Pros and Cons of Sub-leasing Your Site From the Franchisor
Wednesday 6 September 2017 / by Corinne Attard posted in Franchising & Retail

If you are looking to buy a franchised business which operates from any premises other than your home, you will need a lease.  For retail businesses location is critical and it is likely your franchisor will control the negotiation process and require that either the lease be in its name with a sublease or licence granted to you, or allow the lease to be in your name but with some conditions attached.  

Here we look at the pros and cons of both these retail lease structures for you as the franchisee and actual occupant of the premises.

Option 1 – Head lease in the name of the franchisor

The lease may be in the name of the franchisor because either the franchisor wants to have ultimate control over the site or because the landlord insists on it. Franchisors can usually negotiate better lease terms with landlords than individual franchisees can so this is often a key advantage.

You can also expect the franchisor to negotiate the lease directly with the landlord and have the experience to understand a commercial deal that will be sustainable for the business.  If the lease has not been finalised however you should ask to see any offer and determine if there are any terms you wish to negotiate or ask the franchisor to negotiate with the landlord.

If the franchisor holds the head lease it will need to grant you a sublease or a licence to occupy. You should check that the lease allows the franchisor to do this, otherwise the landlord may insist on a formal application for its approval of you as sub tenant/licensee (and further costs are then incurred).

In most cases there is no real advantage to a sublease over a licence to occupy.  A sublease is a more formal document that will require registration on the title in most states and territories, so this means additional costs. If the franchisee changes then the sublease has to be surrendered or transferred and again more costs are incurred and the franchisor will usually pass these costs to you. This is why a licence to occupy is generally favoured.

In either case it is usual for the franchisor to simply pass on its tenant obligations to you as the licensee.  

If there is a landlord’s disclosure statement issued then you should also receive this and you may be required to provide a tenant’s disclosure statement or certificates  detailing any representations about the premises that you relied on or whether you took legal advice on the terms.

This is because under the retail leasing laws in most states a licence is treated the same as a lease: you have the same legal rights against your franchisor as you do against your landlord. Importantly this does not apply in all states so you should obtain advice on this.

Even though you are not the tenant named in the lease you may still be named as personal guarantor and you are also usually required to provide the bank guarantee or security deposit to the landlord and the insurance certificates.  Whether or not you have guaranteed the lease to the landlord, you are still liable to the franchisor if you default in rental payments.

A disadvantage with the licence or sublease arrangement is that you have no formal right to deal directly with the landlord about the lease or matters concerning your tenancy, even if you have provided a personal guarantee and a bank guarantee.  It is up to the landlord to negotiate with the landlord.  

If for example the franchisor does not properly exercise an option or right to renew the lease term within the time required,  or does not negotiate the lease renewal you may be left without a lease and therefore without a shop.

Another problem will be if the lease ends for any reason (which may be beyond your control) your right to use the premises also comes to an end. This is a concern if the franchisor goes into administration or liquidation. The lease may be terminated by the liquidator and you will have no further occupancy rights.  In that situation you will need to negotiate directly with the landlord for a new lease in your own name if you wish to stay on.

Option 2 - Lease in the name of the franchisee

The franchisor may not wish to take on the lease in its own name –this may be its general policy or it may vary from site to site depending on the merits of the location or the requirements of landlords. If the franchisee is the tenant then the franchisee has the ultimate responsibility to pay the rent to the landlord and perform all the obligations.

If there is a default then the landlord will sue you as the tenant and not the franchisor.  

If the lease is in your name you can deal with the landlord directly – you may consider this a plus if you are confident in doing so however you may be able to ask your franchisor for assistance in any case.

If you are negotiating a lease you should obtain your own legal advice and you may also wish to engage a lease consultant if your franchisor is not able to provide the right commercial assistance.   If you sell your business you will need to obtain the landlord’s consent to the transfer of the lease to the buyer as well as the consent of the franchisor.

You may think if you hold the lease and the franchise ends early you will be able to use the premises for another business, perhaps even change your business to a competing system.  In most cases however there will be restraints in your franchise agreement stopping this and your franchisor may also hold “step in rights”.

These rights may be outlined in the lease or in a separate deed with the landlord.  They allow a franchisor to take over a lease if the franchise ends – if, for example, your franchise is terminated for default.  Alternatively if  the franchisor believes  the lease or the site is not favourable, the franchisor may decide in event of default, simply to terminate the franchise  but not to take on the lease. In that case, as the tenant, you will still have to pay the rent until the end of the lease or find a replacement tenant or subtenant.

Whatever the leasing structure, it is important to ensure that the franchise term and the lease term match - and particularly so if you hold the lease directly. If the franchise ends before the lease you may end up responsible for the lease but with no right to conduct the business in it.  

If the lease ends before the franchise (which can happen in any situation for a reason beyond the control of franchisee or franchisor such as shopping centre redevelopment or fire) there should be provision in the franchise agreement for the business to be relocated to new premises within a reasonable period.

In both options you can see that it is important to obtain independent legal advice on what is most suitable for you and what are your legal rights and responsibilities. As a retailer, the importance of the lease cannot be overlooked.

Pros and Cons of Sub-leasing Your Site From The Franchisor was first published in Inside Franchise Business Issue 31 VOL 4 (September/October 2017).

Recent Posts