Checkpoints for Reviewing Franchise Agreements: Practical Issues for Franchisors and Franchisees

Hello, I'm Noriaki Asato, Representative Attorney at LegalAgent.

In corporate legal practice, I see franchise agreements in a wide range of business formats, including restaurants, retail and fitness. The franchisor provides its brand, trademarks, management know-how and training, while the franchisee invests its own funds and operates the store. When the system works well, the franchisor can expand its store network quickly, and the franchisee benefits from easier entry than starting a business from scratch.

On the other hand, because franchise agreements run for long periods and involve substantial initial investment, the financial and business damage when trouble arises tends to be large. It is essential to check not only the text of the agreement but also the pre-contract explanatory materials and disclosure documents, the earnings projections presented, and what was explained in meetings. Even if the agreement is formally in order, if a prospective franchisee signs without sufficient information, serious disputes may arise after the store opens.

The Framework of the Agreement and the Status of Independent Businesses

A franchise agreement is an agreement under which the franchisor provides trademarks and business know-how to the franchisee, and the franchisee operates the business in line with the franchisor's business model while paying consideration. The franchisor and franchisee are legally independent businesses, but to customers they appear as a single unified brand. Although the franchisee is not the franchisor's employee, it is customary to agree that the franchisee will follow the franchisor's instructions on store operations and customer service in order to maintain brand uniformity. Attention should also be paid to the point that the name of the agreement alone does not immediately rule out an individual's status as a worker.

In this system, the focus is on balancing the franchisee's independence with the franchisor's brand management. While the franchisor cannot issue excessive instructions, leaving the franchisee's operations unchecked could damage the credibility of the brand as a whole. In addition, where the business falls under certain specified chain businesses such as retail or restaurants, confirm whether the obligation to deliver documents and provide explanations before concluding the agreement under the Act on the Promotion of Small and Medium Retail Business applies. The Japan Fair Trade Commission's Franchise Guidelines set out an approach to advance disclosure broadly, not limited to retail and restaurants, and this should be checked separately from what is subject to statutory disclosure. A franchise agreement should be understood not merely as a trademark license or a framework for continuous sales, but as a comprehensive business alliance in which investment recovery, operational guidance, post-termination non-compete restrictions and other elements are intertwined.

Pre-Contract Explanations and Earnings Projections

In franchising, discrepancies over what was explained in advance tend to trigger disputes. Typical franchisee claims are "Sales are not what we were told" and "We were told no competing store would open nearby." This is why recruitment brochures, materials presenting the earnings model and meeting records should be compared with the contract clauses to check for discrepancies with what was explained. When presenting sales or earnings projections, the franchisor should explain the basis, such as the results of similar stores, and a reasonable calculation method. It should also distinguish model earnings based on averages from projections for the store the prospective franchisee plans to open, and avoid communicating in a way that suggests profits are guaranteed.

Consideration of the Antimonopoly Act is also essential. Determine, from both the text and its operation, whether the franchisor is abusing a superior bargaining position to impose excessive disadvantages on franchisees, and whether early termination conditions and penalties are unclear or unreasonably heavy. A penalty provision is not immediately invalid or illegal merely because the amount is high, but its practical binding force and the fairness of the transaction are judged case by case. Because franchisees invest not only the franchise fee but also funds in interior and exterior construction and hiring, they cannot easily exit the business even if sales fall short of expectations.

Financial Burdens and Trade Areas and Territories

The fees paid by franchisees are wide-ranging, including franchise fees, royalties, advertising contributions and renewal fees. Checking not only the amounts but also the basis of calculation, such as whether they are a percentage of sales or a fixed amount, whether they are refundable upon early termination, and whether there is a minimum royalty, makes it easier to forecast cash flow after opening.

The design of the trade area, or territory, is also important. The franchisee's sales plan changes completely depending on whether a certain sales area is granted exclusively to the franchisee, whether company-owned stores or other franchisees are allowed to open nearby, and how the franchisor treats mail-order sales via its website. If the agreement provides no trade area protection, check whether that condition was clearly explained in advance.

Franchisor Support, Compliance Obligations and Trademark Management

As for the franchisor's support, an abstract statement such as "the franchisor shall provide appropriate guidance and assistance" does not make concrete who will do what and how often. Specifying the frequency and content for each item, such as initial training before opening, store design support, regular visits by supervisors (SVs) and support when sales are sluggish, makes it easier to prevent gaps between the franchisee's expectations and the franchisor's response. Franchisee compliance obligations typically include business hours, designated suppliers, customer service procedures and periodic reports, and you should check whether they constrain the franchisee's management decisions beyond what is necessary to maintain uniform standards.

For purchasing and promotions, set out rules on the use of designated products and designated suppliers and the procedure for price revisions. A lack of transparency in the reasons for requiring purchases through franchisor-designated channels or in how prices are set can cause franchisee dissatisfaction. For advertising contributions as well, confirm the transparency of their use and whether franchisees may carry out their own advertising. With respect to trademarks and know-how, set out the scope of use on signage and websites, the confidentiality of manuals and the obligation to remove signage after termination. The franchisee secures the usage rights necessary for its business, and the franchisor confirms whether it can demand suspension of use in line with contractual and legal requirements if the brand is damaged.

Restrictions at Termination and Risks for Both Parties

Termination clauses are an area prone to disputes over costs and restrictions. Examples include non-compete obligations, removal of trademarks and exterior features, and handover of customer data. If the period, area and covered businesses of a non-compete obligation are set too broadly, they significantly narrow the franchisee's subsequent business activities. Confirming in advance the notice period for early termination, the cure period for breaches and the basis for calculating penalties provides material for deciding whether to withdraw. The conditions for consent where the franchisee's business or store is transferred should also be checked together with termination.

For the franchisor, it should clarify its authority to audit franchisee stores and the grounds for immediate termination in the event of a material breach, and take measures to prevent damage to the brand. In addition, a stance of not presenting overly optimistic earnings projections or concealing necessary costs in pre-contract explanations is key to limiting future liability risk. For the franchisee, it should soberly assess the prospects for recovering its initial investment and grasp the total ongoing burden, including royalties, advertising costs, designated purchases and renewal fees.

Using generative AI, you can quickly identify gaps and omissions in standard clauses such as franchise fees, royalties, trademarks and franchisor support. However, because AI reads only the text of the agreement, it cannot assess oral explanations given in meetings, the content of statutory disclosure documents or the actual state of store operations. The work of a person directly comparing the agreement with recruitment materials and meeting records continues to remain part of the practice.