Franchise terminations when dealing with the US

Like many commercial agreements, franchise agreements have default and termination clauses

Franchise terminations when dealing with the US

When dealing with a franchise dispute in the United States, particular issues, including the default and termination provisions in franchise agreements, often arise when a franchise relationship is terminated.

Franchise agreement default and termination clauses can be very extensive and since all of them are written by the franchisor, they typically give that party multiple grounds to default and then terminate the relationship. In contrast, most agreements do not give franchisees any contractual right to terminate the agreement. Another important aspect of this dynamic is that these provisions are not generally negotiable, and, if they are modified at all, the negotiation tends to about the number of days between a notice to cure a default and the time at which the franchisor can terminate. 

Many of the default provisions relate to financial obligations.  Not surprisingly, franchise agreements can be terminated if there is a default and failure to cure the payment of royalties and other fees to the franchisor or where the franchisee provides inaccurate information about sales. Franchisees can also be terminated for failing to pay a supplier; vendors are often chosen by the franchisor and used by all franchisees and franchisors are concerned about the supplier’s relationship with the franchise system. Defaults under leases can also trigger a default and franchisors often have rights to take over the franchisee’s premises if there is a default under a lease. Other examples include defaults where the franchised business fails to find a location to operate or open for business within a certain time frame after the franchise agreement is signed, although these deadlines are often extended if the franchisee is acting in good faith. 

One of the most common bases for default and termination are health and safety violations in the operation of the franchise. Here, for example, a restaurant franchise is concerned about its customers and the brand’s reputation and franchisors monitor franchisee operations to make sure that these violations do not occur or are remedied quickly. These kinds of violations are also addressed in the childcare businesses where the safety of children is at stake. 

The time between the default and the termination varies from contract to contract and within contracts. As to the latter, while a franchisor may give a franchisee some leeway and a longer time to cure payment defaults, maybe 30 days, a franchisor might default and terminate a franchisee on short notice or immediately if the franchisee is underreporting sales. Similarly, health and safety violations must be fixed on a shorter time frame, sometimes five days, to protect the brand.  In some cases, these defaults are the basis of an immediate termination.    

There is, of course, another issue to consider when addressing default and termination of franchise agreements. Several states in the U.S. govern default and termination issues.  These are often referred to as “relationship laws.” Approximately 20 states have such laws and, not surprisingly, they differ from state to state. Relationship laws focus on two issues. Many states statutorily require “good cause” for termination. These laws may differ in language and application, but it is fairly clear that a franchise agreement can be terminated after notice and opportunity to cure where there is a financial or other material default. Another issue is the notice period before termination. Although an agreement can allow for termination 30 days after a notice of default, some state laws extend the period to 60 days.

Once the relationship is terminated, a franchisee has several contractual post termination obligations.  Franchisors are and should be zealous about protecting their brands.  Thus, once an agreement is terminated, a franchisee is required to cease using the franchisor’s trademark.  This is not as simple as it sounds.  The brand name of, for example, a restaurant, will be on a sign on the façade of the premises, but there is much more.  The requirements around this issue are referred to a “deidentification.”  This involves removing the brand name from advertising and marketing materials, vehicles, social media, etc.  And then there is trade dress: a brand may require a franchisee to use certain designs in the place of business, unique to the brand.  One prominent example of trade dress is McDonald’s use of its golden arches.  Failing to abide by deidentification obligations often results in legal action by a franchisor.   

Perhaps the most contentious post termination issue is a franchisor’s enforcement of non-compete clauses.  These clauses may prohibit a former franchisee from operating a business similar to the former franchise within its former territory and the territory of any operating franchise in the system.  Franchisors consider this to be a critically important obligation, enabling the sale of a new franchise in the terminated franchisee’s territory, protecting other franchisees from competition and affording protection of confidential information the former franchisee may have obtained.  The law on this issue varies from state to state, with some state laws making it extremely difficult to enforce this post termination provision. 

Michael Einbinder
Michael Einbinder