The number of hotels, particularly limited service hotels, operating under franchise agreements has exploded in recent years, and this trend is expected to continue in the near term. Franchise agreements, including those in the hospitality industry, are personal contracts for the benefit of the named franchisee only, and are further limited by the franchisee’s ownership structure as of the effective date of the franchise agreement. From this point of beginning, it is logical that the franchise agreement would also include strict limitations on the franchisee’s ability to transfer ownership interests of the franchisee both within the franchisee company and to third parties. Each franchisor will adopt its own unique approach to the transferability of interests, but there will be certain commonalities that franchisees should be aware of and carefully study.
Franchisees would be wise to assume that a transfer of any direct or indirect ownership interest in the franchisee is prohibited without the prior written consent of the franchisor or expressly permitted under the franchise agreement. Regardless of some of the variations of language, this means every transfer and covers direct and indirect transfers within the entirety of the franchisee’s ownership structure. There will be variations in the requirements to obtain the franchisor’s consent, and some transfers that may not require consent, but the general expectation should be that the general rule under the franchise agreement will be to prohibit transfers.
Some common basic requirements for any transfer will include that (i) the franchisee is not in default under the franchise agreement, (ii) the franchisee provides prior notice to the franchisor with information about the proposed transfer and the transferee, (iii) the proposed transferee is not a party prohibited from holding a franchise, such as being prohibited under applicable law or being a person of ill repute, and (iv) the proposed transferee is not a competitor of the franchisor.
Once the basic requirements have been resolved, the analysis will turn to whether the transfer involves the interests of a passive investor or the interests of a controlling investor. If the transfer would result in a change in control of the franchisee, the franchisor has the right to approve or disapprove the transfer. Even if the transfer is approved, it will be considered a new franchise and the proposed transferee will be required to submit an application, together with the requisite application fee, sign the then-current form of franchise agreement, and undertake improvements or upgrades to the property as identified by the transferor.
Each element of the transfer process and the franchisor’s right to consent to or participate in the process must be clearly understood and complied with because the consequence of being wrong is a default under the franchise agreement, loss of the franchise and the obligation to pay liquidated damages to the franchisor. The initial work to analyze and understand the entire transfer process at the time the franchise agreement is signed is certainly recommended.