The owner’s guide to master franchise agreements

John H. Pratt describes the factors to consider while drafting a master franchise agreement.

Master franchising has traditionally been the most popular franchise business model for international expansion, primarily because it enables rapid expansion without requiring a significant ongoing commitment of human and financial resources by franchisors, as would be required if other franchise structures were employed.

In a master franchise agreement, the franchisor transfers the primary responsibility for building the system in the projected region to the master franchisee.

As a consequence, a franchisor requires substantially less resources and capital expenditure. In addition, the local master franchisee will have a deeper understanding of the local market than the franchisor.

Despite these advantages, the usage of master franchising seems to have fallen, in part because direct franchising has become less problematic in an era of growing globalization, but also because the downsides of master franchising have become more evident.

The quality and consistency of goods or services across a multi-tiered master franchise network cannot be guaranteed, and this is especially true for complicated franchises like restaurant franchises.


Three-Tier Structure

Master franchising is a three-tier system in which a franchisor offers a master franchisee the ability to grow its brand throughout a specific region (often a whole nation or several countries) by entering into franchise agreements with sub franchises.

Consequently, there are often at least two agreements. First, a cross-border agreement between the franchisor and the local master franchisee (known as the “master franchise agreement”), followed by a domestic franchise agreement between the local master franchisee and each of the local sub-franchisees (known as the “sub franchise agreement”).

This arrangement does not contemplate a contract between the franchisor and sub franchises; therein lays the difficulty, since a franchisor cannot enforce system standards and requirements at the consumer interface.

There are a variety of contractual and non-contractual methods available to minimize the difficulties presented by franchisors’ lack of a contractual relationship with sub franchises.

First, franchisors should force their master franchisees to hire and retain a set number of adequately trained employees whose responsibility it is to uphold brand standards. Alternately or additionally, franchisors might mandate a set number of field trips, with reports from those field visits sent to the franchisor.

Second, the master franchise agreements should require master franchisees to obtain the franchisor’s prior written consent for matters of significance arising from the master franchisee’s dealings with sub franchises, such as the recruitment of sub franchisees and the terms of sub franchise agreements, including their modification, transfer, and termination. Thirdly, franchisors may include some powers to actively enforce specific sub franchise agreement conditions against sub franchises.

However, making all pertinent decisions for the master franchisee and having the capacity to directly enforce commitments against subfranchisees is contrary to the objective of a master franchise agreement. In fact, the majority of franchisors lack the means or the capacity to pay for such resources, knowledge, and experience in order to make these choices on behalf of master franchisees.


Possible solutions

In order to address the aforementioned difficulties, the franchisor’s attorneys have devised a variety of strategies, which are discussed below.

Rights of Third-Party Beneficiaries

The franchisor may be identified as a “third party beneficiary” of the master franchisee’s rights under the sub franchise agreement in sub franchise agreements. Typically, such third party beneficiary provisions provide the franchisor the ability to enforce the terms of the sub franchise agreement as if it were a party to the sub franchise agreement, although the efficacy of such clauses varies depending on the country in which enforcement is attempted.

They are likely to be less effective in civil law and religious law regimes; thus, local legal advice is essential prior to using this strategy.

Direct Secrecy

Some franchisors demand that the franchisor, master franchisee, and sub franchise engage into a tripartite sub franchise agreement. Due to the franchisor’s potential direct obligation to the sub franchise, having the franchisor as a party to the sub franchise agreements diminishes the primary advantage of adopting a master franchise structure.

Individualized Acknowledgment

Franchisors may also ask sub franchises to sign a separate written acknowledgment recognizing the franchisor’s rights under the sub franchise agreement or master franchise agreement and stating that the sub franchise agreement will end upon termination of the master franchise agreement.

License to Use a Mark

In some configurations, the franchisor will need sub franchises to execute a brief and straightforward trademark license agreement. If certain major violations occur, the franchisor will have the power to cancel or restrict the license to use the franchisor’s trademarks.

Without being a party to the sub franchise agreement, the franchisor is granted direct powers to defend its intellectual property rights and enforce standards.

Nevertheless, some master franchisees may be hesitant to let franchisors to establish direct contractual relationships with sub franchises, which would allow a franchisor to circumvent the master franchisee and take direct action. In addition, the franchisor may be concerned that getting into a direct contractual connection with sub franchisees in a foreign nation raises the potential of assuming responsibility for the actions of the master franchisee.

Master franchising may not be the ideal strategy for worldwide expansion if strict control over sub franchise standards is essential, since the legal “structures” described in the preceding section all have downsides.


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