Whether you are investigating a health and fitness franchise – such as a franchise that focuses on a fitness technique that requires patented equipment, a 24 hour gym facility, a race series, a day spa, or a facility that offers a style of class under a franchise model – or you have already invested in a fitness franchise, there are some important legal considerations to examine alongside completing market research, brand development, site selection, the total addressable market, operational training and support, and “territorial protection” that may be offered by these franchising opportunities. At its core, a franchise is a legal relationship created and established by a franchise agreement. A Franchise agreement is a binding, and often extensive, contract prepared by the franchisor (that’s the brand offering the franchise for sale). While contracts are generally weighted in the favor of one side over the other, franchise agreements are often universally weighted in favor of the franchisor (the brand). This is one of the reasons why you should always seek independent legal advice before signing a franchise agreement. It is important to make sure that you have an advocate who will help you understand both your rights and your responsibilities, the benefits of the agreement, the limitations and any possible risks.
Choosing the Right Business Entity for your CircumstancesMost Franchises are limited on business model they can use, which means you need to explore what entity type will work best for you based on that business model. Some of the options for setting up a business entity that will operate the franchised business include: Sole Proprietorship, Partnership, Limited Liability Company (LLC), or Corporation. They each have their own set of positives and negatives to consider and it is essential that you not only make an informed decision about the business entity you choose to form, but that you understand why that option is the best entity choice for your business.
Business Equity and Fitness FranchisesOne of the most significant issues is considering a fitness franchise is that Franchising agreements may not convey any equity in the franchise the business owner purchases. What this means practically is that a fitness franchisee may only own the equipment they buy. Without the license granted by the franchisor, franchisees have no legal right to use the name or logo of the parent company, the financial value of the goodwill normally reflected in a customer base, and where non-compete clauses are included in franchise agreements (and are enforceable) mean that franchisees are prevented from working for a competitor or entering into a franchise agreement in the same market segment. This is important because one of the promoted benefits of franchising is the benefit of support from a known company while owning and operating your own business. This is also problematic because the franchisor (the parent company) generally has all the power in terms of choosing not to renew franchise licenses or revoking those licenses. This has been so concerning for some legislatures, that several states, including Iowa and Rhode Island, have passed legislations guaranteeing franchisees some equity, while many others, including Massachusetts, Vermont, Pennsylvania and Maine, have introduced similar bills that have not succeeded. This is such a controversial issue, that in California, the Fair Franchising Act was passed by both houses in California, but was then vetoed by the Governor in September 2014. Why does this matter? – without a legal right of renewal or some kind of legislative guarantee of the rights of franchisees, the contract terms presented by franchisors are likely to become even less favorable to franchisees over time. The power imbalance in the franchisee-franchisor relationship is so heavily weighted towards the franchisor that often the only way for a franchisee to protect the equity they have in the business is to accept the terms of any renewal offered by the brand (franchisor). The alternative is the franchisor refusing to renew which would force the franchisee to close their location and liquidate fixtures.
Not all Franchises are the sameNot all franchises are the same. So, you should make sure you understand how the business you are interested in works. Some fitness businesses, like CrossFit®, do not require a specific type of business entity, and limit their “franchise” to a training and intellectual property licensing agreement – for more things they need to know about the legal foundations of starting a CrossFit gym. For example, any property lease is between the fitness business and the property owner, CrossFit® itself is not a party to those lease agreements, unlike many McDonald’s® locations, for example. Some require all uniforms, products and packaging to be purchased from the corporate entity, or all classes and services to be provided using a specific methodology or in a specific format, while others only require products of a specific quality to be stocked and sold or allow for great latitude in the ways services are provided. The variation and the obligations involved can be extreme.
Time LimitedWhile buying into a franchise can require a large outlay and substantial capital, the franchise relationship is time limited by contract. It is, in effect, a type of lease agreement. Because of the time limit, if the relationship is to extend beyond the initial period it will likely need to be renewed. The franchise agreement may state some procedure for this renewal process.
Employer – Employee RelationshipWhile it has traditionally been held that the franchisor is not involved in the employee-employer relationship, this has recently been the subject of scrutiny. In 2014, the National Labor Relations Board (NLRB), issued an opinion that McDonald’s® could be considered a “joint employer” alongside individual franchisees in the context of labor complaints. The opinion stated that because the McDonald’s® corporation is partially responsible for hiring and firing, setting wages and benefits, and dealing with employee behavior they are a “joint employer”— For many other franchisors, these are tasks that have traditionally been left to the discretion of franchisees which may mean a NLRB ruling would be different in those circumstances. What this decision speaks to is that the franchise agreement and contingent policies and procedures might lead to a franchisor having control over the day-to-day operations and functioning as a “joint-employer.” This is quite different to the general concept of a franchise which was to create independent contractors who advanced a business model but were able to inject some of their own management style into the business. Some have even questioned if the level of control exercised by franchisors might not constitute an employer – employee relationship with the franchisees themselves.
Protecting your Investment & Fitness Franchise Related DisputesMost, if not all, franchise agreements will detail dispute resolution clauses. They may list activities like arbitration or mediation as being required in the case of a dispute. Some disputes that tend to arise as part of a franchise relationships include: territorial exclusivity or encroachment (when a franchisor grants a franchise in a physically close location, or a location that will not support multiple franchises), rights of termination, non-compete agreements, contractual disputes, renewal refusal and equity disputes.
So what do I need to talk to my Attorney about: Fitness FranchisesLook for an attorney with experience in both the fitness industry and in examining complex contracts and franchise agreements and Franchise Disclosure Documents (FDDs). Some of the legal issues you will want your attorney to advise you on include:
- Business Entity choice
- Time limits on franchise agreement
- Conditions on transfer and renewal of the franchise
- Franchisor responsibility for business development support
- Franchisor termination rights
- Mandatory dispute resolution clauses
- Mandatory supplier provisions
- Non-compete clauses and other post-termination obligations
- System standards compliance and the process for modification
- Intellectual property rights and responsibilities
- Franchisor control over operations and employment practices
- Risks of liability
- Level of insurance coverage needed