Common Franchise Agreement Provisions: Right of First Refusal

Common Franchise Agreement Provisions: Right of First Refusal

February 14, 2019

 

What is it

A right of first refusal is extremely common in the franchise industry. Most (if not all) franchise agreements contain a provision giving the franchisor a right of first refusal on the franchisee’s proposed transfer of its business, including a proposed transfer of the franchisee’s assets or lease interest, to any third party. Pursuant to most rights of first refusal, prior to effectuating such a transfer, the franchisee must first offer to sell such interest to the franchisor, generally on the same terms and conditions offered to the third party. Accordingly, there will usually be, at least, three parties involved in a right of first refusal: the franchisee, the franchisor, and the third party.

In effect, a right of first refusal will function similar to the following:

  • Harry is a WandWorld franchisee.
  • Harry wants to transfer its obligations under its WandWorld franchise agreement to Ron (third party).
  • Harry and Ron work out agreeable terms for Ron to purchase Harry’s franchised WandWorld business, and formalize the terms of the offer in a signed Letter of Intent.
  • Harry provides Hermione (franchisor) with the Letter of Intent.
  • Hermione may either purchase Harry’s franchised business under the same terms and conditions offered to Ron, or allow Harry’s proposed transfer to Ron to go through.

 

Where is it

The right of first refusal provision is commonly located under the “Transfer” provisions of the franchise agreement.

 

Concerns with it

The right of first refusal process both slows down a franchisees ability to sell its business and makes it less likely for a potential purchaser to want to perform the due diligence required to make the franchisee an offer.

 

How to avoid it

Although it is unlikely that a franchisor will agree to remove its right of first refusal, it is best to attempt to avoid it altogether by negotiating for its removal prior to signing a franchise agreement. In the alternative, make sure the terms of the right of first refusal are reasonable. So, in the event you cannot get it removed altogether, make sure the franchisor is required to exercise its right of first refusal within a reasonable amount of time. In the past, we have seen a right of first refusal allowing the franchisor 120 days to decide whether to exercise its right of first refusal, and then 90 days to do its own due diligence with no obligation to purchase—meaning that half a year could go by, during which time the franchisee’s first third party offer would undoubtedly be off the table.

 

*NOTICE: This blog is intended solely for informational purposes and should not be construed as providing legal advice. Please feel free to contact us with any questions you may have regarding this blog post.