The Carefully Crafted Franchise Agreement

May 8, 2014

Recent deal data shows that the Food & Beverage M&A market saw significant activity in 2013. Such activity is expected to continue into 2014, particularly with respect to franchisors and multi-unit franchisees. Private equity groups, for example, have increased their interest in large-scale franchisees, leading to financing by private equity and mezzanine lenders of some of the biggest franchisee deals in recent months. Franchisees have become an attractive target because the well-known brands carry less risk, can generate cash and often go for sales prices less than restaurant brands of similar size. Low-cost debt is helping fuel the acquisitions, but many groups also use sale-leaseback transactions to finance the deals. Given the current expectation of activity and increased interest, potential buyers of franchise operations should take care in their diligence review of all franchise documentation, particularly franchise agreements.

Recently, the U.S. District Court for the Northern District of Florida upheld the idea that a franchise relationship by itself does not create an agency relationship between a franchisor and franchisee. See Cain v. Shell Oil Co., 2014 U.S. Dist. LEXIS 3067. In upholding that well-established rule, the court disagreed with the argument that the franchise agreement established sufficient control by the franchisor, and on that basis, rejected the plaintiff’s argument that franchisor should be liable for an incident occurring at a franchised location based on an alleged agency relationship between franchisor and franchisee. The court noted that while the franchise agreement did contain minimum standards and conditions, “the means of satisfying these conditions are left to the control and discretion of” the franchisee.

Notably absent from the franchise agreement at issue were provisions deemed to control the franchisee’s day-to-day operations, such as requiring the franchisee to stock shelves in a specified manner and purchase from the franchisor a specific software package to use for inventory maintenance.

This case, along with others like it, demonstrates for franchisors and potential buyers and lenders the importance of carefully crafted franchise agreements. In drafting and reviewing franchise agreements, franchisors should consult with experienced advisors to avoid inadvertently assuming additional obligations. Additionally, buyers that plan to assume existing franchise agreements should conduct careful diligence to understand the potential risks associated with such agreements.

The food and beverage and private equity teams at McGuireWoods are dedicated to keeping clients advised of new legislative and business developments as they occur. If you have any questions regarding these issues, please feel free to contact your primary attorney at McGuireWoods, or any of the authors.