A Layman’s Guide to Understanding Franchise Documents

If a franchise disclosure document’s 200 pages of densely packed prose make your eyes glaze over, you are not alone. And if the multitude of contracts, leases, sub-contracts, guarantees, and related documents you will be asked to sign before buying a franchise scare the bejesus out of you, it’s understandable. As a service to franchise buyers across the land, here is a handy breakdown of the documents you will encounter in the process of purchasing franchise rights:

Franchise Disclosure Document (FDD). This is the first document you will receive, and it’s the granddaddy of them all. The FDD includes descriptive text in plain English, financial disclosures, and form contracts. You will be asked to sign a receipt indicating the date you received this document, but otherwise, the FDD involves no commitment on your part. Franchisors are required by federal law and the laws of a number of states to deliver the FDD to you at least 14 days before you commit to the franchise or pay any money to the franchisor. Also by law, the FDD is required to contain the franchisor’s financial information, the franchise agreement, and any related contracts you will be asked to sign should you complete the franchise purchase.

Franchise Agreement. This is the basic contract by which you will be granted franchise rights for a single unit franchise. It is not in plain English, and is usually extensive, exhibiting the light writing touch usually found in a commercial lease. Look for a summary and cross-reference to subjects covered in the franchise agreement in Items 9 and 17 of the FDD. Ask a good lawyer to review the franchise agreement with you.

Development Agreement/Multi-Unit Agreement. This is the contract used for granting multiple franchise rights. If you want the rights to a large market that can support several units, you will be presented with some form of Development Agreement.

Site Addendum. If you have not identified a location for your new franchise, the franchisor may present you with a Site Addendum to the franchise agreement that describes a geographic search area and gives you a period of time in which to find a location in that area. The search area may or may not relate to the protected territory granted by the franchise agreement.

Personal Guarantee. This document is often required as a condition of allowing the franchisee to use a corporation or limited liability company to hold the franchise rights. If the corporation or LLC fails to meet the obligations under the franchise agreement, you will be individually and personally on the hook. This is an important legal document; make sure you understand what it means for you.

Banking Permissions. If the franchisor draws royalty payment by ACH draft from your business account, it will need your written instruction to your own bank to set this up.

Release of Claims. Many franchise agreements require that, as a condition of either transfer or renewal, the franchisee release all legal claims against the franchisor that may have arisen in the past. Check with your lawyer to make sure the release is mutual — that the franchisor releases claims against the franchisee as well.

Lease Override. Franchisors like to place themselves in position to rescue a franchisee lease that goes into default or is proposed to be transferred, and will often require that specified savings language be added to any lease the franchisee may sign.

Promissory Note. If the franchisor provides financing as part of the franchise purchase, you may need to sign a formal promise to pay back the money you are borrowing.

Franchisee Statement. This document is usually a series of factual representations by the new franchisee confirming that the franchisor has complied with its disclosure obligations, and that the franchisee has not received any assurances or outside promises that could cause legal problems down the road.

“As your lawyer, I advise you that….” By all means have your legal counsel look through the legal documents you are being asked to sign. Your lawyer can spot traps, suggest revisions if they are needed, and answer any questions you may have about the effects of these legal documents on your business plans.

Andrew Caffey is one of the nation’s leading franchise legal specialists and he represents franchisors across the United States. Caffey served as General Counsel of the International Franchise Association, a member of the Governing Committee of the ABA Forum on Franchising, and Chair of the ABA Forum on Franchising. He also is a member of the bar in Maryland and the District of Columbia, and a member of the Panel of Neutrals of the American Arbitration Association. Caffey has appeared on numerous franchise programs and is a frequent speaker and author on subjects of franchise and business opportunity regulation.