Do You Understand the Scope of Hotel Franchise Agreements?

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By: Ben Hanuka, Law Works

This article was originally published in Hotelier on January 13, 2015. 

It’s difficult enough to understand the legalese on a franchise agreement, disclosure document (if applicable) and lease agreement, but try to tackle the deal without the help of an experienced franchise lawyer and it could cause a heap of trouble down the line.

It’s not everyone’s favourite topic, either. Many franchisees are hesitant to share their best practices in securing a franchise deal, but when it comes to putting ink to paper, it’s key that they are very involved with the process. Case in point, no hotelier wants to deal with another flag opening down the street from them or be stuck paying increased fees upon renewal, but those who don’t champion their needs will inevitably lose out.

Whether it’s a start-up businessperson entering into a franchise agreement with a big-name hotel brand or a multi-unit franchisee, there are a few areas to negotiate. Unfortunately, many start-up franchisees don’t think they have much negotiating power when it comes to signing franchise agreements with well-established brands, says Ben Hanuka, principal, litigation counsel and arbitrator for Law Works P.C. in Vaughan, Ont. and a leading practitioner in franchise litigation in Toronto.

The big question is, to what extent is the franchise agreement negotiable? “That will vary from system to system and from brand to brand. Generally speaking, the smaller, less established the brand, the more leveraging power the franchisee would have. The more established the brand, the more that brand can say, ‘It’s take it or leave it,’” Hanuka notes.

It’s a sentiment echoed by Eric Watson, COO of MasterBuilt Hotels in Calgary, which owns the master territorial development rights to Canada for Microtel Inn & Suites by Wyndham and is aiming to have 22 properties in operation by the end of 2016. His company also has a franchisee deal with Marriott. “[In terms of] the agreements themselves, for the most part the major brands don’t negotiate much.” He adds: “The franchisee always wants to get the strongest brand for the least amount, and they negotiate it as much as they can. It comes down to fees, area of protection and termination. The brands tend not to negotiate too much on termination.” But there is wiggle room in other areas.

Before entering into an agreement, Watson recommends conducting a thorough inspection of the proposed market. “Always start with making sure the market is viable. There’s lots of factors that come into that in terms of supply/demand, who the players are, which brands are there, how strong the competition is, economic growth and a variety of things,” he says. Brand positioning is also a key area of consideration. “There has been a trend in the industry to overbuild in the last five years, in terms of people continuing to push, with midscale [and] upper-midscale becoming very expensive builds in the market, and they’re not seeing returns.”

That’s why the area-of-protection clause is especially important, as it can help stave off competition down the line. The area of protection will outline the length of time a flag is protected (from similar or the same brands opening nearby) and the geographic region and physical boundaries. “That can really sting people,” says Watson. “That was a big negotiating point for us with our Marriott deals. We don’t want somebody putting up another Residence Inn or TownePlace five kilometres from our hotel within a year.”

Hanuka agrees territory and exclusivity regularly pose problems and are important factors to consider during negotiations. He offers an example: “A certain brand in location A has a certain territory, let’s say a mile, and the franchisor [maybe] tomorrow or a few years into the operation requires a new brand, and it’s a slightly different segment in the market, but there is a clear overlap. And that franchisor is putting a new hotel across the street or just around the corner with the new brand, and the existing franchisee says, ‘Wait a minute, I’m going to lose a certain percentage of my clientele.’ Can the franchisor do it? Well, depending on the wording of the exclusive territory agreement, yes.”

Hanuka contends that special attention must be paid to the renewal portion of the franchise agreement. “One of the biggest issues I see in renewal, which has been going on for some time, is a typical provision that a franchisor may present a materially different contract — its ‘then-current’ franchise agreement at the time of renewal,” he says. “And what franchisees don’t understand is at a time of renewal they may legally be required to sign a very different deal than what they had until now.” The franchisor can also impose different royalty fees, marketing contributions, termination provisions and more. “If the franchisee wants to renew, then that’s the deal he has to take. So, you’re basically agreeing in advance to something that you don’t know,” he says. It’s also important to set a maximum spend if a renovation is required to bring the brand up to different standards.

Either way, when it comes to branching out across provinces, it’s important to be aware of individual laws, including property laws in each respective province. “It is the franchisee’s responsibility to have local lawyers in the different provinces looking after local issues, [such as] wheelchair access, recycling, disposal, zoning — a whole list of issues,” adds Hanuka. “You can argue it’s the whole point of franchising, that the franchisor doesn’t want to have that headache; they want to just manage the brand. Which is why you have to look for sophisticated people who have the resources to hire local counsel to take care of that.