This is the second in a series of articles focused on real estate tips and strategies written with my co-author of Franchise Bible, 8th Edition, Michael Katz. Katz is a franchise, business and real estate attorney and has been working with landlords and tenants for over three decades.
Franchise agreements contain language that materially affects the franchisee’s rights. This language is often identified by its legal title or name, or is described in sufficient legalese to cause the reader’s eyes to glaze over. Here are six terms that any franchisee -- or indeed any person entering into a contract -- should understand.
1. Choice of law
This covenant identifies the law that will govern the interpretation of a contract. In franchising, the franchisor will choose the law of the state in which it is located. This has several advantages, not the least of which is that the franchisor will be familiar with the common law and statutory law in a way that the franchisee from another state may not. Another advantage to the franchisor is that it may preclude the franchisee’s attempt to choose the law of the state in which the franchisee is located, which in turn may serve to deny the franchisee certain rights not available under the law of the franchisor’s chosen state. In franchising, this covenant is usually not negotiable; this may be different with general commercial contracts.
2. Fair market value
In many commercial contracts, the value of a good or service is sometimes measured by its “fair market value.” Generally, this means that the price will be based upon the value that a reasonable person who is under no duress or obligation would pay for an item, good or service that is being sold by a seller who is under no duress or obligation. In franchising, this term is often used to define the price that the franchisor will pay for the franchisee’s trade fixtures, furniture and equipment at the end of the franchise relationship. As the franchisor is purchasing used items for which there may be no ready market, it is usual that the offer will be for a very low price. This may be different in a commercial contract for goods or services that are in high demand.
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3. Force majeure
Though this term may have many meanings, ultimately it identifies events the occurence of which will temporarily excuse the otherwise timely performance of a party under the contract. Sometimes called an “act of God” covenant, one often sees the following definition: “Performance of a party under this contract will be excused for the period of delay if such delay or hindrance is caused by reason of strikes, lock-outs, labor troubles, inability to procure materials, failure of power, restrictive governmental laws or regulations, riots, insurrection, war or other causes beyond the reasonable control of the party.”
4. Forum selection
The “forum” being selected is the locale in which any litigation or arbitration would be held in the event of a disagreement between the parties. In the franchise world, virtually all franchisors select their locale as the forum in which any problem is to be litigated or arbitrated. This could result in the franchisee being “home-towned,” which is legal parlance meaning that the franchisee and his or her witnesses would be disadvantaged by having to travel to the franchisor’s home state and by having to hire local counsel. This probably would not be negotiable in a franchise agreement but should be nonetheless be reviewed and discussed.
5. Implied covenant of good faith and fair dealing
In almost all states, each contract is governed by an unwritten but implied general assumption that each party under the contract will act in good faith in the performance of the contract and will fairly deal with the other party. In franchising, many courts have interpreted this to mean that the franchisor will use good faith when it has the option to exercise its discretion. For instance, absent language to the contrary, a franchisee who asks permission to transfer his or her franchise rights to a new person can assume that the franchisor will exercise its right to vet the prospect using commercially reasonable criteria. The phrase “absent language to the contrary” is highlighted because in most franchise agreements, the franchisor will have a list of conditions that must be first met by the prospective franchisee prior to being approved. In turn, this list may contain requirements that may make it more difficult for the prospect to agree. For instance, the franchise agreement may require the new franchisee to sign the then-current franchise agreement the terms of which are materially different from those found in the current franchisee’s version and which may be less acceptable to the prospect. Though this may be “unfair,” it would most likely not be grounds for claim of breach of this implied covenant.
This covenant is often found in commercial contracts general and in franchise agreements specifically. It means that one party (usually the franchisee) agrees that it will pay the other party’s (usually the franchisor) losses when the franchisee’s actions cause the loss. For instance, if a franchisee fails to clean up a spill which in turn causes a customer to injure herself, the injured party will often name not only the franchisee as a defendant in the lawsuit, but will also name the franchisor. If the injured party wins a judgment against both defendants -- and given that the franchisor had nothing to do with the franchisee’s day-to-day operations -- the franchisee will “indemnify” the franchisor by agreeing to pay all of its losses including any damage award, attorney’s fees and costs.