When you buy a franchise operating from fixed premises, the decision of who holds the head lease is usually made by the franchisor. That decision is generally based on an assessment of how much control the franchisor wishes to have over the franchise site and the network, and the level of risk the franchisor is prepared to take on.

The most common leasing options in a franchise system are:

• Where the franchisor holds the head lease and grants a licence allowing the franchisee to occupy the premises
• Where the franchisor holds the head lease and grants a sub-lease to the franchisee
• Where the franchisee holds the head lease and the franchisee, the franchisor and the landlord enter into a separate agreement that provides for the future transfer of the head lease to the franchisor in certain circumstances (such as termination of the franchise agreement); or
• Where the franchisor or franchisee owns the freehold of the property (if the franchisor owns the freehold, it will grant a lease to the franchisee)

If the franchisor holds the head lease

If the franchisor holds the head lease, franchisees often assume their risk is minimised. However, the franchisee is usually asked to sign an occupancy licence or sub-lease which binds them to the lease terms.

The main advantage of this option, especially if the franchise network is large, is that the franchisor often has greater bargaining power to secure favourable sites and negotiate better lease terms for franchisees. Another advantage is that the franchisor, as tenant, is primarily liable under the head lease to the landlord.

A disadvantage is that the franchisor maintains control over the lease, the site and the renewal of that lease. In many franchise systems, the franchisee has little say in the negotiation and the renewal of the lease. If the franchisor becomes insolvent, the franchisee may lose his or her right to occupy the premises, as was demonstrated in the collapse of the Kleins Jewellery and Angus & Robertson networks.

There may be added legal costs too if the franchisee is required to pay both their own and the franchisor’s costs associated with the lease.

If the franchisee holds the head lease

When a franchisee holds the head lease, he or she will have control of the site and will negotiate the terms of the lease. In this instance, in the event of franchisor insolvency the franchisee may be able to debrand the business and continue operating from the premises, depending on the franchise agreement and lease terms. The consequence of having this control is that the franchisee also bears all risks associated with the lease.

Applicability of retail leasing laws

The application of retail leasing laws is complex and varies greatly from state to state.

Retail leasing laws Australia-wide govern a retail lease between the franchisee and the landlord, a sub-lease between the franchisee, the franchisor and the landlord and – in most Australian states and territories – the occupancy licence agreements between the franchisor and the franchisee, though there are some exceptions.

These laws offer considerable protections to tenants, imposing onerous disclosure obligations on landlords to give information about the proposed lease, its terms and, if the premises are in a shopping centre, details of any plans or redevelopments that may affect the centre.

Tenants are given the right to a minimum five year term and restrictions are imposed on the manner in which rents can be reviewed.

What to consider

Franchisees need to ask who will be required to enter into the lease of the premises, irrespective of who holds the head lease. Franchisees should seek their own independent and comprehensive legal advice in respect of the lease terms and any other occupancy document the franchisor asks them to sign.