Property problems and solutions

When granting a premised-based franchise, both franchisors and franchisees need to be aware of the issues and implications associated with the ownership of the lease.

Often a landlord will not be willing to lease premises to an inexperienced franchisee with no prior retail or business experience as there would be difficulty in obtaining satisfactory references. Granting a lease to an inexperienced start-up, could also increase risk and possibly diminish their property's value.

A franchisee may not want to take a lease if the term is longer than the length of the franchise agreement. If the franchise agreement is not renewed or otherwise terminates, this can leave the franchisee with a property lease which he no longer needs. Yet he will still be obliged to pay the rent and perform the tenant's covenants.

This problem can be overcome if the franchise agreement allows the franchisor to take over the lease on expiry or termination of the franchise agreement but this can result in the franchisor acquiring a property at a time when there is no franchisee to operate the outlet and trading conditions are difficult.

The importance of location to a franchisor must be established at the outset as control of the property because of its location or authorised planning use may be critical. There are a number of ways of dealing with these potential problems. The franchisor could take the lease in its own name and grant an under-lease to the franchisee. If the franchise agreement terminates then the underlease would also terminate. As the franchisee's right to security of tenure under the Landlord and Tenant Act 1954 is excluded, the franchisor has an immediate right to possession at the end of the lease. This gives the franchisor complete control and the costs generated by the acquisition of the head lease can be passed on to the franchisee. Complications, however, can arise when the lease expires. A right to a new lease cannot be invoked because the landlord is not in occupation and the franchisee's right of renewal has been excluded from his underlease. In practice, however, a landlord is usually happy to grant a new lease to an established franchisor.

As a compromise, the franchisor may allow the franchisee to take on the lease (with landlord's consent) on condition that the franchisee grants the franchisor the option to acquire the lease if the franchise agreement terminates. This does have disadvantages:

* The franchisor cannot directly enforce the franchisee's obligations as tenant. If the franchisee defaults under the please the landlord can exercise its rights and even forfeit the lease without notice to the franchisor.
* The option must be enforceable. When it is exercised it results in a contract for the acquisition of property and cannot be void for uncertainty of terms. It must be registered either as a land charge or at the Land Registry if it is to be enforceable.
* The franchisor's acquisition will still be conditional upon landlord's consent.
* The franchisor must oversee the franchisee's original acquisition of the property to ensure the terms are acceptable to him.
* The franchisor must ensure the property is kept in a good state of repair to avoid being liable for the landlord's schedule of dilapidations.
* The franchisor may not be able to take possession immediately on termination, which can be vital. This can however be provided for in thedocumentation.

Another factor to consider when structuring the property system is the potential liability for Stamp Duty Land Tax (SDLT). A franchisee may wish to take the head lease directly to avoid having to pay SDLT twice on the head lease (because he is paying all the franchisor's costs) and underlease. This is an important consideration when marketing a franchise to a prospective franchisee, as it can be an unwelcome additional cost. Where rents are high and leases are longer in duration, substantial sums of SDLT may be due and can be considerably higher than under the previous stamp duty regime. It is crucial that the franchisor's lawyer deals with all the complex issues regarding the property.