Franchising a Hong Kong Business: Aligning Shop Leases with Franchise Agreement Terms

When opening an existing business to franchising, franchisors can easily treat the franchise agreement and shop lease as separate matters: lawyers draft the former, while franchisees negotiate the latter themselves. Yet if the terms, permitted uses and termination arrangements do not align, a franchisee may end up with the right to operate under the brand but nowhere to trade. Building a reliable franchise network means connecting these two sets of rights and obligations from the outset, rather than simply stating that “the franchisee is responsible for the lease”.

1. Distinguish brand rights from the right to occupy premises

A franchise agreement grants the right to operate a branded business on agreed terms. It does not automatically give the franchisee the right to occupy any property. Even if the franchisor approves a particular address, this does not mean the landlord has agreed to the shop’s actual use, fit-out or signage arrangements.

Hong Kong currently has no legislation specifically regulating commercial franchising in general, nor any franchise-specific mandatory disclosure, registration or statutory code regime. Franchise relationships are primarily governed by common law principles of contract and applicable legislation, including the Misrepresentation Ordinance. Shop leases also require consideration of the lease itself, property law and the applicable provisions of the Landlord and Tenant (Consolidation) Ordinance. The filing and disclosure requirements under mainland China’s Regulations on the Administration of Commercial Franchises cannot simply be applied to franchise arrangements operating solely in Hong Kong.

Franchisors should therefore not turn an “expected lease renewal” into a “guarantee that the business can operate until the franchise term ends”. Commercial tenants should not be assumed to have an automatic right to renew. Any statements made during franchise recruitment about renewal or landlord consent should be supported by documents and clearly identify any conditions that remain unresolved.

2. Prepare a timeline for both agreements before signing

Franchisors can require prospective franchisees to submit the proposed lease for review by the relevant professional advisers before making an irrevocable leasing commitment. The purpose is not to make the investment decision for the franchisee, but to establish whether the premises arrangements can support the franchise relationship.

The timeline should set out at least the following items side by side:

• Franchise term: When the licence starts and expires, and whether the term begins running before the business opens.
• Lease term: The handover date, rent commencement date, rent-free period, fixed term and any break rights.
• Renewal procedure: Whether there is an exercisable renewal option, the notice deadline, the method for determining rent and any conditions attached.
• Exit obligations: The time needed to hand back the premises, remove signage, carry out reinstatement works and clear equipment.

For example, if the lease expires before the franchise agreement, the parties need to agree in advance what happens if renewal is unsuccessful. Conversely, if the franchise agreement expires first, the franchisee may still have to pay rent despite no longer being entitled to use the brand. Even matching the two expiry dates exactly may not be enough, as reinstatement works may need to take place after trading has stopped.

Franchisors should specify which mismatches are acceptable, who must approve them and which consequences must be explained to the franchisee. This is an internal risk management standard and should not be presented as a statutory minimum lease term.

3. Confirm the tenant, permitted use and landlord consent

Beyond aligning the timelines, it is essential to check who leases the premises and who operates the business. If a company signs the franchise agreement but a shareholder personally, or another company, holds the lease, the operating company does not automatically have the right to use the property. Lease clauses prohibiting subletting, assignment or parting with possession may affect the arrangement and should be assessed by a lawyer against the relevant documents.

Franchisors should maintain a lease review record identifying the tenant, franchisee and actual operator, and checking that the permitted use under the lease meets the business’s needs. Restrictions affecting food and beverage, retail or service premises should not be verified solely through an estate agent’s verbal assurances.

Where signage, fit-out works or equipment installation require the landlord’s written consent, record who is responsible for applying, the documents required and when consent must be obtained. The franchisor’s design approval cannot replace landlord consent or any required government approvals.

If the franchisor leases the premises and then allows a franchisee to use them, it must first confirm that it has the right to do so. Rent, deposits, repairs and handover obligations should also be set out separately and clearly. Avoid simply referring to “providing a shop” in the franchise agreement without explaining what right of use the franchisee receives.

4. Agree in advance what happens if the premises are lost

A lease not being renewed, a landlord exercising a contractual termination right and a landlord repossessing premises because the franchisee has failed to pay rent are different situations. The franchise agreement should distinguish between them, rather than treating every case as a franchisee breach or promising that the franchisor will always arrange replacement premises.

The procedure can be set out in four steps: first, the franchisee reports the relevant notice within an agreed period after receiving it; next, the lease documents are submitted to assess whether lawful occupation can continue; the parties then determine relocation, suspension or termination in accordance with the agreement; finally, they deal with branded materials, stock and outstanding transactions. Where relocation is involved, separate provisions should cover approval of the new site, the deadline for reopening and responsibility for costs.

In particular, specify which fees remain payable during a closure, which may be suspended and whether an approved relocation changes the franchise expiry date. These arrangements should have a clear basis in the franchise agreement, rather than being decided unilaterally only after the premises are lost.

If the franchisor wishes to retain an option to take over the shop, it must also recognise that an agreement between franchisor and franchisee cannot bind a landlord who has not consented. Any arrangement to take over the lease or enter the premises must be checked against the lease, and the necessary consents obtained.

Practical takeaway: Before recruiting franchisees, prepare a comparison table of the franchise and lease terms, then ask a Hong Kong lawyer to review any mismatches and the rights to use the premises. Agreeing responsibilities in advance if the premises are lost is more useful than simply requiring franchisees to bear all leasing risks themselves.