What Happens to the Lease When a Franchise Terminates?

What Happens to the Lease When a Franchise Terminates?

by | Nov 30, 2020 | Blog, For Franchisors

Leasing property for a franchise involves two different agreements – the franchise agreement and the commercial lease. The franchise agreement sets forth the franchisor’s rights and requirements with respect to leases signed by the franchisee. The lease terms must comply with the franchise agreement which often complicates negotiations. One area that is particularly difficult is what happens to the lease when a franchise terminates. Franchisors, franchisees, and landlords may have conflicting interests. As a result, consulting an experienced franchise attorney is a must both before signing the franchise agreement and again when negotiating a lease. 

Franchisor’s Interests

Frequently, the franchise agreement provides that the franchisor has the right to approve a lease and the franchisee must include specified language in the lease relating to assignment, notice and a franchisor’s right to inspect the location in the event that the franchise agreement is terminated. Typically, franchisors want the right to take over the lease if the franchise terminates. This allows the franchisor to continue to operate the business without interruption and maintain the goodwill the location has built. However, franchisors do not want to be responsible for any past due rent owed by the franchisee. 

Franchisee’s Interests

The franchisor’s requirements may complicate lease negotiations for franchisees as commercial property landlords are often reluctant to agree to those terms. Those concerns can be addressed with the guidance of an attorney. However, franchisees may have other issues with the franchisor’s terms. The lease may be valuable independent of the business, in which case the franchisee may want to retain the lease for itself if the franchise terminates. This enables the franchisee to start a different business in that location. Alternatively, the franchisee may want to sublet or assign the lease to another party as a more lucrative option. In this situation, both the franchise agreement and lease will need to be carefully negotiated to give the franchisee needed flexibility in the event the franchise terminates.

Franchisees may have difficulty eliminating the franchisor’s requirements. However, where the franchisee is an area developer, it may have more leverage to negotiate with a franchisor to get beneficial terms in the franchise agreement as it relates to real estate. 

Landlord’s Interests

The issue of assignment of the lease is often a sticking point with landlords. They object to any limitation on their right to approve an assignment. While some landlords may make an exception if the franchisor is the one to take over the lease, they want to ensure that any defaults, including paying back rent, will be cured before they approve the assignment. This is often a heavily negotiated point. 

The varying concerns of each party makes leasing property for a franchise a complex issue. Franchisees entering into a franchise agreement should discuss real estate issues with their attorney. Once the franchise agreement is signed, it is important to consult an attorney knowledgeable in both franchising and leasing to assist with the negotiation of the lease and ensure compliance with the terms of the franchise agreement. A lawyer only familiar with real estate law may not be familiar with the intricacies of franchise law leading to problems with the lease.

Lusthaus Law can help you with your commercial leases for franchises. Contact us today.

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