Buying a Franchise: Protecting Your Security Deposit

Joining a franchise network may involve paying a security deposit, particularly where the franchisor provides equipment. This payment should not be confused with the initial franchise fee: it secures certain obligations and may be refundable under the agreed terms. Before committing, check what it covers, who holds it and how you can recover it.

Identify exactly what the deposit secures

Do not settle for a line labelled ‘security deposit’ in your start-up budget. Ask for the clause defining its purpose and identify who will receive the payment: the franchisor, a related company or a separate service provider. The company receiving the money is not necessarily the one signing your franchise agreement.

Where a deposit relates to equipment supplied for your use, have an inventory attached to the agreement. It should identify the items concerned, their initial condition and, where relevant, their accessories. Dated photographs and a condition report agreed by both parties can help prevent disputes when the equipment is returned.

Ask four questions before paying:

• Does the deposit secure only the return of the equipment, or other obligations as well?
• Can it cover unpaid invoices, and if so, which ones?
• Can the amount change during the agreement?
• Will you have to top it up after a deduction?

A deposit presented as security for equipment should not conceal a poorly defined guarantee covering wider obligations. If the clause also covers royalties or penalties, ask your lawyer to assess its implications.

Follow the French legal requirements before making any payment

France has no single statute governing all aspects of franchising. Franchise relationships are governed, among other things, by general contract law and specific pre-contractual disclosure rules.

Article L. 330-3 of the French Commercial Code, introduced by the Doubin Law of 31 December 1989, applies where a party makes a trade mark, trade name or trading identity available while requiring exclusivity or near-exclusivity in carrying on the business. In these circumstances, the pre-contractual disclosure document, known in France as the DIP, and the draft agreement must be supplied at least twenty days before signing or, where applicable, before any advance payment is made.

Requesting a deposit before signing does not therefore allow this waiting period to be bypassed simply by giving the payment a different name. If payment is requested by another company or under a separate agreement, have the relationship between the documents checked before paying.

Article R. 330-1 sets out the required contents of the DIP, including the nature and amount of expenditure and investment specific to the trading identity or trade mark that must be incurred before trading begins. Ask for the deposit to be clearly identified in your financial and contractual documentation. The general duties of disclosure and good faith under Articles 1112-1 and 1104 of the French Civil Code supplement this framework.

Assess the funds tied up and the risks to them

A potentially refundable sum is still an immediate cash outflow. Include the deposit in your initial funding plan, without confusing it with a non-refundable payment to the franchisor. Your accountant can advise on its accounting treatment based on the signed documents.

Distinguish this deposit from the other security arrangements for the business: the commercial lease deposit, supplier security requirements or a personal guarantee. Together, these can reduce the cash available to launch the business, even if each seems reasonable in isolation.

Also ask how the funds are held. The term ‘security’ does not mean that your money is held in a separate account or protected if the recipient encounters financial difficulties. If the recipient enters insolvency proceedings, recovery may be at risk; the steps you need to take will depend on the precise legal circumstances.

For a substantial amount, discuss alternatives that tie up less cash with your advisers, subject to the franchisor’s agreement. A bank guarantee, for example, carries its own fees and may use up some of your borrowing capacity: it is not automatically a better option.

Agree the refund arrangements during negotiations

The clause should specify a clear trigger for repayment: return of the goods, an inspection agreed by both parties, settlement of the relevant accounts or the end of the equipment loan arrangement. Then negotiate a definite repayment deadline rather than a vague phrase such as ‘following checks’.

Ensure the agreement specifies the supporting evidence required for each deduction. For equipment, distinguish between normal wear and tear, damage attributable to the franchisee and missing items. Agree a valuation method that takes account of the items’ initial condition and age, to avoid routinely being charged the cost of new replacements.

Also ask for the undisputed portion to be repaid where a disagreement concerns only part of the deposit. Finally, clarify what happens to the money if the equipment is never supplied or the business changes hands.

Key takeaway: before making any payment, obtain a clause specifying the deposit’s purpose, its recipient, the permitted deductions and a repayment deadline. Keep the proof of payment, inventory and return documentation together.