Option Not to Renew Lease with Landlord by agy33516


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									Lease of the Premises by a Third Party
with Option in Favor of Franchisor

                        Carl Zwisler
                        Gray Plant Mooty
                        Washington, DC

                        2010 IDI Annual Conference
                        Torino, Italy
                        June 11-12, 2010
Be Careful What You Wish For

 There are two tragedies in life. One is to
 lose your heart’s desire. The other is to
 gain it.”
                 - George Bernard Shaw

In the US, one FDD item requires
disclosures about the duties of the
franchisor to a franchisee. The first
requirement in this item is:
– Describe the franchisor’s obligation to the
   franchisee in locating a site and
   negotiating the purchase or lease of the
   site. If such assistance is provided, state:
A. Whether the franchisor generally owns the
   premises and leases it to the franchisee
B. Whether the franchisor selects the site or
   approves an area in which the franchisee
   selects a site…
Most franchisors whose franchisees
operate from a fixed location choose B.

They also disclaim liability to the
franchisee for their role in appraising a
site or the terms of its lease, claiming
that the final decision over these issues
belongs to the franchisee.

Franchising and Subleasing Are
Distinct Businesses

 At its essence, franchising is shifting
 investment obligations and risks to
 franchisees. If a franchisor will not
 invest in businesses operated by a
 franchisee, why would it invest in the
 real estate from which a franchised
 business operates?

• In most franchise programs, the franchisor's
  marginal costs of granting a new franchise are
  recovered from initial fees. Thereafter, the
  franchisor's exposure to risk is principally from
  litigation from franchisees.
• By subleasing, a franchisor exposes itself to
  months or years of liability if a franchisee does
  not pay rent.
• Commercial real estate is a business. It is
  different from franchising. Being in the real
  estate business only makes sense if it is an
  independently profitable business, and the
  returns from subleasing include a risk
  premium.                                          7
When a franchisor takes over a
franchisee’s store, the franchisee has
usually fallen several months behind in
royalties, rent and other amounts owed
to the franchisor.

Most franchisors make little on rent they
charge their franchisee subtenants.
When franchisee/tenant defaults or is
terminated, franchisor must find a new
franchisee and/or hire a manager to
operate the business. Often, reason for
the default is related to the location.

Operating as a company owned store or
re-franchising the store may be the only
way to protect the lease investment.

What does it do for the brand?

What is the risk of subleasing?

 Owning a location which is unprofitable
 for the franchisee, and having to recruit
 a new tenant or franchisee to occupy
 the location to reduce losses. Consider
 some statistics relating to vacancy

Mall Vacancy Rate: 30%, Rents Falling

          - Zmarter.com finances May, 2010

Exxon Mobil announced yesterday it's
had it with the measly returns on selling
gas to consumers. Following the
industry trend away from the retail gas
station business, the oil giant plans to
unload the 2,200 stations it still owns.
BP expects to be rid of its company-
owned stations in the US by the end of
next year and Conoco Phillips is nearly
out of the business altogether.
      - www.minyanville.com June 13, 2008
If the objective is to control the location,
keep it affiliated with the franchise
brand, but avoid the risks of subleasing,
conditional lease assignments or lease
riders are the instrument of choice for
most US franchisors.

Elements of a Conditional Lease

Elements of a Conditional Lease

 Amendment to Franchisee’s lease
 signed by Landlord and Franchisee
  – Landlord must be a party
 Incorporates references to Franchise
  – No mistake about relationship between
    Franchise Agreement and Lease

Restricts use of premises to the
franchised business
– Establishes a basis for Franchisor to
  assume control if Franchisee attempts to
  change the use of the premises
Requires notices of default and
termination to be delivered to Franchisor
in time for Franchisor to act
– With notice Franchisor can decide whether
  to help Franchisee comply, or whether to
  assume the lease and search for a new
  Franchisee for the location
Franchisor has the option, but not duty,
to cure breaches
– Avoids liability arising from a sublease
Franchisor has the right to enter the
premises to cure breaches
– Self-help cure rights always depend upon
  the Franchisor not breaching the peace.
– In many jurisdictions self-help cure rights
  are not enforceable and may be treated as
  an unlawful trespass

Franchisee has unconditional right to
assign lease rights to Franchisor or its
affiliates or successors, without changes
in lease terms, and without executing a
guaranty of the Lease
– Gives flexibility to Franchisor as to the entity
  which will hold the lease if the Franchisor
  exercises the option.

Lease assumption only occurs, and
Franchisor only assumes liability, after
notifying Landlord and Franchisee of its
– Avoids disputes about whether and when
  Franchisor incurs lease liability

Franchisor is not liable for pre-
assumption obligations of Franchisee to
– Allows Franchisor or its assignee to be
  treated as a new tenant. Landlord can
  pursue claims it has against the Franchisee
  and its guarantors (if any)

After assuming the lease, Franchisor
may assign lease to a new Franchisee,
with Landlord’s consent, but without
changes in lease terms
– Gives Franchisor flexibility to operate
  business as a “company owned store” until
  a new Franchisee can be recruited for the

Optional Components

Franchisor has right to receive all
reports of sales, income that Landlord
receives from Franchisee
 – Aids Franchisor in corroborating Franchisee
   reporting, and may alert Franchisor to
   issues not regularly identified in its own

Landlord has right to receive notices of
default or termination from Franchisor.
Allows Landlord to have advance notice
of potential problems.
– May accelerate Landlord’s exercise of
  remedies against Franchisee

 Benefits to Landlords of Conditional
 Lease Assignments

• The franchisor may become the
  landlord's "partner" in quickly finding a
  new tenant to keep the premises
  occupied, using the same brand,
  maintaining the same tenant mix.

• The landlord's willingness to sign a
  conditional lease assignment may
  induce a franchisor to approve other
  locations owned or managed by the
  landlord for future franchisees.

• As use of conditional lease assignments
  has become a standard for many
  franchisors, landlords who wish to
  attract franchisee tenants have a
  competitive advantage over those who
  do not. In the US franchising accounts
  for approximately 40% of retail sales.
Benefits of Conditional Lease
Assignment - Franchisor Perspective

• The CLA substantially reduces the
  likelihood that a franchisee will break
  away or not renew at the end of its
  franchise term if it is a successful

• If a franchisee is unsuccessful and
  breaches lease, the franchisor has the
  opportunity to preserve the location and
  its reputation with the landlord.
• Except for the benefit of rental income,
  a franchisor acquires every advantage
  of a sublease, but none of the risks, and
  none of the financial statement liabilities.

• In international franchising in countries
  which prohibit foreign property
  ownership or foreign business
  operation, a CLA allows a foreign
  franchisor to control real estate, without
  owning it.
     Thank you.
       Carl E. Zwisler
      Gray Plant Mooty
 2600 Virginia Avenue, NW
Suite 1111 – The Watergate
  Washington, DC 20037
   Phone: 202-295-2225
 Facsimile: 202-295-2275


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