Need-to-Knows of Negotiating a Franchise Contract

From area of protection and new construction fees to capital expenditure mandates, hoteliers have a lot of business issues to consider before signing a franchise agreement. Mitch Miller, principal at Palo Alto, Calif.-based Miller Law Group, offers the following advice for franchisees.

Don’t sign agreements on the spot. Be wary of a salesperson who says the franchise agreement is non-negotiable and pressures you to sign on the spot. “They may say, ‘No changes will be made anyway, so just sign it,’” Miller says. “While there are limitations on what the lawyer is going to be able to obtain for the client, a number of important provisions are negotiable, and will typically justify any legal fee incurred.”

Negotiate extensions. When you’re doing a new project, it is critical to negotiate extensions in writing, Miller says. “It’s important to understand the development process and the timing of the franchise agreement so you don’t trigger any extension fees that will make you beholden to the franchisor. You don’t want to end up in breach of the agreement.”

Assess the area of protection. Area of protection is a protected territory around a franchised hotel in which the franchisor will not allow another hotel with the same or similar brand name to operate. That area of protection will usually burn off after a period of time, however. So even if a franchisee has a 20-year contract, the area of protection could expire in three to seven years after the hotel’s scheduled opening, Miller warns. “It’s not typically for the duration of the term of the agreement but it is negotiable.”

Understand cyber security risks. If a franchisor’s computer system gets hacked, the franchisee must indemnify the franchisor, Miller says. “The franchisee needs to have cyber risk insurance and have the franchisor as an additional insured under those policies to protect themselves.”

Know that franchisors reserve the right to make system-wide decisions. Franchise agreements include language that says all decisions the franchisor makes will be made in the best interest of the franchisor and the system as a whole. “If a franchisor says, ‘We’re updating the look of the brand,’ you don’t really have a choice. If you don’t do it, you’ll be in breach.” However, you may be able to obtain certain waivers and a protracted period of time to construct any required changes, Miller says.

Look at the fees section of the franchise disclosure document. The FDD requires that all fees are disclosed and summarized in a tabular presentation. Watch out for miscellaneous fees, in addition to the standard royalty, marketing, and reservation fees. All in all, the total franchise cost can be as much as approximately 12 percent. Miller says, “If you read nothing else in the FDD, you should read that.”

Don’t go overboard when requesting changes. Limit requested changes to the contract to those issues that are negotiable. “If you go back to the franchisor with too many requests, then they often will reject them all,” Miller says. If reasonable in the negotiation, a franchisee may get movement on many of the requests. Getting changes on 50 percent or more will make a substantial difference and should be considered a realistic objective.

Hire a knowledgeable lawyer. When you look at the big picture, it’s worth hiring a lawyer to review a proposed franchise agreement and negotiate terms, Miller advises. If a franchisee is building a $10 million hotel and will be shelling out an average of nearly 12 percent in overall franchise fees each year, the legal expenses are negligible in comparison. “You’ll only be spending a tiny fraction of 1 percent to know what you’re doing on arguably the most important agreement a hotelier signs, and further, you will have a better understanding of the risks.” Only an experienced hotel franchise lawyer will know the risks and what is possible in a negotiation.

There are many other provisions to consider than what is addressed here, so consult a lawyer to get the optimal benefits.