Post-termination problems and how to avoid them

The ability of a franchisor to prevent competition from an ex-franchisee is critical to the successful operation of a franchise

Post-termination problems and how to avoid them

Without the protection of post-termination restrictions, the reselling of an exclusive territory would be more difficult because prospective purchasers would be deterred by having to compete with the established business of the previous franchisee. The exclusivity of the territories of adjoining franchisees would also be compromised because the ex-franchisee would no longer be prevented from operating in their areas.

Without these restrictions there would be a strong incentive for franchisees to only complete a single term and then start their own business rather than renew; thus saving the management service fees. Many branches would therefore not reach their full potential and the overall strength of the brand would be impaired.

Courts have consistently upheld this proposition, rejecting counter arguments that an ex-franchisee should not be prevented from earning a living. This has emboldened franchisors who almost always take a hard line and rigorously enforce the rights that these clauses provide.

All this stated, the amount of protection that franchisors enjoy has been steadily eroded over the past decade. Prior to that, two years was the generally accepted period of protection. This has been whittled down to one year and the previously unlimited area of protection is now almost universally accepted as being only within the territory.

Last year, a landmark high court judgement added another relaxation of these parameters by accepting arguments based on the short period that the franchisee in the case had been operating and his lack of market penetration. A further consideration was the detrimental economic impact that the restrictions would have had on the individual. The court also took into consideration the questionable recruitment decision by the franchisor of a person without adequate funding or the basic skills needed to operate the business.

The Fredbar decision was not a seismic shift, but it did confirm that the direction of travel is established as being towards a relaxation of rules. Against this the need remains for franchisors to retain robust post-termination protection. Many venerable legal brains in the industry have been hard at work to devise strategies to cope with this, but an even better solution lies in the hands of franchisors themselves. Firstly, and directly related to the legal decision last year, is the recruitment process and the importance of declining applications by unsuitable franchisees. Secondly is the need for strong leadership and the continual adding of value by the franchisor.

It is vital that only suitable applicants are accepted and become franchisees. This may seem obvious, but evidence of questionable recruitment abounds. At least one franchisor is currently waiving the initial fee and awarding franchises to applicants with inadequate funding or without even meeting them personally. This is obviously a recipe for disaster, but less extreme examples of poor selection are commonplace. 

The second way in which franchisors can avoid having to rely on post-termination restrictions is to consider why a franchisee should want to leave and start a similar business on their own. The reasons for this may be complex but the two most obvious are economic or because the working relationship with the franchisor has deteriorated. A franchisee is unlikely to leave or be unwilling to renew if the franchisor is continually providing good value for the management fees that it receives. It is not sufficient to simply create a business and teach franchisees how to operate it. The franchisor should continually improve the business and add value.

Many franchised brands have examples of resales by retiring franchisees who have sold for huge multiples of their initial investment. This would have been less likely if they were not part of an established brand with a good reputation. If franchisees can continually see evidence such as this they are less likely to leave and risk going it alone. If the franchisor is securing better terms from suppliers, winning national customers, providing support and building the brand, franchisees will want to continue.

Franchisors should also remain engaged with their franchisees and develop a feeling of collaboration. If franchisees believe that they are not valued or that the franchisor lost interest in them as soon as they paid the joining fee and signed the franchise agreement, they will be less likely to renew and more likely to leave.

The same will happen if the franchisor fails to comply with the terms of their own agreement, as frequently happens with the handling of the advertising contributions of the franchisees. If franchisees discover that the franchisor has received undisclosed kickbacks from suppliers, dissatisfaction will grow, encourage in-term abandonment, disincentivise renewal and add to the likelihood of violations of post termination restrictions.

Not surprisingly, avoiding post termination problems is far better than having to deal with them after they have arisen.

Tony Bowman
Tony Bowman