Lease of the Premises by a Third Party
with Option in Favor of Franchisor
Moderator:
Carl Zwisler
Gray Plant Mooty
Washington, DC
2010 IDI Annual Conference
Torino, Italy
June 11-12, 2010
Be Careful What You Wish For
There are two tragedies in life. One is to
lose your heart’s desire. The other is to
gain it.”
- George Bernard Shaw
2
In the US, one FDD item requires
disclosures about the duties of the
franchisor to a franchisee. The first
requirement in this item is:
– Describe the franchisor’s obligation to the
franchisee in locating a site and
negotiating the purchase or lease of the
site. If such assistance is provided, state:
A. Whether the franchisor generally owns the
premises and leases it to the franchisee
B. Whether the franchisor selects the site or
approves an area in which the franchisee
selects a site…
3
Most franchisors whose franchisees
operate from a fixed location choose B.
4
They also disclaim liability to the
franchisee for their role in appraising a
site or the terms of its lease, claiming
that the final decision over these issues
belongs to the franchisee.
5
Franchising and Subleasing Are
Distinct Businesses
At its essence, franchising is shifting
investment obligations and risks to
franchisees. If a franchisor will not
invest in businesses operated by a
franchisee, why would it invest in the
real estate from which a franchised
business operates?
6
• In most franchise programs, the franchisor's
marginal costs of granting a new franchise are
recovered from initial fees. Thereafter, the
franchisor's exposure to risk is principally from
litigation from franchisees.
• By subleasing, a franchisor exposes itself to
months or years of liability if a franchisee does
not pay rent.
• Commercial real estate is a business. It is
different from franchising. Being in the real
estate business only makes sense if it is an
independently profitable business, and the
returns from subleasing include a risk
premium.
7
When a franchisor takes over a
franchisee’s store, the franchisee has
usually fallen several months behind in
royalties, rent and other amounts owed
to the franchisor.
8
Most franchisors make little on rent they
charge their franchisee subtenants.
When franchisee/tenant defaults or is
terminated, franchisor must find a new
franchisee and/or hire a manager to
operate the business. Often, reason for
the default is related to the location.
9
Operating as a company owned store or
re-franchising the store may be the only
way to protect the lease investment.
What does it do for the brand?
10
What is the risk of subleasing?
Owning a location which is unprofitable
for the franchisee, and having to recruit
a new tenant or franchisee to occupy
the location to reduce losses. Consider
some statistics relating to vacancy
rates:
11
12
India:
Mall Vacancy Rate: 30%, Rents Falling
- Zmarter.com finances May, 2010
13
Exxon Mobil announced yesterday it's
had it with the measly returns on selling
gas to consumers. Following the
industry trend away from the retail gas
station business, the oil giant plans to
unload the 2,200 stations it still owns.
BP expects to be rid of its companyowned stations in the US by the end of
next year and Conoco Phillips is nearly
out of the business altogether.
- www.minyanville.com June 13, 2008
14
If the objective is to control the location,
keep it affiliated with the franchise
brand, but avoid the risks of subleasing,
conditional lease assignments or lease
riders are the instrument of choice for
most US franchisors.
15
Elements of a Conditional Lease
Assignment
16
Elements of a Conditional Lease
Assignment
Amendment to Franchisee’s lease
signed by Landlord and Franchisee
– Landlord must be a party
Incorporates references to Franchise
Agreement
– No mistake about relationship between
Franchise Agreement and Lease
17
Restricts use of premises to the
franchised business
– Establishes a basis for Franchisor to
assume control if Franchisee attempts to
change the use of the premises
Requires notices of default and
termination to be delivered to Franchisor
in time for Franchisor to act
– With notice Franchisor can decide whether
to help Franchisee comply, or whether to
assume the lease and search for a new
Franchisee for the location
18
Franchisor has the option, but not duty,
to cure breaches
– Avoids liability arising from a sublease
Franchisor has the right to enter the
premises to cure breaches
– Self-help cure rights always depend upon
the Franchisor not breaching the peace.
– In many jurisdictions self-help cure rights
are not enforceable and may be treated as
an unlawful trespass
19
Franchisee has unconditional right to
assign lease rights to Franchisor or its
affiliates or successors, without changes
in lease terms, and without executing a
guaranty of the Lease
– Gives flexibility to Franchisor as to the entity
which will hold the lease if the Franchisor
exercises the option.
20
Lease assumption only occurs, and
Franchisor only assumes liability, after
notifying Landlord and Franchisee of its
assumption
– Avoids disputes about whether and when
Franchisor incurs lease liability
21
Franchisor is not liable for preassumption obligations of Franchisee to
Landlord
– Allows Franchisor or its assignee to be
treated as a new tenant. Landlord can
pursue claims it has against the Franchisee
and its guarantors (if any)
22
After assuming the lease, Franchisor
may assign lease to a new Franchisee,
with Landlord’s consent, but without
changes in lease terms
– Gives Franchisor flexibility to operate
business as a “company owned store” until
a new Franchisee can be recruited for the
location
23
Optional Components
Franchisor has right to receive all
reports of sales, income that Landlord
receives from Franchisee
– Aids Franchisor in corroborating Franchisee
reporting, and may alert Franchisor to
issues not regularly identified in its own
reports
24
Landlord has right to receive notices of
default or termination from Franchisor.
Allows Landlord to have advance notice
of potential problems.
– May accelerate Landlord’s exercise of
remedies against Franchisee
25
Benefits to Landlords of Conditional
Lease Assignments
• The franchisor may become the
landlord's "partner" in quickly finding a
new tenant to keep the premises
occupied, using the same brand,
maintaining the same tenant mix.
26
• The landlord's willingness to sign a
conditional lease assignment may
induce a franchisor to approve other
locations owned or managed by the
landlord for future franchisees.
• As use of conditional lease assignments
has become a standard for many
franchisors, landlords who wish to
attract franchisee tenants have a
competitive advantage over those who
do not. In the US franchising accounts
for approximately 40% of retail sales.
27
Benefits of Conditional Lease
Assignment - Franchisor Perspective
• The CLA substantially reduces the
likelihood that a franchisee will break
away or not renew at the end of its
franchise term if it is a successful
operator.
• If a franchisee is unsuccessful and
breaches lease, the franchisor has the
opportunity to preserve the location and
its reputation with the landlord.
28
• Except for the benefit of rental income,
a franchisor acquires every advantage
of a sublease, but none of the risks, and
none of the financial statement liabilities.
• In international franchising in countries
which prohibit foreign property
ownership or foreign business
operation, a CLA allows a foreign
franchisor to control real estate, without
owning it.
29
Thank you.
Carl E. Zwisler
Gray Plant Mooty
2600 Virginia Avenue, NW
Suite 1111 – The Watergate
Washington, DC 20037
Phone: 202-295-2225
Facsimile: 202-295-2275
[email protected]
30