Terminating a franchise agreement should be handled with care

The best laid plans oft go awry and not every franchisee / franchisor relationship goes the way it should. Geoffrey Sturgess, consultant solicitor at Warner Goodman Commercial, explains learning how to terminate an agreement fairly is an essential skill

Terminating a franchise agreement should be handled with care

A franchise agreement produced by any competent franchise lawyer is designed, amongst other things, to ensure that the franchisor can terminate the agreement if it needs to or if it is broken by the franchisee. If the franchisor does it properly, it should be confident of defeating any subsequent claim from the franchisee for damages relating to wrongful termination.

Defeating such a claim is not, however, necessarily enough. Even if it wins, the franchisor will have expended time and money on the dispute and it will never recover that cost from the ex-franchisee. Furthermore, if the termination is not managed well, the franchisor will for a time lose the income from that franchisee’s territory and may manage to upset its other franchisees. A very public dispute could also put off prospective franchisees from joining that network. As they say, not all publicity is good publicity.

There are, of course, circumstances where immediate and unplanned action is required. Perhaps the franchisor has discovered that the franchisee has been dishonest or set up a separate and competing business. In such circumstances, the franchisor should come down on the franchisee like a ton of bricks, meaning fairness and brand management go out the window. Apart from the damage that may be caused by such a franchisee, it is sometimes necessary to demonstrate to the rest of the network that such behaviour will not be tolerated. Most other franchisees will support the actions of the franchisor in those circumstances, particularly if the behaviour of the errant franchisee risks tarnishing the good name of the franchised business and, in turn, their own businesses.

But more often than not, a franchisor will terminate a franchise agreement when a franchisee is just not up to the job, lazy or for some other reason just can’t consistently comply with the performance or quality standards legitimately required by the franchisor.

A franchise agreement can be terminated by the franchisor by service of notice under the provisions of the franchise agreement, by agreement or – although strictly this is not termination by the franchisor – by not allowing the franchisee to renew when its term comes to an end.

There are a few caveats however: termination by notice is normally only permitted if the franchisee is in breach of the terms of the agreement, which would include not complying with the provisions of the franchise manual. Meanwhile, a franchisee is normally entitled to renewal of their agreement unless they are, or have been, in breach of its terms or its performance criteria.

Whatever the reason the franchisor has for terminating and whatever the method it wishes to use, the first stage is generally to establish that it has the right to terminate or not renew, as the case may be. Often the agreement will require the franchisor to give the franchisee an opportunity to correct their breach in order to prevent termination. The requirement of fairness in the bfa’s Code of Ethics would also suggest that a franchisee should be given a chance to put things right. If the breach or under-performance is rectified, that may be sufficient and there may no longer need to be a termination.

Sometimes however, the particular breach is merely a symptom of a franchisee not being suitable for the franchised business. At this stage it is essential that the franchisor takes legal advice, both on whether it has the right to terminate and the correct procedure and timetable that it should follow in order to terminate correctly and fairly.

Once the franchisor has established that it has the right to terminate – and sometimes even if it does not – it should then consider whether there is any alternative to forced termination. That would be termination by agreement, either with the parties agreeing that the franchisee should just give up the franchise or ideally by them working together to achieve a sale by the franchisee of their business and / or territory to a new franchisee.

A sale in these circumstances should produce the fabled win-win outcome. The franchisor gets rid of an unsatisfactory franchisee, the territory remains occupied so there should be no – or at least less – loss of income to the franchisor and there may be a training fee or other upfront payment from the incomer. From the franchisee’s perspective, they should at least get back their upfront franchise investment – possibly with a small goodwill premium on top – and will be able to leave with their head held high. The franchisee in these circumstances will not be bringing a claim against the franchisor and the franchisor does not need to declare a franchise termination when disclosing details of the business to prospective new franchisees. The other franchisees are reminded of what a nice, but firm, company the franchisor is.

It does not need to be a direct sale between the outgoing and incoming franchisees. It could be arranged as a surrender to the franchisor followed by the grant of a new franchise to the incomer with some of the incomer’s payment ending up in the pocket of the departing franchisee or used to pay off their debts to the franchisor.

If the win-win solution is not obtainable then there may be no alternative to forced termination. Except in those ‘ton of bricks’ scenarios, it is still good to talk and it may be necessary to comply with the Code of Ethics. In the final analysis, however, the franchisor needs to look after the business and may have to remove a franchisee that’s unwilling to go.

The better such a franchisee has been treated and the better they understand the reasons for their termination, the less likely they are to dispute it, create bad publicity or try to set up in competition in their old territory. Whatever way you look at it, that is good news for the franchisor.

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