Franchise operational penalties: what to check before you buy

A franchise outlet can face penalties even while it remains open and pays its fees on time. Late reports, unauthorised materials and failures to meet customer service standards are examples of situations that may trigger penalties under the contract. Before joining a franchise network, prospective franchisees need to understand not only which rules they must follow, but also how any breaches will be identified, remedied and charged for.

1. Find the penalties in the disclosure document and contract

Brazilian Law No. 13,966/2019, known as the Franchise Law, requires the Franchise Disclosure Document (Circular de Oferta de Franquia, or COF) to state the circumstances in which penalties, fines or compensation payments apply, along with the corresponding amounts set out in the contract. This requirement appears in Article 2, item XVIII. The standard-form contract must also accompany the COF in full, including its annexes.

It is therefore not enough to find a general statement saying that the franchisee must follow the brand’s standards. You need to identify which breaches trigger a charge and how the amount will be calculated.

For ordinary private-sector franchise agreements, the COF must be provided at least ten days before the contract or preliminary agreement is signed, or before any fee is paid to the franchisor or a person or company connected with it. This is a minimum advance disclosure period, not a deadline for completing your review.

Ask your lawyer to compare the penalties described in the COF with those in the draft contract. If a charge appears only in the contract, or its terms differ between the documents, request clarification and correction before committing.

2. Turn each penalty into a practical scenario

Create a table with five columns: obligation, breach, evidence required, deadline for remedying the breach and financial consequence. The aim is to translate legal wording into situations you can recognise in day-to-day operations.

Take, for example, a rule on submitting sales data. Ask whether the first late submission counts as a breach, whether there is a grace period and what happens if the system supplied by the network is unavailable. Do not assume these exceptions are already covered.

For each penalty, check:

• Trigger: is the prohibited conduct described objectively?
• Calculation: is there a fixed amount, a percentage or a daily charge for continued non-compliance?
• Repeat breaches: does the contract define when a further breach increases the penalty?
• Multiple penalties: can the same incident trigger more than one penalty?
• Responsibility: can failures by employees, service providers or systems be attributed to the outlet?

Pay particular attention to rules that rely on operating manuals. Request access to the provisions you need to understand the penalties, and check how future changes will be communicated. A broad reference to documents you have not seen makes it difficult to assess the risk you are taking on.

3. Check how the network gives notice and allows breaches to be remedied

Even a clear obligation can lead to disputes if the monitoring and enforcement procedure is vague. Find out who records the breach, what documents support the charge and how the outlet receives notice.

Ask whether a warning is issued before a penalty and whether there is a deadline for putting right breaches that can be remedied. Brazil’s Franchise Law does not establish a general remedy period for every operational breach. Do not therefore assume you will automatically have an opportunity to put things right: look for this provision in the contract and negotiate where necessary.

Also check whether there is a procedure for submitting explanations, who reviews challenges and whether collection of the charge is suspended during that review. These arrangements should be documented, not merely promised during sales discussions.

When speaking to existing franchisees, focus your questions on how the rules are applied: do notices explain the problem? Does the network provide evidence? Are similar situations treated consistently? Their accounts can help you assess practice, but they do not replace the written terms that will govern your outlet.

4. Test the financial impact and negotiate before signing

Using the amounts stated in the contract, model the effect of an isolated breach, a daily charge and a repeat breach. Use the outlet’s actual budget to check how much each scenario would affect cash flow. Do not treat penalties as a normal operating expense: the purpose of the exercise is to assess your exposure.

Ask your lawyer to review clauses containing vague wording, cumulative charges or no cap on daily penalties. The Brazilian Civil Code also regulates contractual penalty clauses and provides for an equitable reduction in certain circumstances, such as where a penalty is manifestly excessive. This does not mean that every large penalty will automatically be set aside, nor is it a reason to sign in the expectation of a future court review.

Negotiate verifiable criteria, notification channels and opportunities to remedy breaches that reflect their seriousness. Check that all agreed changes appear in the final documents.

In practice: before buying, make sure you can explain each penalty in one sentence: what conduct triggers it, how it will be proved, how much it costs and how you can respond. If any of this is unclear, your review is not yet complete.