The advantages and disadvantages of subletting in franchise

Franchise organizations can choose to rent locations themselves and then sublease them to franchisees. Alternatively, they can allow the franchisee to rent a location directly. If you choose to be the primary tenant, the question then arises: what should you consider? There have been various legal cases concerning subleasing in franchising. Therefore, it's important to make good agreements about the relationship between the franchise agreement and the lease agreement.

What is subleasing in franchising?

Subleasing in franchising occurs when the franchisor rents a space from a third party (the primary landlord) and then subleases it to the franchisee for the operation of the franchise formula. This allows the franchisor to maintain control over the business space. The franchisee can often benefit from favorable rental terms that only a larger party like a franchisor can negotiate.

With subleasing in franchising, there are two separate lease agreements: the primary lease agreement between the primary landlord and the franchisor, and the sublease agreement between the franchisor and the franchisee. This is an additional agreement alongside the franchise agreement between the franchisee and the franchisor. If the lease agreement is added as a separate appendix to the franchise agreement, there is a linkage. This linkage often appears within franchising, where both agreements contain 'linkage clauses.'

Rent protection

An example of such a linkage clause is that the end of the franchise agreement also means the end of the lease agreement. However, such a clause is only valid if prior approval from the subdistrict court is obtained. Tenants have tenant protection, and therefore, a lease agreement cannot simply be terminated without a judge's approval. Moreover, the law offers limited termination options.

The judge will only grant approval if he believes the franchisee does not need tenant protection. The judge will also ensure that the franchisee’s interests are sufficiently safeguarded. This is the case, for example, if it is agreed that the franchisee will be compensated for his investments, at least partly, at the end of the contract.

Lease agreements often run for a minimum of five years and are automatically extended to ten years. After the first five years, they can only be terminated on a limited number of grounds. After ten years, more termination grounds are possible, including termination after a reasonable weighing of the landlord’s interests against those of the tenant. After 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 agreements is also emphasized in the Explanatory Memorandum of the Franchise Law:

“A franchisor who is also the primary tenant and sublandlord of the premises where his franchisee operates a franchise business cannot completely separate his decisions regarding the lease agreement from the franchise collaboration and the norms that apply within it. The decision to, for example, terminate the franchise agreement on one hand but keep the sublease agreement ongoing on the other, can be unfair to the (former) franchisee. This is particularly 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 certain period after the end of the franchise relationship.”

What should you arrange to ensure successful subleasing in franchising?

Linking 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 appendix with corresponding provisions in both agreements. It's important that the start and end dates of the franchise agreement match those in the lease agreement. It is undesirable for a franchisee to have obligations under the franchise agreement but no location to fulfill them. Conversely, the franchisee should not have a location but no franchise formula to operate there.

Subdistrict court

Always seek approval from the subdistrict court. Without prior approval, there's uncertainty about how a judge will ultimately react to a linkage between the franchise and lease agreements. For instance, you might end a franchise agreement with a franchisee due to non-performance, yet the franchisee cannot be removed from your location. To address this, draft a petition as referred to in Article 7:291 of the Dutch Civil Code concerning the linkage between the lease agreement and the franchise agreement, sign it jointly with the franchisee, and submit it for approval to the relevant subdistrict court.

Real Estate in a separate entity

Although landlords may prefer otherwise, we advise against entering into lease agreements through the Franchise B.V. or holding company. Instead, use a separate entity to spread the risk. This way, the real estate is separated from regular business activities and can be excluded in a potential sale of the franchise formula.

Is your subleasing process in order?

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