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Special Issues for an Area Representative

Guest post by: Keith Kanouse

Article Overview: An area representative is best described as a "super" franchise broker and servicing agent for the franchisor. You will be disclosed in ITEMS 2, 3 and 4 of the franchisor's Franchise Disclosure Document with your 5-year biography and litigation and bankruptcy history if you will have management responsibility relating to the sale or operation of franchises. An area representative differs from a subfranchisor in that the area representative uses the franchisor's Franchise Disclosure Document and the franchise agreement is signed directly between the franchisor and the franchisee. The area representative is not a party to the franchise agreement. Under the area representative agreement between the franchisor and the area representative, the franchisor delegates to the area representative certain of the servicing and support obligations

Special Issues for an Area Representative



An area representative is best described as a "super" franchise broker and servicing agent for the franchisor. You will be disclosed in ITEMS 2, 3 and 4 of the franchisor's Franchise Disclosure Document with your 5-year biography and litigation and bankruptcy history if you will have management responsibility relating to the sale or operation of franchises. An area representative differs from a subfranchisor in that the area representative uses the franchisor's Franchise Disclosure Document and the franchise agreement is signed directly between the franchisor and the franchisee. The area representative is not a party to the franchise agreement. Under the area representative agreement between the franchisor and the area representative, the franchisor delegates to the area representative certain of the servicing and support obligations of the franchisor to the franchisee. All initial franchise fees, royalties and other payments are usually paid by the franchisee directly to the franchisor. The franchisor then remits a portion of these fees to the area representative as negotiated in the area representative agreement.

The sale of area representative rights may or may not be considered to be the sale of a "franchise" under federal and state franchise laws. There appears to be no specific law, regulation or case on point. The majority of franchise lawyers seem to be of the opinion that, if the area representative pays a fee of $500 or more for the area representative rights, then it is a franchise. If so, usually a separate Franchise Disclosure Document must be given by the franchisor to the prospective area representative disclosing the area representative relationship.

There will usually be a number of provisions in the one-sided area representative agreements that are substantially similar to the provisions contained in the franchise agreement. Therefore, you need to renegotiate these provisions in the same manner as the franchise agreement. There are also special issues unique to an area representative that must be addressed to make the relationship between the franchisor and the area representative more equitable, including (in alphabetical order):

A. AREA OF RESPONSIBILITY OR SERVICE AREA

An area of responsibility or service area is the area (for example, state, county or city) where the area representative can sell and service franchises. Make sure the franchisor gives you exclusive rights to the service area so that the franchisor cannot open company-owned outlets or grant a franchise to another party within the area. Some franchisors try to reserve the rights to certain key locations within the area of responsibility (for example, regional malls, airports, highway facilities, schools, etc.) for the franchisor to open its own units.

B. AREA REPRESENTATIVE FEE

This fee is usually negotiable. An area representative fee is the up-front fee paid by an area representative to the franchisor for the area representative rights. The franchisor desires to get as much up front as possible. The area representative was to pay as little up front as possible. Although there is no set formula, the franchisor usually calculates the fee by taking a percentage of the initial franchise fee (e.g., 50%) and multiplying it by the number of outlets to be sold by the area representative under the area representative agreement. The area representative should negotiate that he or she retains all initial franchise fees until he or she recoups the entire area representative fee. Thereafter, the initial franchise fees are divided as negotiated by the parties. Royalties and other fees paid by the franchisee are also divided as negotiated by the parties. A rule of thumb is 1/3rd to the franchisor and 2/3rds to the area representative if the area representative does all the work. For any outlets owned by the area representative, the initial franchise fees and royalties should be correspondingly reduced.

C. CROSS-DEFAULT

If you are also going to own and operate one or more franchises, make sure that the representative agreement and each franchise agreement stands on its own. Do not allow a provision that states that default under the representative agreement or a franchise agreement constitutes a

default under any or every other agreement. Otherwise, it would have a "domino effect" and jeopardize everything.

D. DEVELOPMENT SCHEDULE

In my experience, the major issue to be negotiated in an area representative agreement is the development schedule. The development schedule is the agreement between the area representative and the franchisor as to how many franchised outlets will be sold, constructed and opened over a specified period of time. The franchisor wants the area representative to sell as many outlets as quickly as possible to saturate and pre-empt the market. The area representative wants a very conservative schedule because of the uncertainties of the future, the area representative's financial condition, and the ability to find prospective franchisees that want to purchase the franchise. The development schedule is totally negotiable since the circumstances vary greatly in each deal. The development schedule is usually a "minimum" development schedule. Negotiate the right (but not the obligation) to open more outlets within your area representative area if it makes sense to you without the payment of any additional up-front fees.

E. FAILURE TO ACHIEVE DEVELOPMENT SCHEDULE

The typical area representative agreement has a provision that states that if you fail to achieve the Development Schedule the area representative agreement can be terminated by the franchisor resulting in your loss of your area representative rights and the entire area representative fee. You need to make insure that the area representative agreement provides that if you fail to achieve the development schedule, you have several possible options including the payment of an extension fee, payment of minimum royalties or other terms that are fair to both of you. In addition, make sure the area representative agreement provides that if it is terminated due to the failure to achieve or maintain the development schedule, you retain the right to continue to service the franchises already sold and receive the fees. In addition, if you are also a franchisee, that you retain the outlets already open or under construction provided you are not otherwise in default under the franchise agreement.

F. FORM OF FRANCHISE AGREEMENT

The area representative agreement normally provides that the franchisor retains the right to change the form of franchise agreement. Since the area representative agreement runs for several years, conceivably, there could be major material changes to the franchise agreement including larger initial franchise fees and royalties and a smaller protected area. These changes may make the franchise less marketable. Therefore, negotiate in the area representative agreement that the franchise agreement you negotiate in conjunction with the negotiations of the area representative agreement will be the form of the franchise agreement you sell for each outlet opened pursuant to the area representative agreement and that you must agree to any material changes.

G. INDEMNIFICATION BY FRANCHISOR

An area representative is considered a "franchise broker" under the FTC Franchise Rule and state franchise laws. You can be held responsible for errors in the Franchise Disclosure Document. Make sure the area representative agreement requires the franchisor to indemnify you for any liability you may incur due to any false or erroneous information contained in the franchisor's Franchise Disclosure Document. Also, have the franchisor warrant and indemnify you that the franchisor has complied with all applicable federal and state franchise disclosure and registration laws. Be prepared to indemnify the franchisor from any liability due to your violation of the franchise laws in selling franchises.

H. LIMIT OTHER FEES

If you plan to also open and operate your own units, each franchise agreement probably contains numerous other fees such as renewal fees, transfer fees, securities offering fees, etc. Don't allow these fees to multiply just because you are a multiple-outlet franchisee. Limit these fees to something reasonable.

I. OPTION TO RENEW

Once the area representative agreement expires, the franchisor will be free to open company-owned outlets, grant franchises and/or appoint another area representative within your service area. Try to negotiate an option to renew the area representative agreement for an additional term subject to you and the franchisor negotiating a new development schedule. If there is room for further development in your service area make sure you have this option.

J. REDUCED ROYALTY FEES

If you plan to also own and operate multiple units, you may consider trying to have the royalty fees of all your outlets aggregated and negotiate a reduced sliding scale of royalties as gross revenues increase. Your argument is that this serves as a greater incentive to you to increase sales and also that the franchisor incremental services as gross revenues increase are not as great. Some franchisors already have a sliding scale of royalties - many do not.

K. SEPARATE CORPORATION AS FRANCHISEE

Like the taxi cabs in New York, it may be desirable to have each franchise outlet you plan to own and operate be owned and operated by a separate entity (for example, a corporation) so that a lawsuit or other claim against one outlet will be affect the other outlets. Negotiate this right in your representative agreement.

L. FRANCHISOR'S FAILURE TO TIMELY UPDATE FDD

What if you are a salesperson with nothing to sell? This could happen to you if the franchisor fails to timely update its FDD and maintain its registration in the franchise regisrtation states. Under the FTC Franchise Rule a franchisor must update its FDD upon any material change in the information contained in the FDD and within 120 after the end of the franchisor's fiscal year. If the franchisor fails to do this all franchise sales must cease. You need to negotiate a provision in the area representative agreement that if this happens, the franchisor will pay you some amount of liquidated damages. In

addition, the term and development schedule should be correspondingly extended by the period in which you are prohibited to sell.

M. STATE REGISTRATION OF FRANCHISE BROKERS

Franchise brokers that franchisors retain no longer have to be disclosed in ITEMS 2, 3 and 4 of the Franchise Disclosure Document, However, a Franchise Seller Disclosure Form for each franchise seller must be submitted as part of registering the franchise in the states of California, Hawaii, Illinois, Maryland, Minnesota, North Dakota and Rhode Island. Franchise brokers must go through a formal registration process in New York and Washington. If you are going to sell franchises in any of these states, you will have to register. You will need to review the registration requirements. You should negotiate that the franchisor will have its franchise counsel register you at the franchisor's expense. Under Illinois law an area representative is considered a subfranchisor. If you will sell in Illinois you will have to separately register as a subfranchisor. This includes preparing your own Franchise Disclosure Document and having audited financial statements.

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Article Tags: Area Representatives Franchise Brokers, Development Agents, Master Franchising



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