Review Agreements with an Eye Towards Future Events

I am continually reviewing real estate control documents, in connection with franchised businesses, where a franchisor requires some assurance that if your franchise rights are terminated or expire, they will be able to maintain control of your location. A boots on the ground storefront is the single best advertising a franchise system has, as well as the best way to build customer awareness and loyalty in a specific area, so some form of control makes sense, but to what extent?

Let's take the example of a frachisee who also owns the dirt his establishment sits on. Some franchisors will require upon termination of the franchise (or its expiration), that they have the right to retain the location for a specified time, typically at a market rental rate. As long as the term of the "optional" lease is reasonable, meaning for the remainder of the franchise agreement (if involuntarily terminated) or for five years following expiration, those terms can be fair and not materially impact the properties value or the investment of the property owner.

I have seen some agreements that allow a franchisor to take control of the property, for well below market rent, and for time periods that span tens of years after the termination event of the underlying franchise agreement. I advise clients to review the impact with their CPA, since there is a potential for negative implications with respect to value, marketability and retirement equity.

In many cases termination due to anything other then natural expiration typically indicates financial struggle, and in most cases an underperforming unit. One agreement that comes to mind, allowed a franchisor upon termination, to take control of the property, including options, for up to twenty (20) years. The base rent was calculated on an average of gross volume over a three-year span, mind you the underperforming years. The franchisor in some cases was paying 50% of the then market rent for the location. If an investor was looking to purchase this property, it would pen out to a much lower value, then a market rent analysis, thereby lowering the actual market value dramatically.

Franchisees must be aware of the ramifications of certain documents which may not trigger for years into the future. They must, in a pre-commitment analysis, take into account eventualities, such as termination, to prepare and negotiate agreements before they are put into play.

Now, in many cases, with reasonable agreements, the property owner/franchisee will end up with a solid rent, and tenant for many years, but preparing for down stream events is a must in a relationship where you are bound for years to come.

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