Anatomy of a Sports League Franchise Agreement

We have already discussed that sports leagues across the world follow the franchise model.

Franchising is at the core of billion-dollar sports leagues which take place across the world. It is important to realize that franchising provides the legal and business framework which ensures coordination between the actions of different league participants.

It is important to realize that the sporting league only derives its value because the teams act in a coordinated and uniform manner.

For instance, any financial valuation of the Chicago Bulls is derived from the fact that it is a participant in the NBA. There is no valuation of the Chicago Bulls outside of the NBA. This is the case for all the teams of any league.

It is therefore in the interest of all the teams as well as the league to have a strong legal framework. Since the interests of all franchise owners as well as the franchisor are intertwined, it only makes sense to regulate them.

The franchising agreement is the main document that governs the details of relationships between the franchisors and franchisees. A wide variety of legal as well as financial issues are discussed in a sports league franchise agreement. In this article, we will have a look at some of the most common topics which are discussed and detailed in such agreements.

What is a Franchise Agreement?

A normal business franchising agreement involves an agreement between a franchisor and a franchise. The franchisor remains the same. However, it can have agreements with multiple franchises.

Depending upon the agreement between them, a franchisor can have a standard agreement drafted for all franchises or could enter into unique individual agreements with each franchise. However, a franchise agreement outlines the details about how the franchisor will allow the franchises to use their brand name and other business methods.

In the case of sports league franchises, the league owns the format in which the game is played and the brand name. The franchises are given the right to participate in the league. As mentioned above, the right to participate provides economic value since it provides a readymade fan base and viewership which will be generated by the league.

There are numerous issues that come up when a franchising agreement is in place. The details of some of these agreements have been mentioned below.

1. Territorial Rights: First and foremost, the franchisor needs to grant exclusive geographical rights to a franchise. This means that if Chicago Bulls is the designated participant in the league from the Chicago area, then no other team from the same area will be allowed to participate. This territorial exclusivity is very important for the franchise. The Chicago Bulls franchise would derive its economic value from the fan following of basketball in the Chicago region.

   Now, if the league (NBA) were to allow more than one team to participate from Chicago or its nearby areas, then the fans would be split between the two teams. As a result, ticket sales, merchandise sales, and all other economic parameters would be impacted. Hence, it is important that the franchise agreement clearly demarcates the exclusive territory which is being granted.

2. Franchisor Obligations: The franchise agreement needs to clearly state what the league i.e. the franchisor is obligated to provide.

   For instance, the franchisor is obligated to make sure that there are a certain number of other franchises in the league. It is also obligated to ensure that a certain number of top-grade players participate in the league and are distributed somewhat evenly across the teams. The franchisor may also be required to spend a certain amount of money on creating a brand recall and brand presence.

   The franchises may advertise locally to cater to the local market. However, league-level advertisements and publicity need to be handled by the franchisor. The franchisor may also be obligated to create a schedule that is acceptable to all teams and takes into account other engagements of important players.

   The league is also obligated to deal with the local government agencies such as the police and obtain the necessary permissions to host the event as the decided-upon schedule. One of the main responsibilities of the franchisor is to put a framework in place which allows other franchises to resolve any conflicts with one another in an amicable and fair manner.

3. Default and Termination: The franchise agreement should also clearly define the situations in which a particular franchise or the franchisor will be considered to be in default.

   It must also clearly explain the various stages of default i.e. the stages at which the relevant parties will be considered to be in default viz. non-payment of dues in a timely manner, the interest rate that will be charged, etc.

   It should also clearly explain how long the default stage will continue and whether there are any stages to default. Finally, it should also explain the final stage when the franchisor will have the right to terminate the agreement of the franchise and if such a situation does arise then what the obligation of both parties will be in such a case.

4. Payments and Financial Obligations: In the previous article, we discussed how the franchise agreement outlines the obligations of the franchisor. Similarly, the franchise agreement also outlines the obligations of the franchise.

   Firstly, it provides a detailed outline of the financial obligation of the franchises. Generally, franchises contribute to the finances of the league in three ways.

   1. Firstly, they pay the franchisor an annual fee,
   2. Secondly, they pay them an ongoing fee which may be paid monthly and
   3. Finally, they also pay the franchisor a percentage of the revenues which have been earned by them.

   The franchise agreement must clearly define when these payments are due. It should also define the interest rate which will be applicable to the franchises if they are in default.

5. League Obligations: The obligations of the franchises do not end with making financial payments to the franchisors.

   There are many other duties that the franchises are expected to fulfill. For instance, franchises are expected to lease out and maintain a stadium that matches the standards of the lease. Also, they are expected to ensure that some types of facilities are available in these stadiums for the players as well as for high-net-worth fans.

   Franchises are also expected to actively participate in the league meetings where the rules are being drafted and then implement these rules in letter and in spirit within their respective teams. For the league to become a success, there has to be a certain degree of uniformity in the behavior of the franchises. This can be accomplished using the franchise agreement.

6. Revenue Sharing: The franchise agreement must list the various known sources of revenue which the franchisor and the franchisee will be able to generate. It also lays down the rules which will be used to determine how this revenue should be distributed.

   For instance, the franchise agreement must clearly explain how the proceeds from ticket sales will be distributed between the home team, the away team as well as the league. The issue of revenue sharing is quite complex and will be detailed in a later article. However, it is important to understand that the rules related to revenue sharing must be included in the franchise agreement.

   The principles which will be used to share revenues that cannot be foreseen when the agreement is being drafted must also be included in the franchise agreement. Any ambiguity related to revenue sharing can lead to a string of litigation and bad publicity for the league as a whole.

7. Commercialization Rights: The franchise agreement should also clearly outline the aspects of the league which can be commercialized and the ones which cannot be.

   For example, a team may obtain sponsorship for the entire team. However, they may not be allowed to raise sponsorship from named competitors of the main sponsor of the league. Also, the league may not be allowed to obtain sponsorship from companies that are engaged in businesses that are not considered to be moral. This includes sponsorships from companies engaged in gambling, drugs, arms, liquor, and tobacco business.

   In many other cases, leagues have chosen not to allow sponsorships from companies engaged in environmentally destructive businesses such as oil and cement. Commercialization of the league has seen several innovative solutions in the recent past. However, all the innovation needs to be driven by the basic rules and code of conduct outlined by the franchise agreement.

8. Accounting Standards: The franchising agreement is generally based on revenue sharing. This means that the term “revenue” must be uniformly defined across all franchises.

   If the accounting definition of revenue varies from franchise to franchise, it will become impossible to do accounting and reconciliation on a macro level. It is for this reason that sports league franchises are expected to follow the accounting standards which are agreed upon in the franchise agreement.

   The standards outline the set of accounting practices which will be used to define revenue, expenses, and other such complex accounting topics. It is also important for the franchisor to ensure that they draft the agreement in such a way that they have the authority to inspect the books of accounts and make binding decisions in the event of a dispute.

9. Intellectual Property Rights: The franchising agreement must also clearly define the ownership of the intellectual property that might get created during the execution of the sports league. This intellectual property could be related to branding, trademarks, copyrights, etc. It is important to ensure that there is clarity about how intellectual property-related rights will be commercially exploited.

The bottom line is that the franchising agreement is a very important document that builds the foundation for a formidable sports league. It is important to ensure that there are no legal disputes which threaten the financial viability of the league at a later stage.

It can be said that the franchise agreement needs to be robust enough to ensure that it provides a framework for different participating parties to engage with each other without interactions resulting in litigations.