Franchisee Fraud: should the franchisor terminate without notice?

When acting for franchisors, an issue will often arise where a franchisee is clearly acting in a fraudulent manner.

Should the franchisor confront them, disclose the information you hold and give them a right of reply or just terminate?

The Franchisor might have clear evidence of fraudulent activity. There are still risks to terminating a franchisee without notice, even though the Franchise Code gives franchisor that right.

The Franchising Code of Conduct generally requires franchisors to provide notice of an intention to terminate. Clause 23(f) of the Code however, gives a right to the franchisor to terminate immediately without giving notice and without giving a reasonable time to a franchisee to remedy the breach where the franchisee is "fraudulent in connection with the operation of the franchise business."

A franchisee will undoubtedly allege that the franchisor has acted unconscionably where there has been a termination for fraud particularly where there is some doubt. Allegations of unconscionable conduct are difficult to prove by a franchisee. There are implied terms of good faith and fair dealing. 

Other considerations are:

• whether the franchisor acted for some "ulterior motive" or was acting legitimately to protect its commercial interests;
• whether the franchisor stands to benefit from termination after taking control of the business.  

Ultimately, there are risks for franchisors in terminating without notice.  

The franchisee has equitable rights and rights under the Trade Practices Act. Termination without notice should be carefully considered by franchisors as an action of last resort and only where there is clear evidence of fraud. Raising the allegation of fraud with the franchisee, may be an option. This will give the franchisee a right to respond and provide an explanation.

Proceeding to mediation may be an option before terminating without notice, however in some circumstances that may be adverse to the franchisor’s interests.

It may well be that there is no option but to terminate a fraudulent franchisee where there is compelling evidence that they have acted in an intentionally dishonest way and their conduct is likely to continue to cause loss to the franchisor and possibly to the franchise system as a whole.