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Leasing Options in Franchise Agreements

January 21, 2013

When it comes to placing a franchisee at a particular location, franchisors generally have two options – be the tenant or don’t be the tenant.

One of the most common lease arrangements in franchise relationships is where the franchisor negotiates a lease for the premises, enters into the head lease with the landlord and subsequently sub-leases the space to the franchisee.  Landlords like the sublease model because they have the franchisors (i.e. the party with the deeper pockets) on the hook for the lease, which is the party they would prefer to have recourse against if problems arise.  Franchisees like the sublease model because they obtain the benefit of the franchisor’s bargaining power, due to its size and experience, to negotiate more favourable lease terms than the franchisee likely could on its own.

The sublease model is also an attractive option for the franchisor because, assuming it’s a desirable location, it can retain possession of the premises as franchisees come and go over time.  There is also the added advantage that a franchisee is less likely to compete with a franchisor post-termination of the franchise agreement if it doesn’t have the location anymore.

One of the disadvantages of subleasing is that, as is self-evident, the franchisor is now on the lease, adding to its list of potential obligations and liabilities.  Since there is no relationship between the landlord and the subtenant franchisee, each of those parties has to rely on the franchisor to enforce their respective rights.  And, ultimately, a franchisee’s non-performance under the sublease (such as failure to pay rent) will fall on the franchisor.

Where the franchisor would prefer to not enter into the lease, the franchisee becomes the tenant, but the franchise agreement must specify that the franchisor have a conditional assignment clause whereby the franchisor can automatically assume the lease if the franchisee is in default of its obligations.  As a result, any such clause should require the landlord to give notice to a franchisor of any franchisee default.  It is also critical that the franchisor, franchisee and landlord sign an agreement together in order for the assignment right to be enforceable.

There is no right answer to the question of whether or not a franchisor should be a tenant on a lease for a franchised location – it varies by preference and circumstances.  Each option carries its share of advantages and disadvantages.  None of that may matter, however, if the landlord isn’t prepared to grant that option to the franchisor and would prefer to make the decision itself.

Tags: Franchising