Franchisor beware: Troublesome lease clauses that can leave your franchisee out in the cold

There are numerous benefits to a franchisor electing to negotiate and enter into a head lease directly with the landlord and then assigning or subletting the lease to a franchisee. The franchisor often has expertise and superior bargaining power when negotiating leases with landlords than would a franchisee. The franchisor also has the benefit of maximizing its control over the location in the event that any issue arises with either the franchise agreement or lease agreement. However, there are pitfalls that the franchisor should be aware of when negotiating lease terms, recognizing the fact that certain clauses in the lease agreement are often more important to the franchisee than the franchisor. The franchisee is relying on the strength of the tenant’s rights under the lease agreement and is also looking for a degree of certainty when it agrees to make a significant investment in the business. When negotiating a lease agreement, the franchisor should pay particular attention to these clauses, a few of which are highlighted in this article, which could have a significant impact on its franchisee.

Relocation

Often in shopping centres, the landlord will reserve the right to relocate the tenant during the term of the lease. If a relocation clause without any restrictions or conditions is exercised by the landlord, the franchisee would be obligated to move its premises within the shopping centre to a potentially worse location, at its own expense.

The franchisor should attempt to remove this clause. In large shopping centres, the landlord will most likely refuse to delete the relocation clause, but will often agree to add restrictions and/or conditions.

The franchisor should negotiate revisions that would only permit the landlord to exercise the relocation clause in the event that it plans on a reconfiguration or expansion of the shopping centre. It should not be permitted to relocate the franchisee if it wishes to provide the leased premises to another tenant.

The relocation clause should stipulate that the relocated premises will be a similar size and configuration as the current premises and be in a comparable location. For example, if the leased premises are in a food court of a shopping centre, the clause should dictate that the relocation must be within the food court. Without this clause, the franchisee could be forced to accept premises that are unfit for its business. In addition, the franchisee’s rent will likely increase if the relocated premises are larger than the original location. The franchisor may also be able to negotiate a revision to this clause that would permit it to terminate the lease should the relocated premises being offered to the franchisee be not to its satisfaction.

The franchisor should also negotiate compensation to the franchisee for relocating the premises. As a first step, the franchisor should require that the landlord pay for the franchisee’s costs to move its premises and the cost of new fixtures required to replace any fixtures that cannot be relocated. At a minimum, the landlord should be paying for the amortized value of the fixtures that cannot be relocated.

Demolition

The landlord will often have a clause that would permit it to terminate the lease in the event that it wishes to demolish the building. In this event, the franchisee would be forced to relinquish its leased premises.

The franchisor should attempt to remove this clause from the lease agreement. However, depending on its bargaining power, the landlord may insist that this clause remain in the lease. At a minimum, the franchisor should obtain a condition that would require the landlord to provide a year’s notice prior to terminating the lease and provide evidence that it has taken steps towards demolishing the building.

The franchisor may also attempt to negotiate compensation to the franchisee for the amortized value of the fixtures that cannot be removed from the premises.

Sale

The Landlord may have a sale clause in its standard form lease agreement, which would either entitle it to terminate the lease agreement upon entering into a sale agreement for the property, or would entitle the purchaser to terminate the lease agreement. Same as in the demolition clause, the franchisee would be forced to relinquish its leased premises.

The franchisor should demand that this clause be deleted from the lease agreement. It is more likely that a landlord would sell the property rather than demolish the property, and it creates too much uncertainty for the franchisee’s prospects in the location.

Renewal

It is in franchisor’s interest to obtain options to renew, whenever possible. It provides more certainty to the franchisor that it can have control over the leased premises for a period that is longer than the original franchise / lease term. Although the franchisee, when entering into a franchise agreement, is not likely to receive options to renew its franchise, it may still view options to renew the lease as a favourable term. In their mind, it increases the likelihood that its franchise agreement would get renewed at the end of the original term.

The thing to be careful with renewal clauses is that the landlord will likely stipulate that the tenant cannot be in default of the lease or previously in default of the lease. Considering the fact that the franchisor is not involved in the day to day operations at the premises and is relying on the franchisee to perform the tenant’s obligations, the franchisor should attempt to soften the condition. The tenant should have the option to renew if it has previously been in default, provided that the said defaults have been rectified. It may be reasonable for the landlord to require that the tenant cannot have been in default more than a couple of times during the term.

The franchisor should either negotiate the amount of rent that will be payable during the option(s) to renew or stipulate that the rental rate will be at the fair market rental rate and that the franchisor is permitted to take the landlord to arbitration in the event that the sides cannot agree on the fair market rental rate during the renewal term. Without an agreed upon rental rate or a method of determining the rental rate, the options to renew would be subject to the landlord agreeing to offer a fair rate.

Lastly, the franchisor should be mindful of when it must provide notice to the landlord of its intent to exercise an option to renew. If the franchisor intends to renew its franchise agreement with the franchisee, it should be in contact with the franchisee prior to the expiry of the lease’s notice period.

Disclosure

In addition to negotiating these clauses in the lease, the franchisor should highlight them in the disclosure document that it sends to the franchisee. In many cases, these clauses could result in either the franchise agreement being terminated before the end of the term or an increase in costs borne by the franchisee. As a result, they should be properly disclosed and considered by the franchisee before deciding on whether to make a significant investment in acquiring and establishing the business.