Franchise agreements: setting clear terms for payment security

Turning your business into a franchise means not only passing on a concept, but also managing new receivables: initial franchise fees, royalties and sometimes invoices for goods. Should you require security from the franchisee? To build a sustainable franchise network, the answer should start with the actual risk, rather than a desire to cover every eventuality. Here is how to prepare this part of the agreement before the first contracts are signed.

1. Identify the receivables genuinely at risk

Before choosing a form of security, list the amounts your future franchisor company will actually need to collect. Distinguish between one-off payments, recurring royalties and any credit extended on deliveries. An invoice payable immediately does not create the same exposure as an outstanding balance for goods replenished every week.

For each receivable, identify the debtor, the party entitled to payment, the due date and the consequences of late payment. If products are invoiced by an independent supplier, the supplier’s receivable does not automatically become the franchisor’s: security arrangements must reflect the actual legal relationships.

Next, assess how much could remain unpaid before your team intervenes. The aim is not to secure, in the abstract, all the income expected over the life of the agreement, but to understand the foreseeable financial exposure.

Prepare a risk assessment sheet for each operating model, covering:

• the nature of the amounts due;
• the proposed payment terms;
• the procedures for monitoring overdue payments;
• the level of cover sought and the reasons for it.

This gives you a useful basis for discussions with your legal adviser, rather than copying a clause designed for another franchise brand.

2. Choose security whose implications you understand

The term ‘security’ covers very different mechanisms. Three instruments in particular should be distinguished in the French context.

A surety guarantee (cautionnement) commits a person to pay the franchisee’s debt if the franchisee fails to do so, within the limits set out in the guarantee document. Where a company director gives a personal guarantee, their personal assets may be at risk. A surety guarantee given by an individual is subject to protective rules, notably on formal requirements and, where the creditor acts in a professional capacity, proportionality. It should never be treated as a routine administrative attachment.

An independent guarantee (garantie autonome), which may provide for payment on first demand, creates an undertaking separate from the underlying debt. The conditions for calling on it and the grounds for challenging a demand differ from those of a surety guarantee. These two options should therefore not be presented as interchangeable. A bank guarantee may also tie up financial capacity that the franchisee needs to launch the business.

Security over the business as a going concern (nantissement du fonds de commerce) uses a business asset to secure a receivable. Its effectiveness depends, among other things, on compliance with the required formalities, creditors’ priority rankings and the realisable value of the business. It guarantees neither immediate payment nor recovery in full.

Before combining several instruments, assess the usefulness of each and its cost to the project. Additional security may look reassuring on paper while making it harder to finance the opening.

3. Set out the requirements before any commitment

In France, franchise agreements are governed primarily by general contract law and competition law. Security arrangements are also subject to their own rules, notably those in the French Civil Code and, for certain forms of security, the French Commercial Code.

Pre-contractual disclosure is governed by Article L. 330-3 of the French Commercial Code, introduced by the Doubin Law, where its conditions are met: a trade name, trade mark or trading identity is made available in return for an exclusive or near-exclusive commitment. Article R. 330-1 specifies the contents of the pre-contractual disclosure document, known in France as the DIP.

The DIP and draft agreement must then be provided at least twenty days before signing or, where applicable, before any advance payment. The security required must be clearly set out in the contractual documentation, together with draft security documents where available. Do not reveal a personal guarantee requirement only at the signing meeting.

Explain who is making the commitment, which debts it covers, the maximum amount and its duration. Any significant last-minute change should prompt a legal review of its implications for the information given to the prospective franchisee and the signing timetable.

4. Manage monitoring and the release of security

Useful security must remain clear throughout the relationship. Ensure that the conditions for calling on it, the supporting documents required, the relevant deadlines and the release arrangements are specified. Distinguish between the period during which new debts can be covered and the treatment of debts already incurred.

Keep a register of signed documents, limits, expiry dates and formalities. Appoint someone to oversee it. Do not assume that security automatically continues on the same terms when the agreement is renewed, the company’s management changes or the business is transferred.

Finally, maintain a payment-chasing process: security is no substitute for reliable invoicing or prompt discussions when difficulties arise.

Key takeaway: start with the receivables you need to protect, choose proportionate security and have the documents legally reviewed before proposing them. Protecting the franchisor must remain compatible with the franchisee’s ability to finance the business.