FRANCHISOR REQUIREMENTS due to a NEW SHAREHOLDER / PARTNER

Buying and selling a franchise is rarely, if ever, a simply task - as there are all too often a multitude of complexities, hurdles and pressures bearing down upon the parties involved.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

When a current franchisee seeks to add a new shareholder or partner, this should not be done without the formal approval of the franchisor due to the adverse consequences that can emanate from the Franchise Agreement. The process is treated similarly to a full transfer or assignment of the franchise, with the failure to attain the franchisor's prior approval being a violation of the Franchise Agreement that could have serious legal consequences.

A. Franchisor Consent is Mandatory

The most critical requirement is obtaining the franchisor's prior written consent for any change in ownership, including adding a partner or shareholder.

• Review the Franchise Agreement: The agreement contains detailed provisions, often in the "Transfer" or "Assignment" section, that outline the specific steps, conditions, and restrictions for any change of control or ownership structure.

• Formal Notification: The franchisee must provide formal, written notification to the franchisor of the proposed change, including all relevant details about the new shareholder or partner.

B. Prospective Owner Qualifications

The new shareholder or partner is typically required to meet the franchisor's established criteria for a franchisee. This is to protect the integrity and consistency of the franchise system. Requirements usually include:

• Application and Due Diligence: The prospective owner must often complete a formal application and submit to the franchisor's due diligence process, which may include background checks, credit checks, and reference checks.

• Financial Stability: The franchisor will assess the financial qualifications of the new owner to ensure they can contribute to and support the financial health of the franchised business.

• Training and Experience: The new individual may be required to attend and successfully complete the franchisor's training programs, even if they are only a passive owner, or demonstrate sufficient relevant business experience.

C. Execution of Legal Documents

A change in ownership structure usually requires the new party to sign various documents to bind them to the franchise system's rules:

• Guarantees and Indemnities: New shareholders or partners are almost always required to personally guarantee the franchisee's obligations to the franchisor and may be required to sign an indemnity agreement.

• Ancillary Agreements: They will typically be required to sign non-competition, non-solicitation, and confidentiality agreements to protect the franchisor's intellectual property and business interests.

• Franchise Agreement Adherence: The franchisor may require the existing franchisee entity to sign an addendum affirming the existing agreement, or the entire franchise entity might be required to sign the franchisor's then-current form of the franchise agreement, which may contain less favorable terms than the original.

D. Fees and Compliance

The franchisee is usually responsible for various costs associated with the change:

• Transfer/Consent Fee: The franchisor typically charges a non-refundable transfer fee to cover their administrative, legal, and training costs associated with reviewing and approving the change.

• Operational Compliance: The franchisor may condition its consent on the franchisee first bringing the franchised location up to current system standards, which could involve costly renovations, equipment upgrades, or physical premises changes.

E. Internal Partnership / Shareholder Agreement

While this is a step for the franchisee, it is a crucial legal requirement from a business standpoint to govern the relationship between the existing and new owners:

• A Shareholder Agreement (for a corporation) or a Partnership Agreement (for a partnership) should be drafted or amended to clearly define the new partner's/shareholder's rights, responsibilities, voting power, capital contributions, and exit strategies (e.g., buy-sell provisions). This document must not contradict the terms of the Franchise Agreement.

Christopher Neufeld is a business lawyer knowledgeable in the rigors and challenges of the franchise business, together with the legal constructs that are critical to their effective operation. For experienced legal representation in starting, acquiring / selling, operating and managing a franchise, contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.