Commercial Leases and Franchise Agreements

According to Forbes magazine, the franchising industry is booming as the effects of the Covid pandemic seem to be lessening. The opportunity to own a proven business model with a national brand is especially attractive to first-time business owners restarting careers. The location of a prospective franchisee is critical, necessitating the negotiation of commercial lease arrangements with property owners.

Interested Parties in a
Franchise Commercial Lease

After a site is identified, the first critical question is “who owns the property?” In a franchise arrangement, the property’s location whereby the franchised business operates is crucial to the company’s success (or failure). The franchisee must then determine “who will be the tenant?” under the lease. In some cases, the franchisor is the lessee and subleases to the franchisee.

The most common arrangement is the franchisee (as a corporation, Limited Liability Company, or sole proprietor) being the tenant with lease provisions acceptable to the franchisor. A franchise real estate lease typically involves three to four separate principal parties:

• Franchisee Business Entity. Business owners often elect to do business as a C-Corporation (Inc.) or a Limited Liability Company (LLC) to limit the principal’s liability, inherent when operating as a sole proprietorship. A C-Corporation or an LLC is a legal entity distinct from its owner(s).
• Franchisor. A franchisor is a legal entity that owns the rights to a brand, supplier arrangements, and documented business practices used to deliver the franchisor’s products or services. In return for an initial fee and continuing royalties, the franchisor provides the use of a brand, access to specialized providers, and business training.
• Property Owner. The property owner provides business space to a franchisee to operate the franchisor’s business plan in return for a lease payment. Under the lease terms, the property owner gives rights to the franchisor to replace and assume the Franchisee Business Entity under certain conditions.
• Individual Franchisee Owner. The individual(s) who own the Franchise Business Entity may be required to personally guarantee specific financial or performance obligations to the commercial property owner or the franchisor.

Understanding the impact of a commercial lease agreement on each affected entity is critical before accepting a lease contract. Inexperienced franchisees can unintentionally agree to lease terms that unnecessarily increase their personal and business risk or operating costs.

Franchisee, Franchisor,
and Property Owner Relationship

Franchise agreements typically require that commercial leases comply with specific franchise standards and requirements as a condition of the licensing of a franchise. Their requirements can conflict with the interests of the property owners and complicate negotiations.

Franchisees may not realize the nuances of a franchisor’s requirement for specific provisions in the lease. For example, the overriding priority of a franchisor is to protect its brand and usually includes the right to approve a franchisee’s location before opening the business. A franchise agreement typically gives the franchisor the right to intervene in property owner and franchisee disputes.

Conversely, a commercial property owner might expect the franchisor to indemnify the owner for any liability arising from franchise operations. The franchisor and property owner frequently require the franchisee (or the owner of the franchise in the case of a corporation or LLC) to guarantee the franchisee’s performance personally. Negotiation, agreement, and documentation of the resolved issues become necessary when the parties’ intent conflict.

Long, confusing boilerplate paragraphs appear in commercial real estate leases. A misunderstood or overlooked clause in the lease can become critical in a subsequent dispute. For that reason, no one should sign a contract without prior review by a licensed attorney in the State that governs the agreement.