, training, guidance, and the use of the franchisor's recognized brand,
- The landlord gives the franchisor substitution rights to replace the franchisee if obligations are not being met, and
- The individual person behind the franchisee provides both the landlord and the franchisor a personal guarantee for the future rent.
The power dynamics in this arrangement can be nuanced. Depending on the circumstances, standard or boilerplate provisions in either the commercial lease or the franchise agreement can prove to be an existential threat to any of the parties involved – usually the franchisee.
Common Disputes to Arise in Franchise Leases
In a complex franchise arrangement like this, commercial lease disputes can come in a huge variety of forms. Some of the most common are:
- Exclusivity and franchise encroachment: The franchisee has a strong interest in being the only one around that provides its services. The franchisor has an interest in leasing as many franchisees as possible, even if they are in the area. The property owner has an interest in leasing to similar providers. This three-way tug-of-war frequently leads to lease disputes.
- Renewal rights: When the commercial lease ends, both the landlord and the franchisor often want to renegotiate its terms to extract more value from the franchisee's success on the premises.
- Costs of improvements: Particularly when the commercial lease is for many years, the premises will depreciate and affect the franchisee's business operations. Who is responsible for which property improvements and repairs is a common source of dispute in commercial leases involving franchises.
- Branding: Commercial landlords often have an interest in limiting advertisements on their premises. Franchisors and franchisees generally want to push those limitations to attract customers.
- Personal liability of the franchisee: Both the franchisor and the property owner want to protect themselves in the event that the franchise does not make money. They often do this by requiring the franchisee to individually guarantee at least a portion of the future rent owed to the property owner. Because that personal guarantee can be exorbitant, the franchisee has a strong interest in keeping it low or limited to certain circumstances.
- Business interruptions: Sometimes, the franchisee's business operations will get interrupted through no fault of its own, like a fire, or from decisions made by the property owner, like parking lot repairs. Who suffers the losses is a common dispute to arise in these commercial leases.
Franchise and Commercial Lease Lawyers at the Katz Law Group
The negotiation and drafting process for commercial lease agreements that involve franchisees can, and should, be extensive. As many different possibilities should be covered by the agreement so there is a firm understanding of what will happen in a given event. Additionally, the risk inherent in such an endeavor should be allocated as equitably as possible, as the success of each interested party depends largely on the successes of the other two.
The franchise and real estate lawyers at the Katz Law Group have extensive experience in this sensitive area of the law. Contact them online or call their law office at (508) 480-8202.