Franchising: real estate issues and solutions

Franchising: real estate issues and solutions


Author: Daniel Cartledge

Franchising can allow a business to grow with a reduced capital outlay but there are issues to consider.

A frequent conundrum is how to deal with premises - how can a franchisor retain statutory rights to renew the lease of premises that will be occupied by the franchisee?

Security of tenure under the Landlord and Tenant Act 1954 requires occupation of the premises for business purposes by the tenant. In many cases, the franchisor will want to retain the right to renew provided by the Act, but the franchisee will usually be the person in occupation.

The ability for the franchisor to go back into occupation at the end of the term is often maintained to allow the franchisor to secure the renewal rights but, in practice, doing so is likely to be commercially unpalatable.

Which alternative structures can be used?

Licence or concession - a less formal licence arrangement generally retains a high level of control for the franchisor, although carries with it the risk that the franchisee may be considered to be a tenant by the courts (and therefore one with security of tenure in its own right).

Third party landlord - a franchisee may acquire its own interest in premises directly from a third party. This is attractive from the perspective of the franchisor's balance sheet but leaves it with a low level of control over the premises and relationships with landlords.

There are ways to give comfort to the franchisor at the end of the franchise relationship but this needs the agreement of third parties, who are also likely to be less keen to have a franchisee as tenant, rather than the franchisor.

Sublease - a traditional subletting to a franchisee allows a franchisor to retain a large amount of control over both the occupation of the premises by the franchisee and the relationship with the landlord. A franchisor can control the discussions with the landlord (for example over rent reviews or consents) and can retain control of the premises if the franchise relationship ends.

Franchisors and landlords will usually want to prevent a franchisee from obtaining security of tenure in its own right. This will mean that neither franchisee nor franchisor will have statutory renewal rights: the franchisee's lease will be contracted out and the franchisor will not be in occupation. Generally, both leases will be subject to SDLT.

How can a franchisee retain the right to renew the lease of the premises?

Agency - case law has highlighted that occupation by a franchisee can, in limited circumstances, amount to occupation by the franchisor via its agent, the franchisee.

However, it is clear that this arrangement is highly dependent on the circumstances will require that a franchisor has a higher level of control over the franchisee's business than is seen in the majority of franchise arrangements.

Joint tenancy - a franchisor and franchisee holding a lease together as joint tenants can allow the renewal rights to be protected, whilst allowing a franchisor to maintain a high level of control.

A franchisor can maintain its direct relationship with landlords and its control over the franchisee's occupation whilst retaining security of tenure at the end of the term, even where the franchisee remains in occupation. A franchisor can be sure that its franchisee will not obtain rights in respect of the property independent of the franchisor.

As an added bonus, one lease means only one charge to SDLT.