What is a Franchise Agreement?
This is the center of every franchise arrangement. A franchise agreement grants franchisees the right, for a fee, to operate a single franchised business, per the terms as outlined in the agreement. Every franchised business needs a separate franchise agreement.
The three types of franchise agreements include:
- Master Franchise Agreement
- Area Representative
- Area Development Agreement
Master Franchise Agreement
A master franchise agreement grants a master franchisee (or subfranchisor) the ability to approve franchises to others in specific geographical locations.
The master franchisee:
- Provides services to the franchisees in the territory
- Oversees the development of the territory according to an agreed-upon development schedule.
- May satisfy some of the development by operating franchised businesses in its territory
Fees are typically split with the franchisor, based on the proportionate share of responsibility. In some registration States, including California, master franchisees must register and provide disclosures (FDD) to prospective franchisees.
This is also known as an "area director agreement" or "area franchise agreement,” an area representative agreement grants the contracting party similar rights and abilities, but with less responsibility and rewards than that of a master franchisee.
The area representative, normally cannot grant or sign franchise agreements, but only the right to help with the franchise marketing process and provide assistance to franchisees on the franchisor's behalf, within a specific territory.
The franchisor will collect the fees from franchisees and then pays the area representative a percentage. The area representative in many cases does not own a franchised business.
Area Development Agreement
An area development agreement is, in essence, an option agreement wherein an area developer agrees to open and operate a specified number of franchised businesses in a specific location. They also pay fees for developers to obtain exclusive rights to create more units in the area, conditioned upon a development schedule. Normally each franchised business opened is memorialized with a separate franchise agreement.
Development fees paid upfront are typically applied against the initial franchise fee for each franchised business opened. We see a large portion of area developers fail to meet their development schedule, which may cause a termination of the development agreement and forfeiture of the remaining upfront fee paid, or a revision of the development agreement.
In some registration States, such as California, the franchisor must file and provide an FDD specific to this type of Agreement.