Many franchisors, as well as their financial and legal advisors, are wondering whether there is an ideal model for holding the leases of a franchise network.
A number of judgments handed down in recent years have demonstrated the weaknesses and shortcomings of some of these methods, notably the one that some believed to be the best: having the leases of a franchise network signed and held by a corporation controlled by the franchisor, and having no other assets (an "empty shell").
Before answering that question, here's an overview of the main models for holding franchise network locations:
1. Franchisor owns, and franchisee leases, the site
This model is used by some franchisors (generally large franchisors) for at least some of the locations of their franchised establishments.
It enables the franchisor to make a real estate investment and ensures a high level of control over each location.
2. Franchisor leases, and franchisee subleases, the site
It's also a model used by many franchisors.
It ensures a good degree of control over each location, but makes the franchisor liable for all the obligations of each lease (a liability which must be reflected in its annual financial statements).
3. Franchisee lessee with a tripartite agreement (lessor - franchisee - franchisor) giving the franchisor the right to take over the lease in certain circumstances.
At least in theory, this method may seem ideal, since the franchisor assumes no liability to the lessor while benefiting from the option of taking over the lease in the event of termination of the franchise agreement or default by the franchisee.
On the other hand, it may be more difficult to sell to a lessor (who has no assurance that the franchisor will take over from the defaulting franchisee), and requires injunctive relief if, once in default, the franchisee refuses to comply voluntarily.
4. Franchisee tenant without tripartite agreement
This model is mainly used (a) when the location is not really important to the franchisor, (b) for locations that the franchisor considers risky or unattractive, and (c) when there are several alternative locations available nearby.
5. Franchisee owns the site
Finally, the franchisee (or someone associated with the franchisee) may own the site.
Obviously, this offers the franchisor little control over the location.
However, it is possible for a franchisor to combine this model with the second or third model above, for example by having the franchisee-owner sign a long-term lease with the franchisor, who then signs a sublease with the franchisee, the term of which is limited to that of the franchise agreement.
It is also possible, in this model, for a franchisor to obtain from the franchisee-owner an option to purchase (in certain circumstances, including termination of the franchise agreement) or a right of first refusal on his building.
Each of these models also has a number of variants, and there are also a few other models that are less frequently used (but which may still be appropriate in some cases).
To return to our original question, and as you can probably imagine, there is no "ideal" model that suits all franchisors.
The choice of leasehold model for a franchise network must therefore be carefully considered by each franchisor, since it depends on a number of factors, including (a) the importance of the site of each establishment, (b) the interest, and commercial value, of the site, (c) the distance of the site from the franchisor's place of business, (c) the franchisor's ability and willingness to take over a site in which a franchisee has failed, (d) the franchisor's financial resources, and (e) the importance the franchisor places on controlling the locations of its network, compared with the risk that may arise from being responsible for the leases.
What's interesting for any franchisor, however, is that you don't have to use just one model for all the locations in the network.
By adapting its contracts accordingly, a franchisor can reserve the choice of model for each location. For example, a franchisor could very well own some locations, be the main tenant and sub-lessor for others, have a tripartite agreement for still others and, finally, let the franchisee be the owner for some.
Whatever the model(s) chosen, the quality of the drafting of agreements dealing with the location (franchise agreement, lease, sublease, tripartite agreement, etc.) is often the most important factor in preserving the rights, and protecting the interests, of the franchisor. But they must also be signed by all parties (including, in many cases, the lessor of the site)!
Unfortunately, it is often only when a problem arises that the franchisor is really in a position to assess the quality of his contracts.
