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NFC16 NATIONAL FRANCHISE CONVENTION LEGAL SYMPOSIUMLEASING AND LICENCING OF PREMISES – ISSUES, HINTS AND TIPSHow can the franchisor become comfortable about the security of sites in the network? The decision as to whether the Franchisee or Franchisor holds the lease is largely a commercial decision. It will be driven in part by the nature of the franchise system and partly by risk and commercial factors around the site.Each franchise system is different. Franchisors can: negotiate a lease and transfer the lease (either by assignment or by share sale) to its Franchisee; hold all the leases and grant occupancy licences or subleases to its Franchisee; ask that the Franchisee arrange and hold its own occupancy rights (ie lease or licence) and grant licences to the Franchisee associated with use of the brand name and business procedures. In this instance, the Franchisor may want to consider requiring that the Franchisee and landlord enter into a Deed of Re-Entry or that the Franchisor be given a Right of First Refusal with respect to the site. There are advantages and disadvantages to all of the above approaches:Leasing/Licensing Strategy AdvantagesDisadvantagesHold all the leases and grant occupancy licences or subleases to its FranchiseeControl of site and ease of accessDirect relationship with the landlordIncreased negotiating powerGreater access to market informationQuick access to the site where there is a poor operator and reputational issuesIn the event of a change in the market, the Franchisor or its related entity would have the rent on its balance sheet.The franchisor may also have operational responsibilities, which it might find challenging.Difficulties in recovering unpaid rent from the franchisee.Potential for increased liability for site selectionNegotiate a lease and transfer the lease to its FranchiseeControl of the site and of negotiationsIncreased negotiating powerGreater access to market informationTransfer of financial and operational risk to FranchiseeIncreased costs Potential for increased liability for site selectionInability to access the site or take control where there are operational or reputational issuesFranchisee controls the site, but the Franchisor has a step in right or first right of refusalLess financial riskLess operational exposureLack of control of the siteLack of transparency of unpaid rent and outgoingsNo direct relationship with the landlordLack of information on rental marketIncreased complexity to the deal (more moving parts)Problems with enforcement of step in arrangements or right of refusalIn the Subway? system, a leasing company holds the majority of restaurant sites in Australia to retain control, and the sites are then sub-let or sub-licenced to the Franchisee depending on the site with the documentation having cross default provisions with the Franchisor’s franchise agreement. However, there are sites that are Franchisee controlled locations within the system; with Franchisees either owning the freehold or taking the head-lease with a Right of First Refusal or type of Step in Deed allowing the Franchisor or its nominated entity to step in under certain circumstances. When the franchise business or site is sold, it may also become necessary for a lease to be negotiated and put in place for any new Buyer of the business to obtain security of tenure (for example if the freehold is not being sold but the business is).In some franchise systems, for example, the Franchisor negotiates the terms of the Lease, establishes an SPV tenant company to hold the lease and then sells the tenant company to the incoming Franchisee (by a share sale), thereby automatically transferring the lease. Over the life of the lease whenever the Franchise business is sold, the shares in the SPV tenant company are sold to the new Franchisee. The terms of the Lease should contemplate and allow for this transaction to take place. The Franchisor should retain step in rights under the lease by a separate Step in Deed, enabling the Franchisor to retain some control (ie in the event of default). In the Quest franchise system, the Franchisee holds the lease via a SPV Tenant Company. The Franchisor has step in rights under the Lease and a separate Step in Deed which permit the Franchisor rights in certain circumstances to step into the Lease. This provides the Franchisor with control over the site (ie in the event of default). Some systems are a combination of both and hold the leases for their prime locations (and operate the business from those locations) whilst allowing those sites which are not prime sites to be held by the Franchisee. In some situations, due to the way the asset is owned and controlled different leasing arrangements will need to be entered into (eg airport land is owned by the Commonwealth government and a lease granted to the airport corporate operating the site). In these situations, Franchisors may enter into a Head Lease with the corporation operating the site and grant the Franchisee a sub-lease. Whilst this provides the Franchisor with control of the site it does of course mean the Franchisor is primarily responsible for the obligations under the Lease. Sites such as airports or shopping centres may also have special considerations to take into account for storage away from the actual leased site or outside the premises. Separate licence arrangements may be needed for operational purposes. Security required by landlords or the head leasing entity will vary. Landlords will typically look for some sort of guarantee or performance bond from the Franchisee tenant or a parent company guarantee in the situation where a sub-lease is granted to the Franchisee tenant.In the Subway? system, the Franchisee would usually provide that guarantee under the leasing arrangements direct to the Head-landlord pursuant to the terms of the sub-lease. What’s the best way to handle negotiations with landlords?Where the Franchisee does not hold the leaseMost Franchisors hold the lease and grant an occupancy licence therefore there is little power the Franchisee will have with respect to lease negotiations. However, Franchisors may include Franchisees in such negotiations (especially if a Franchisee has been identified for the site) and open transparency is encouraged between all parties. Franchisees may be very sophisticated and capable of handling own negotiations or prefer to do so. Remember, ultimately Franchisees must understand their rights and obligations of operating their own franchised business. Therefore, the lease documentation must be well documented as to any understandings reached between the parties. Some Franchisors may also have standard special conditions which commercially they wish to incorporate into every lease with landlords. With major landlords, Franchisors should consider whether there is an opportunity to negotiate a consistent set of terms across the country. In the Subway? system, they endeavour to build relationships with landlords, especially those with multi-sites that may be advantageous to development plans; mutually agreed lease conditions between the parties may be accepted for deals which occur. Franchisors should pay particular attention to clauses dealing with:rent review mechanisms generally;turnover rent and ensuring that the threshold increases with the rent;relocation clauses and compensation;demolition clauses and compensation; andmake good obligations at end of lease.The Franchisor would retain the relationship with the various landlords, but as Franchisees run the business from the site, the Franchisee’s impact on landlord relationships can be significant. Those relationships can potentially affect negotiations in the future for further lease terms with the landlord or in resolving site concerns during the term of the tenancy. Having a good relationship is certainly beneficial. Franchisors can endeavour to protect that relationship by:regularly meeting face-to-face with Franchisees to stay close to the Franchisee’s business;reiterating to Franchisees that payment of rent should be made on time without the landlord needing to chase arrears;encouraging both the Landlord and the Franchisee to deal with (and if necessary escalate) issues – particularly issues with non-payment or under-payment of rent;early and proactively managing Franchisee relationships with their landlords by:seeking regular updates and reports from landlords regarding any arrears or late payments;meeting with both the landlord or centre manager/agent together with the Franchisee when serious matters arise;encouraging the Franchisee not taking petty legal stances (eg changing a light bulb scenario and being the “pain in the neck” tenant for every little thing if there is really a simple fix.) Where the Franchisee does hold the lease:For those franchise systems where the Franchisor allows or requires the Franchisee to hold the lease, it is usually beneficial for the Franchisee to have the Franchisor assist with the lease negotiations. This is for a number of reasons:Bargaining Power – The Franchisor will more than likely have more experience in, and the ability to influence the leasing negotiations. For example, Franchisor may have multiple leases from that landlord across different Franchise sites. Resources and Experience – The lease may set out a very prescriptive process for lease negotiations (ie rent review or refurbishment obligations) which must be strictly followed by the Franchisee tenant.Security of Tenure – Tenure (or secure occupancy rights) is likely to be a key asset in the franchise system, so it is in the Franchisor’s best interests to provide oversight and guidance during negotiations with the landlords to ensure tenure is secured and renewed. How do you navigate the complexities of issues in retail leasing across Australia? Each State and Territory has its own retail leasing legislation which differs largely from State to State and Territory and there are no uniform retail leasing laws.Most Franchisors operate nationally and therefore it is important to have a basic understanding of the legislation in each State and Territory. A good starting point is the Retail Leasing Legal Compendiums which some of the larger firms have available for access on their websites which gives a good summary of each State and Territories legislation and also gives a cross comparison of all the different clauses.It is also very important to understand the importance of registration of leases in each of the jurisdictions and also lodging caveats to protect the tenant's interest and the consequences of not doing so.For example, in Western Australia, all leases for a term of 5 years or more must be registered. The decision in the case of Primewest (Mandurah) Pty Ltd v Ryom Pty Ltd as trustee for Golden Asset Pty Ltd [2012] WASC 443 supports a previous view of the Western Australian Supreme Court that an unregistered lease for a term in excess of five years is destroyed on transfer of the freehold of the land to a third party. In South Australia, the problem is that in order to register a lease or lodge a caveat, you must also obtain a survey plan. The costs involved of registering a lease or lodging a caveat are so prohibitive (over $2,500) that many leases in SA are not registered, which then does not give the tenant indefeasibility. A summary of the some of the clauses relevant in the franchising context that you should have a basic understanding of are as follows:Definition of LeaseDefinition of Retail PremisesDefinition of landlord (as franchisors can be caught under the definition)Disclosure Statement RequirementsRent Review Minimum TermRelocation and DemolitionProhibited OutgoingsCompensation for disturbanceWhen practising nationally, it is also really important to establish your own network of other leasing lawyers in each jurisdiction that you can call on if you need guidance or advice. What issues should you consider when dealing with disclosure for retail leases? The obligation on a landlord to provide a Disclosure Statement to a tenant at least 7 days prior to a tenant entering into a lease together with a draft copy of the proposed lease is a requirement in all States and Territories.Each State and Territory defines a landlord and tenant differently which means, in the context of Franchising, that where an occupancy licence is granted to a Franchisee, the Franchisor in numerous States is caught under the definition of a "landlord" and/or the franchisee is caught under the definition of a "tenant" and therefore must issue the Franchisee with a current disclosure statementFor example:Victoria - Section 96 of the Retail Leases Act 2003 requires the franchisor to give the franchisee a copy of any Disclosure Statement it has received together with details of any changes.Queensland - The Schedule to the Retail Shop Leases Act 1994 defines a lessee to include a franchisee entitled to occupy the premises. A lease is defined as an agreement under which a person gives or agrees to give to someone else for valuable consideration a right to occupy the premises. The granting of an occupancy licence by a franchisor to a franchisee would therefore be caught under the legislation in Queensland and the franchisor would therefore need to comply with the Disclosure Statement requirements.South Australia - Section 3 of the Retail and Commercial Leases Act 1995 defined lessor as the person who grants or proposes to grant the right to occupy a retail shop under a retail shop lease. A "retail shop lease" is defined as an agreement under which a person grants another person a right to occupy the premises. The granting of an occupancy licence by a franchisor to a franchisee would therefore be caught under the legislation in SA and the franchisor would therefore need to comply with the Disclosure Statement requirements.The problem with issuing a compliant Disclosure Statement in circumstances where the landlord is the Franchisor is that as Franchisor, you do not have all the information, so the Disclosure Statement is completed on the basis only of the information you have and where you do not have the information, or cannot get the information from the landlord, you specify that "as the franchisor is not the owner of the premises, it cannot complete this information".Importantly, any notices a Franchisor has received from a landlord must be disclosed as well as up to date information on rent and outgoings.Step in rights – the good, the bad and the ugly? Step in Deed – If Franchisor elects not to grant an occupancy license to a Franchisee, but rather allows the Franchisee to hold the lease, then the Franchisor should seek to enter into a Deed of Re-Entry or similar arrangement with the landlord of the premises to protect the site in the event that the Franchisee defaults under the lease and the lease is terminated. The right to take over the premises can also be important if the site is significant and the Franchisor wishes to retain control of the site following termination or expiration of the Franchise Agreement.Franchise Agreement considerations – Franchisors should consider whether their Franchise Agreement has sufficient termination rights for breaches by the Franchisee under the Franchise Agreement and (in situations where the Franchisor has a legitimate interest) the Lease. Importantly, Franchisors should give careful consideration to whether any cross-default clause in their Franchise agreement falls afoul of the ‘unfair contract terms’ legislation that comes into force in November 2016.Lease Negotiations – Not all landlord's will agree to enter into a Deed of Re-Entry. Be clear at the start of negotiations for the lease of the site that a step in right for the Franchisor is a key commercial term. It may also be helpful to provide context as to how step in rights generally are an important part of the both the franchise system as a whole (especially where the site is being purpose built by the landlord for that franchise system) and specifically with regards to the security of the site. This will increase your chances of being able to secure it in the negotiations and in any later enforcement proceeding (should that prove necessary). Typical scenarios when a Franchisor will rely on their step in rights – Franchisors can find themselves in situations where there is a risk that the Franchisee will default under their Franchise Agreement. Franchisors in this situation should act cautiously, as they do not want to unreasonably terminate a Franchisee and take their franchise business away. Franchisors in this situation should also consider impacts to the brand of the franchise system and its reputation. Equally, there are situations where the Franchisor must be willing to act, so as to send a message to the Network that the Franchise Agreement must be upheld and that key sites will be retained within the Network.The following are examples of where step in rights by the Franchisor may be considered:Breach by the Franchisee (eg insolvency by the Franchisee tenant or non-payment of rent)Franchise Agreement – Ensure franchise agreement is well drafted and includes appropriate termination rights.Involve interested parties– consider the Franchisor’s interest and also those of secured creditors (like the tenant’s financier) and significant third parties (like the landlord). It will also not likely be beneficial for a Franchisee to ignore the financial reality. Often, the Franchisor, Franchisee tenant and bank will have entered into a Tripartite Deed that prescribes certain notices and processes which must be followed in the event of an act of insolvency by the tenant. Open and early dialogue with secured creditors the landlord and the Franchisee to determine and agree the best course forward may be useful to achieving an acceptable resolution for all without costs getting out of control. In some instances, for example, the financiers may be amenable to the Franchisor stepping in to manage and operate the business (ready it for a resale) rather than attend to appointment of their own receiver and manager. Each circumstance will need to be considered on its own facts, and the Franchisor may not have capacity to run the business. Breach or Default – Consider issuing breach notices and other notices, such as under any Tripartite Deed with the financier to protect the Franchisor’s interest. There may also be an authority to divulge commercial information between the parties so to allow open communication to work through concerns to work out a resolution. Generally, for minor breaches of the Franchise Agreement (where the site isn’t at risk), then a Default Notice and mediation process under the Code is preferable, as it helps to maintain the relationship between Franchisor and Franchisee. However, if the breaches are serious, the site is at risk (for unpaid rent or a refusal to upgrade) or there is a reputational risk for the Network, then you should issue a breach notice (and consider whether further notices are required under any step-in arrangements). Also, be wary of state laws regarding termination rights for leases and other occupancy rights.Act on termination – There are number of areas to consider when you terminate a Franchise Agreement. You need to be mindful of the Franchising Code of Conduct, processes and notices required under the Franchise Agreement and other agreements like Tripartite Deeds (with financiers and the tenant) and the Lease or License to Occupy. You will also need to consider operational issues associated with taking control of the Franchise business (including employees (and the risk of taking on employee entitlements), third party suppliers, bank accounts, payment systems, stock, customer bookings, communication’s and messages to the Franchise network and externally and so on). It is best to prepare a project plan to anticipate and plan for each of these matters. Failure by Franchisee to exercise an option or other right under the leaseA good step-in deed will include a requirement that the landlord notify the Franchisor if a Franchisee has not exercised an option or other right under the lease, and provide that opportunity to the Franchisor to exercise the right. Likewise, it will require the Landlord to notify the Franchisor about the Franchisee’s failure to pay rent or meet other obligations. Addressing smaller debts early is easier than months of arrears. In the Subway? system, they regularly contact landlords to obtain an update on balances and any concerns from landlords about the Franchisee’s occupation of the site. Franchisors not stepping in and the message this may send?At times, a Franchisor may elect not rely on its rights to step in to the business where there has been a breach of the Franchise Agreement. It may instead, for example, put in place a Management Deed and assist the Franchisee trade through the issue (perhaps assisting the tenant renegotiate lease arrangements with the landlord). Franchisors are often caught trying to balance their rights under the Franchise Agreement with not being seen as overly aggressive or due to a genuine desire to work with and support their Franchisee.However, Franchisors need to consider the impact of not stepping in where there is a very clear breach (eg non-payment of Franchisee fees) or breaches giving rise to reputational issues. By not stepping in where a Franchisee is in breach, this can send the Franchisee a message that the breach is acceptable. It is generally recommended for these serious type of breaches, that the Franchisor issue a breach notice to give the Franchisee notification of the breach, and an opportunity to remedy the breach. Where the Franchisor has taken no steps to issue a breach notice and let things go on, the breach may become very significant, and the chance of recovering, for example, outstanding rental arrears may become seriously impacted. Failure to rectify a breach may lead to termination of the Franchise Agreement, where perhaps the situation could have been averted by the issuing of a Breach Notice early on, which forced attention and resolution of the breach. ................
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