Business / Commercial

A Landlord's Guide to Leasing to Franchise Tenants

Franchising is serious business in New Zealand.  If you go to any mall in New Zealand you will find a number of the outlets are operated by franchise tenants.  In fact there are probably more than you think.

To some extent, leasing to a franchise tenant is no different to leasing to any other commercial tenant.  However, there are issues which a landlord should be aware of and take into consideration when leasing premises to franchisee.

Who is the tenant?

Often franchisors negotiate the terms of the lease but the tenant will be the franchisee.  Other times franchisors will negotiate and enter into the lease either themselves or via a special purpose company specially set up to hold the lease and then they will sublease or licence the premises to the franchisee.

Subleases and Premises Licences/Licences to Occupy

In the subleasing scenario landlords should consider carefully what approval rights they would like in relation to the granting of a sublease or premises licence to the franchisee.  Sometimes franchisors will request that the security for the performance of the tenant’s obligations under the headlease is provided by the franchisee who will be granted either a premises licence or sublease.  It is important to make sure that the security which is being provided is adequate.  See below for information about security options.

Due Diligence

If a landlord is considering leasing premises to a franchise tenant or to a franchisor who will then licence or sublease the premises to a franchisee, the landlord may take comfort from the fact that the tenant is part of a well known brand and proven business model with the support of a franchisor.  However, while there may be situations where a franchisor will provide assistance when a franchisee gets into trouble there is no guarantee of this so it is vital that landlords do not skip on their due diligence when investigating a prospective tenant.  It is still important to investigate the tenant’s financial backing, their experience (the actual training and support of the franchisor should be considered), to review their business plan (which may already be a requirement of the franchisor) and to run the usual credit checks.  The landlord should also consider conducting investigations into the franchise system – in particular its reputation (i.e. what is the franchisor likely to do if the franchisee gets into difficulty?), its size and how long it has been in existence.  The landlord may also wish to consider reviewing the franchise agreement to understand the franchisor’s rights of termination and to ensure the term of the franchise agreement is at least equal to the term of the lease.

Security

Some consider that leasing to a franchisee tenant is a safer option than leasing to a non franchise business owner.  While a franchisee tenant will have the benefit of the training and operational support provided by the franchisor and the goodwill which comes with a well known brand it does not necessarily follow that the franchisee tenant will be a safe bet.  There have been well known franchise systems which have suffered multiple franchisee failures resulting in landlords and suppliers being out of pocket.  Landlords should think carefully about what security they will require for the tenant's obligations under the lease. Options include a bank guarantee, a bond, personal guarantees and entry into a General Security Agreement (which will provide the landlord with security over the tenant's assets).  If a personal guarantee is given, landlords should ensure that the guarantee is backed by sufficient assets. Ownership of major assets should be checked – a prospective tenant may say they own property but in reality this could be held in a trust or be jointly owned by husband and wife / partner in which case both should be guarantors.  In such cases you may wish to consider requiring a bank guarantee or a personal guarantee from the trust as well.

Special Conditions

Franchisors will often request certain special concessions and provisions in the lease, examples include:

  1. Exclusivity
    If the premises form part of a development with a number of tenancies, the landlord may be asked to provide the franchisee tenant with exclusivity of their business use.  This could manifest itself in a couple of ways – a clause in the lease which prohibits the landlord from allowing other tenancies in the development to use their premises for a similar use.  Another option is an encumbrance registered against the title which provides for the exclusivity and will bind future owners.  Landlords should think carefully before granting rights of exclusivity and weigh the benefit of securing the tenancy versus the restriction it may present when securing other tenants.  Of course if the tenant is a big brand and wants a long term lease then it may be worth granting rights of exclusivity due to the customers (and potential tenants) this tenant may attract to this development.

  2. Waiver of approval rights
    The franchisor may request that a landlord agrees that their approval is not required in certain circumstances – for instance subleasing or assignment to a new franchisee and alterations to the premises in line with system wide brand changes.  In these cases the landlord will be relying on the fact that the franchisor will conduct the necessary due diligence on new franchisee tenants and have high standards when it comes to any rebranding requirements.  This is why it is essential that landlords conduct due diligence on franchisors (including in relation to their franchisee approval processes) to establish that this is actually true.

  3. Special benefits and concessions
    Franchisors will often try to negotiate special benefits and concessions.  A landlord may be willing to agree to these based on the fact that they will be dealing with a tenant who will be required by the franchisor to maintain certain standards.  Examples of special provisions include removing the obligation to redecorate when required by the landlord, removing the obligation to reinstate the premises on termination or expiry of the lease and special signage rights.  When considering whether or not to grant a franchisee tenant such concessions it is again important to understand what standards the franchisor has – for instance how often will the franchisee have to redecorate and what inspections will be conducted by the franchisor to make sure the franchisee is complying?

Step in Rights

A franchisor may require a landlord to provide the franchisor with what is known as “step in rights”.  These rights can be documented by way of additional clauses in the franchise agreement or a separate agreement between the landlord and the franchisor.  Typically “step in rights” will provide the franchisor with the following rights:

    1. the right to take an assignment of the lease (or nominate a franchisee to take an assignment) if the lease is terminated;
    2. the right to receive notice of any default by the tenant and the opportunity to remedy such default;
    3. the right to exercise rights of renewals if the franchisee does not;
    4. the right to remove proprietary items from the premises on termination or expiry of the lease e.g. any signage. 

Obviously such rights put obligations on the landlord which if not performed could expose the landlord to liability.  Landlords should think carefully about whether they want to grant a franchisor “step in rights” and incur that potential liability.  If the answer is yes then rights should be reviewed carefully and the landlord’s liability limited where possible.

It is vital that landlords do not skip on the usual checks they do when granting a lease to a franchisee tenant.  Landlords should also think carefully about the impact of granting a franchisee special concession or benefits or granting “step in rights” to franchisors.  These can create additional liability on the landlord and restrict the landlord’s ability to lease other premises within the same development or may even create difficulties when selling the property.

Brookfields Lawyers can provide landlords with assistance in relation to the grant of a lease to franchisee tenants.  For more information contact:

Lizandra Bailey
Ian McCombe
Chris Paterson
Bruce Costain

Disclaimer
This information is intended to be general in nature.  You are strongly recommended to seek your legal advice in relation to the matters dealt with here.

@ Brookfields Lawyers 2016.  All rights reserved

 

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