The advantages and disadvantages of subleasing in franchising

Franchise organizations may choose to lease locations themselves and then sublease them to franchisees. Alternatively, they can allow the franchisee to lease a location directly. If you decide to be the primary tenant, the next question is what factors to consider. There have been various court cases concerning subleasing in franchise. Therefore, it is important to make proper agreements regarding the relationship between the franchise agreement and the lease agreement.

What is subleasing in franchise?

Subleasing in franchise occurs when a franchisor leases space from a third party (the primary landlord) and subleases this space to a franchisee for operating the franchise formula. This allows the franchisor to maintain control over the business premises. In many cases, the franchisee can benefit from favorable lease terms that only a larger entity like a franchisor can secure.

In subleasing within a franchise, there are two distinct lease agreements: the primary lease agreement between the primary landlord and the franchisor and the sublease agreement between the franchisor and the franchisee. This sublease agreement is additional to the franchise agreement agreed upon between the franchisee and franchisor. If the lease agreement is added as a separate annex to the franchise agreement, there is a linkage. This situation is commonly seen in franchises where 'linkage provisions' are included in both agreements.

Lease protection

An example of such a linkage provision is that the end of the franchise agreement also signifies the end of the lease agreement. However, such a provision is only valid if prior permission is obtained from the district judge. A tenant is entitled to lease protection, meaning a lease agreement cannot be terminated without the court's permission. The law provides limited termination options.

The judge will grant permission only if they believe the franchisee does not require lease protection. Additionally, the judge will ensure that the franchisee's interests are adequately safeguarded. This is the case, for example, if there is an agreement that the franchisee will receive some compensation for their investments at the end of the contract.

A lease agreement typically lasts at least five years and is automatically extended up to ten years. After the first five years, termination is only possible on limited grounds. After ten years, more grounds for termination are available, including termination after a reasonable weighing of the interests of the landlord against those of the tenant. After these ten years, the lease agreement generally continues indefinitely with a notice period of at least one year.

Dutch Franchise Law and subleasing in franchising

The importance of making good arrangements is also emphasized in the Explanatory Memorandum of the Franchise Act:

“A franchisor who is also the primary tenant and sublessor of the premises in which the franchisee operates a franchise business cannot view decisions related to the lease agreement entirely separately from the franchise cooperation and the norms that apply within it. A decision to terminate the franchise agreement while maintaining the sublease agreement can be unfair to the (former) franchisee. This is especially true in combination with a post-contractual non-compete clause in the franchise agreement, which prohibits the franchisee from being active in the same market for a specific period after the franchise relationship ends.”

What needs to be arranged to ensure proper subleasing in a franchise?

Linking the Lease Agreement and Franchise Agreement

Ensure that the lease agreement and franchise agreement are linked. This can be done by including the lease agreement as an annex with corresponding provisions in both agreements. It is important that the start and end dates of the franchise agreement match those in the lease agreement. It is undesirable for a franchisee to still have obligations under the franchise agreement but not have a location to fulfill those obligations or vice versa, having a location but no formula to operate within it.

District Court Approval

Always seek approval from the district court. Without prior approval, uncertainty remains on how a judge will ultimately react to a link between the franchise and lease agreements. It might happen that you terminate a franchise agreement with a franchisee due to non-performance, yet the franchisee cannot be removed from your location. To address this properly, draft an application as referred to in Article 7:291 BW linking lease agreement & franchise agreement, sign it jointly with the franchisee, and submit it for approval to the respective district court.

Real Estate in a Separate Entity

Although landlords might prefer otherwise, we advise not to enter lease agreements through the Franchise B.V. or holding company but through a separate entity to spread risks. This way, the real estate is separated from regular business activities and can be excluded if desired during a potential sale of the franchise formula.

Is your sublease process in order?

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