When It Takes Three to Tango: Franchisor Addendums to Franchisee Leases Part 1
Commercial leases and the negotiations that lead to them typically involve only two parties: the landlord/lessor and the tenant/lessee. Each side attempts to get the best possible deal, maximizing the benefits they receive, minimizing their respective risks, and clearly defining the parties’ rights and obligations. But when the putative tenant is a franchisee, a third party has a vested and more-than-passing interest in the lease’s terms: the franchisor.
The franchisor undoubtedly wants the franchisee to succeed in their new location, and obtaining favorable lease terms can go a long way to that end. But while the franchisor’s and franchisee’s interests are aligned in this respect, the franchisor will want their additional concerns considered, addressed, and included in any franchisee lease.
That is why many franchisors choose to inject themselves into lease negotiations involving franchisees and why they often require the lease to include a standard addendum. When that is the case, disclosing the existence and terms of the addendum early on in negotiations is in everyone’s interests to avoid surprises, allow for time to resolve any issues, and ensure all parties are on the same page.
When it takes more than two to tango, and a franchisor becomes part of the lease negotiation process, understanding the pressures and priorities of each party can help establish a foundation for productive discussions. Understanding many of the provisions frequently contained in franchisor addendums can also help.
In this first article in a series on franchisor-mandated lease addendums, we discuss each party’s respective interests in this tripartite dance and one of the most important clauses in these documents: the assignment of the franchisee’s rights in the lease to the franchisor.
Where All Three Parties Are Coming From
Since the addendum is included in the lease at the franchisor’s demand, their interests, rights, and goals are reflected most in its terms. The franchisor’s goals relate to both the lease and the franchise itself: (1) protect the location for the franchise, (2) protect the franchise’s reputation (that is, have control over a troublesome franchisee), and (3) maintain consistency across franchise operations.
The landlord’s goals are simple: (1) limit the nature and extent of the landlord’s obligations and liabilities, (2) eliminate opportunities for the franchisee or franchisor to terminate the lease, and (3) maintain security interests such as guaranties, liens, and security deposits. The landlord also wants to maintain consistency between the lease and the addendum and avoid having conflicting obligations to the franchisee and the franchisor.
The franchisee/tenant typically has little interest in the franchisor addenda apart from ensuring the deal gets done, and they can get up and running. Ideally, the franchisee came into the lease negotiations aware of the addendum requirement and terms and, therefore, has no basis for objecting or seeking to muck up the works by asking for changes to the document.
Assignment to Franchisor
One bedrock provision of a franchisor lease addendum is a clause that allows the franchisor to take an assignment of the lease. While the details of such clauses may differ, they all focus on giving the franchisor the right to step into the franchisee’s shoes in the event of a franchisee default – either under the lease or under the franchise agreement. This is usually a welcome no-brainer from the landlord’s perspective, as this provision can provide additional security and reassurance of performance under the lease terms, including the franchisor’s deeper pockets.
The keys to making an assignment provision work for all parties are knowing who is responsible for the liabilities of the defaulting franchisee and clearly identifying those responsibilities in the addendum. Generally, the franchisor will take the position that the franchisee’s liabilities stay with the franchisee, and the franchisor will not have to assume its existing debts. This approach would result in the landlord pursuing the franchisee for outstanding debts. The landlord will understandably take the position that the franchisor chose the franchisee and, therefore, should share in the burden of the franchisee’s failure to meet its lease obligations. The resulting language in this provision often will be determined by the relative leverage of the parties.
Assignment to New Franchisee
A second assignment clause allowing the franchisor to assign the lease to a new franchisee is closely connected to the above provision. As with the assignment to franchisor provision, this clause offers advantages to the landlords. Having another franchisee take over the lease, particularly when faced with a defaulting franchisee, is a welcome development—especially when another new tenant may not be readily available. Franchisors desire this provision because many franchisors either do not have a business plan that includes company-owned stores or may not have the administrative capacity to manage a company store in a location far from corporate headquarters. Allowing a franchisor to assign the lease to a new franchisee allows the franchisor to continue business in a desirable location or target market.
While the addendum spells out the conditions that will trigger the franchisor’s right to assign the lease, the landlord might require any new franchisee to undergo the same review and approval process as the original franchisee/tenant. This could include the right to request a review of financial statements, tax returns, and other documents before approving a new franchisee as a tenant. Additionally, the landlord may want to require a guaranty and security deposit from the new franchisee. With these protections in place, the parties can balance the business needs of both the landlord and the franchisor.