Finding a great location is key to the success of any business, and franchises are no different. Regardless of industry, good franchise systems rely on the strength of their sites to create visibility, brand recognition and goodwill. Therefore, franchisors must have a real estate strategy in place and actively maintain control over the franchise locations.
As most franchises rely on leased premises for their businesses, the ability of the franchisor to have input and control becomes increasingly important and challenging. Franchisors need to ensure that even in the event of a default or termination of the franchise agreement or a default by the franchisee in their lease, the franchise system can continue operating at the location with minimal disruption.
There are two primary ways franchisors can address this issue:
(a) directly entering into a lease with the landlord and subsequently subletting the premises to the franchisee, or
(b) incorporating a lease rider into the franchisee’s lease.
Franchisor’s lease with landlord
The franchisor can enter into a lease directly with the landlord, and then concurrently sublease the premises to the franchisee. This option gives the franchisor maximum control over the lease negotiation and the premises itself. In cases of any issues with the franchisee, the franchisor can either continue operating the business at the location itself or find a new franchisee to sublease to, while maintaining the head lease in good standing.
However, this option presents its own set of challenges and risks. Depending on the number of franchise locations, the franchisor may expose itself to greater liability as a tenant across multiple lease locations and jurisdictions. This could result in increased costs and expenses (including insurance and legal) and place strain on resources due to the management of multiple leases, landlords and subtenants (franchisees). Additionally, dealing directly with lease issues or disputes with landlords requires valuable time, energy and money.
Using a lease rider
A more practical option is to employ a lease rider. Essentially, the lease rider is an additional/separate agreement between the franchisor and the landlord, which accompanies the franchisee’s lease with the landlord. The purpose of the lease rider is to protect the franchisor by including options for specific contingencies that may arise concerning the franchisee. For example, the rider may give the franchisor the option to cure certain defaults or to even to “take over” the lease or find an alternative tenant. By incorporating a lease rider, the franchisor maintains control over the premises without assuming direct liability as a tenant.
While lease riders can be customized depending on the franchisor, the type of industry, or the location, they typically include key clauses such as:
- Notice of Default: the landlord agrees to notify the franchisor in case of a lease default;
- Opportunity to Cure: the franchisor is afforded the ability to cure certain franchisee defaults;
- Use of the Premises: the franchisor can restrict the franchisee’s ability to change the use of the premises other than as the franchised business;
- Amendments: the franchisor can ensure that the landlord and the franchisee do not amend the terms of the lease without the consent of, or input from, the franchisor.
- Lease Assignment: the franchisor can restrict the ability of the franchisee to assign the lease to a third party or it can also give the franchisor the opportunity to take over the lease or to assign to a new franchisee.
While lease riders can be a useful tool, caution should be exercised during their drafting to ensure they achieve the franchisor’s intentions without creating unnecessary issues or liabilities Even if the franchisor has a well-structured lease rider, the landlord may decline to incorporate it into the lease or may require it to be customized to their satisfaction.
Regardless of which option a franchisor chooses, it is important for the franchisor to actively engage in the lease negotiation process from the outset. Even in situations where the franchisee is entering into the lease with the landlord and a lease rider is being used, franchisors will often be directly involved in the negotiation of the main lease in order to provide input, maintain control and ensure that there are no terms included in the lease that could negatively impact the success of the franchise location.
How MLT Aikins can help
The lawyers in our Franchising group have wide-ranging experience advising domestic and international clients on navigating the legal and regulatory requirements that apply to Canadian franchises. Contact us to learn how we can help.
Note: This article is of a general nature only and is not exhaustive of all possible legal rights or remedies. In addition, laws may change over time and should be interpreted only in the context of particular circumstances such that these materials are not intended to be relied upon or taken as legal advice or opinion. Readers should consult a legal professional for specific advice in any particular situation.