Franchise Transfers to a Corporation or Limited Liability Company

By: Lance Winslow
Submitted: 2007-01-17 11:42:32
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As a franchisor often one will be presented with relatively simple transactions, which on paper have significance but in reality will not change the franchise relationship between the franchisor and the franchisee. Even so such changes could be significant down the road. For instance, take the assignment of the franchise agreement, which is transferred into a newly formed corporation or LLC. A franchisee may do this, to limit its liability, for tax purposes or other legal reasons.

A franchisor must consider how this will effect his operations in dealing with the franchisee and making sure that the new corporation as the same partners and legal entities behind it, because a franchisee might be bringing in monies from a competitor, someone who has not signed the franchise agreement and is not bound by its stipulations or they might be trying to dodge tax laws, and thus jeopardizing the company brand-name if something wrong. It is for this reason that I modified our clauses in our franchise agreement regarding assignments of the franchise agreement to a corporation or LLC. Below is the clause that I came up with for our company;

5.3 Assignment to Corporation or Limited Liability Company

If Franchisee is a partnership or individual and hereafter desires to conduct the Franchised Business in an incorporated or limited liability company form, Franchisor will not unreasonably withhold its consent to the transfer of this Agreement and Franchisee’s interest herein to any corporation or limited liability company formed for that purpose; provided that Franchisee and such corporation or company must, prior to such transfer, satisfy such reasonable requirements as Franchisor shall impose, which may include, without limitation, the following:

(a) Franchisee or its partners will at all times be the record and/or beneficial owner of, and will have, by law or by written agreement satisfactory to Franchisor, voting control of, not less than fifty-one percent (51%) of the issued and outstanding shares or membership interests of each class of the capital stock or membership interests of such corporation or company;

(b) No other person or entity, except members of Franchisee’s or its partners’ respective immediate families or trusts for the benefit of such family members, may own or have any right to acquire any capital stock, membership interests or other securities of such corporation or company;

(c) The form and content of the articles or certificate of incorporation, organization or formation of such corporation or company and by-laws of any such corporation or operating agreement of any such company must contain provisions enforceable under applicable law restricting the issuance and transfer of capital stock, membership interests or securities of the corporation or company to such extent as Franchisor shall reasonably require;

(d) Franchisor must have been furnished in writing the names and address of all existing or prospective shareholders or members of the corporation or company and Franchisee or its partners and (if requested by Franchisor) each such shareholder or member, or prospective shareholder or member, must have guaranteed in writing (in form and substance satisfactory to Franchisor) the performance by the corporation or company of the obligations of the Franchisee under this Agreement; and

(e) Each shareholder or member must have executed and delivered to Franchisor a non-competition covenant in form and substance satisfactory to Franchisor, containing the covenants not to compete required by Section 3.20.3 hereof. After assignment of this Agreement to a corporation or limited liability company as above provided, or, if Franchisee is a corporation or limited liability company at the date of this Agreement, the sale, transfer, assignment or encumbrance or change in rights of any class or series of capital stock, membership interests or other securities of such corporation or company, whether by operation of law or otherwise, will be deemed a sale by Franchisee or (if a partnership) its partners or its or their interest(s) in this Agreement and will in all respects be subject to the limitations set forth in this Section 5 on the sale of Franchisee’s interests in this Agreement. Any merger, consolidation or reorganization by any corporation or limited liability company having an interest in this Agreement will be deemed a sale of such interest and, unless the prior written consent of Franchisor has been obtained, will constitute a material breach hereof.

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It is interesting how something so simple can become so problematic. It is for this reason that I suggest that you consult an experienced and knowledgeable franchisee attorney and ask them how such a clause would best fit your franchise in company. I hope you will consider this in 2006.

Lance Winslow

Article source: Expert Articles