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Franchisor Issues in a Lease to a Franchisee: How to Avoid Allowing the Franchisor to Crash the Party

This article will address issues which arise in the context of a lease by a landlord to a franchisee and the issues raised by a franchisor in a proposed addendum to the lease. The franchisor has legitimate interests it desires to protect. A well-structured document will allow those interests to be protected and, at the same time, preserve the rights a landlord will require in a retail lease.

The franchisor is interested in protecting its interest in the leased premises in order that the space could potentially be made available to a replacement franchisee if the initial franchisee is unsuccessful. The franchisor will request notice of any default by the franchisee under its lease together with an opportunity (but not the obligation) to cure the default. The landlord should make certain that the mechanics of giving any such notice and opportunity to cure are clearly set forth in the agreement. The landlord should not commit to send to the franchisor a notice in the event the franchisee is in default; rather, the landlord should merely agree to give the franchisor a copy of any default notice that the landlord gives to its tenant. The franchisor should have the same cure period as is given to the tenant under the lease.

A more problematic concepts arises in the situation in which the franchisor requests a current assignment of the interest of its franchisee under the lease but accepts no liability under the lease unless the franchise agreement is terminated and the franchisor elects to exercise its right to assume the lease.

A landlord always needs the right to be able to gain control of its space upon an uncured default by its tenant. The rights requested by the franchisor in this context are similar to rights which a leasehold mortgagee will typically require. The same solution in addressing those issues in a leasehold mortgage context can be employed in this context. If the franchise agreement is terminated but the franchisee, as tenant, is not in default with the landlord, the landlord not only may not care if the franchisor steps in but may, in fact, be obtaining a credit upgrade as far as the identity of the tenant is concerned. The landlord must be concerned, however, with the timing and mechanics of how this provision will work in practice, particularly if its tenant is in default. The bottom line is that the landlord must be able to notify the franchisor if the landlord intends to terminate the lease of its tenant. The franchisor should then be given a short time period within which to elect to either take over the lease or waive its rights, thereby allowing the landlord to exercise its remedies against its tenant, regain possession of its leased premises and then move forward to release the space.

Finally, the franchisor might raise a concern as to defaults which are of such a nature that they can’t be cured by the franchisor. This is the same issue raised by a leasehold mortgagee. The landlord could resolve this issue by offering the franchisor a new lease similar to the new lease provision which is typically found in leasehold mortgagee protection provisions. The franchisor would be given notice and a short time period within to make the election to obtain a new lease. The franchisor would, however, be obligated to cure both monetary defaults and any non-monetary defaults which are capable of being cured. The franchisor would only get a pass for non-monetary defaults which are of such a nature that they can’t be cured.

A properly drafted franchisor agreement can satisfy the reasonable concerns of both the landlord and the franchisor and enable the lease with the franchisee to be consummated.