How Should Security Be Structured in a Franchise Agreement?

When preparing to franchise your existing business, you need to decide not only what fees to charge, but also how to respond if payments fall behind. Security cannot remedy poor franchisee selection or an unsustainable business model; it helps manage specific credit risks. In a healthy franchise network, the aim is not to tie up all the franchisee’s resources, but to ensure both parties know in advance which security covers which debt. Security arrangements should therefore be a separate workstream, developed jointly by the finance and legal teams before the first contract discussions.

1. Define the debt being secured before setting the amount

The opening question should not be “How much security should we ask for?” but “Which amounts owed to us could be left unsecured, and in what circumstances?” Some risks that are not apparent in company-operated branches emerge when you start working with independent operators. For example, selling products on credit from head office creates a different risk profile from simply collecting a monthly franchise fee.

Start by preparing a schedule of receivables. For each item, record the creditor, debtor, payment due date, calculation method and potential impact of late payment. In particular, keep the following categories separate:

• Recurring fees payable to the franchisor.
• Trade receivables arising from products sold directly by head office.
• Debts payable to independent suppliers, rather than to head office.
• Obligations that may arise from the supply or hire of equipment.
• Claims for losses whose existence and amount have not yet been established.

Do not assume that an independent supplier’s receivables can be covered by security held by head office simply because the businesses operate under the same brand. If such an arrangement is being considered, the parties involved and its legal basis must be identified separately.

When setting the amount, consider payment frequency, the credit period allowed and the time that may pass before a delay is detected. Adding up every possible future debt as though they will all arise at once can unnecessarily restrict the franchisee’s resources at launch. Also explain at the outset when the security requirement may be reviewed.

2. Choose the form of security in line with Turkish law

Türkiye has no dedicated franchise law governing franchise agreements exclusively. Nor is there a general public registration requirement specific to franchising or a standardised mandatory pre-contract disclosure document regime. However, this does not remove the duty to act in good faith during contract negotiations and to communicate material information accurately.

The Turkish Code of Obligations No. 6098 and the Turkish Commercial Code No. 6102 are particularly relevant to security arrangements. Other aspects of the franchise relationship may also engage the Industrial Property Code No. 6769 and the Law on the Protection of Competition No. 4054. Freedom of contract does not make security arrangements valid if they breach mandatory legal provisions.

The options available in practice differ in cost and legal effect:

• Cash deposit: Relatively straightforward to administer, but it reduces the operator’s liquidity. Specify where it will be held, how it may be applied against debts and who is entitled to any interest or other return.
• Bank letter of guarantee: This may use part of the franchisee’s available bank credit limit and incur commission charges. Its validity period, demand conditions and the debts it covers must be assessed against the wording of the letter.
• Suretyship: A personal undertaking by a third party to answer for a debt. Its validity depends on more than simply having a signature on the agreement.

Article 583 of the Turkish Code of Obligations imposes specific requirements for suretyship, including written form and details such as the maximum amount and date; certain declarations must be written in the surety’s own handwriting. Article 584 on spousal consent, and the exceptions relating to commercial activities, must also be examined. Giving security provided by an individual a different name does not automatically bypass the protections applicable to suretyship.

For this reason, do not casually add a personal undertaking from a company shareholder to a standard agreement. Have a lawyer verify the legal nature of the document and the requirements for its validity.

3. Make recourse to security a documented process

Security should not serve as an automatic mechanism for head office to collect penalties. Clearly describe the process, from the debt arising through to recording the amount recovered. Check that the contractual procedure is consistent with the demand conditions in separate documents, such as a bank letter of guarantee.

A suggested internal procedure could include the following steps:

1. The finance team verifies the basis of the debt and its due date.
2. The franchisee receives an itemised written notice.
3. The period allowed under the agreement for an explanation or payment is observed.
4. Any objections and supporting evidence of payment are assessed.
5. With approval from an authorised person, action is taken in accordance with the terms of the relevant security instrument.
6. The amount recovered is allocated to the relevant debt, and the remaining balance is communicated.

Put accounting controls in place to prevent the same debt being recovered twice, through both direct payment and recourse to security. If the franchisee will be required to replenish the security after it has been used, specify the deadline and limits for doing so.

For example, a claim may include both overdue recurring fees and an alleged loss arising from a breach of quality standards. While invoices and payment records may support the former, the latter may require further investigation. Do not combine these two items into a single demand for payment without justification.

4. Set out expiry monitoring and return arrangements from the outset

Avoiding the retention of security for longer than necessary is just as important as obtaining it. For bank letters of guarantee with a fixed term, maintain a register showing expiry dates and tracking renewals. It should identify the person responsible, the department holding the document and the method for issuing alerts as deadlines approach.

For the return or release of security, use verifiable conditions rather than vague wording such as “once all dealings have been fully concluded”. The final account reconciliation, outstanding invoices and equipment due to be returned can each be assessed separately. Do not treat every unresolved possibility as a reason to retain the entire security indefinitely. Consider options for partial release or reduction as well.

Practical takeaway: Before making your first franchise offer, bring together the debt categories, form of security, steps for using it and conditions for its return in a single working schedule. Then have the agreement and security documents reviewed together. A sound security arrangement is not the one that demands the highest amount, but the one that addresses the actual risk clearly and proportionately.