Pay upfront?

Legal expert Manzoor Ishani asks whether franchise deposits are ethical

Some franchisors ask for financial commitments from prospective franchisees so they can take their applications for a franchise seriously and engage in discussions with them. Not so many years ago, it was fairly uncommon for franchisors to require franchisees to pay a deposit as a sign of good faith. Most franchisors were content to entertain applications from prospective franchisees and take time to explain to them what was involved. Short of actually training prospective franchisees or disclosing to them in detail the contents of their operations manual, franchisors did impart a great deal of information about their business. Franchisees tended to be fairly settled in their minds as to the type of franchise they wanted. It was not so much a matter of choosing which franchisor they wanted to do business with, but rather, a matter of deciding whether they were suited to the business.

In these circumstances, if no deal was done, each party walked away and there were no recriminations. This idyllic period came to an end in the 1970s and, as franchising grew, competition increased. By the mid-90s, prospective franchisees had a choice for the first time.

During this period, franchisors found it easier to recruit and there were more prospective franchisees in the market than ever before. The led to franchisees being more analytical in their approach, investigating franchises more thoroughly and shopping around.

For the first time, franchisors began complaining that some applicants were ‘time wasters’. Some felt that the best way to sift the wheat from the chaff was to attain a deposit from the prospect as a sign of commitment. 

There is nothing illegal about franchisors taking deposits. Whether or not it is ethical depends on the circumstances under which the deposit is taken and whether or not it is refundable, in whole or in part.

I see nothing unethical if the deposit is fully refundable. However, problems can arise when the terms for the refund are not clearly stated. The taking of a deposit, which is not refundable under any circumstances, should be regarded as unethical unless the franchisor can justify it. Most deposits, however, tend to be partially refundable, with the franchisor reserving the right to retain a small proportion. If franchisors wish to take deposits, the following basic rules ought to be observed:

1. The franchisor should be able to justify the deposit.
2. If the prospective franchisee does buy a franchise, he ought to be given credit for the deposit towards the payment of the initial franchise fee.
3. Except in the most exceptional circumstances, a deposit should be either fully or partially refundable. Where it is partially refundable the franchisor should be entitled to retain only that part of the deposit which constitutes a genuine cost to the franchisor of his dealings with the prospective franchisee.
4. There should be a definite period within which a decision has to be made as to what is to happen to the deposit.
5. If a refund is necessary, it should be refunded without delay.
6. It should be clear at the outset who is to get the interest earned on the deposit.
7. The amount of the deposit must be reasonable bearing in mind the initial franchise fee and the investment the prospective franchisee will be required to make if he purchases the franchise.

In the present economy, some franchisors are now relenting on this issue and are willing to give prospective franchisees the benefit of an doubt. As franchisors mature, they are more able to form a judgement as to whether or not they are dealing with a ‘time waster’.

Prospective franchisees who have been reluctant to pay deposits to franchisors have, on occasions, suggested that such sums should be paid to the franchisor’s solicitors who are required to hold the money as stakeholders. This can work well, but much depends on the nature of the franchise and how much is involved.

Ultimately, it boils down to a matter of trust between the franchisor and franchisee, the reputation of the franchisor and the ability of the franchisee to look after himself.


Manzoor Ishani is a Senior Consultant Solicitor with Sherrards (Solicitors). Call: 01727 832 830, email: mgi@sherrards.com or visit www.sherrards.com

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