You are considering buying a franchise. You have every intention of growing a successful business and complying with your franchise agreement. But what happens if it all goes wrong and you can’t make ends meet? The most common causes of disputes in franchising are related to system compliance and profitability.

Unforeseeable problems with profitability
Even with the best-laid plans factors beyond franchisor and franchisee control can impact on profitability. Maybe a new lease is to be negotiated and the rent is increased, maybe a major competitor opens across the road, maybe the broader economy is in downturn and consumer confidence is weak. There are so many what ifs and it is worth giving consideration to how you will manage unexpected obstacles before you sign a franchise agreement.

What should you do if you default on royalty payments?
In a word, negotiate. If you are struggling to make royalty payments you will grow to resent your franchisor, you will be under significant stress, you will have signed a personal guarantee and your family home will be at stake. You might blame the system for failing to produce a profit.

Understandably, talking to your franchisor will seem daunting and perhaps pointless. But, generally franchisors prefer a direct discussion of the problem.
 
It is easy to adopt a ‘head in the sand’ approach and ignore the problem in the hope that it will go away. Maybe the problem is a temporary one, brought on by a sudden illness for example, in which case the franchisor is more likely to be sympathetic if they know what the problem is and what steps you will take to fix it, like employing a staff member to fill any gaps in customer service.

If the problem is likely to be ongoing, leaving the issue unaddressed will probably escalate it. The franchisor will become increasingly anxious as the debt grows. Early intervention could result in negotiation of rent or royalty relief. The franchisor’s brand and bottom line will benefit when your business is successful.

Notice to remedy
If you default in royalty payments you are in breach of your franchise agreement and the franchisor has the right to issue a Notice to Remedy (also called a breach notice). The franchisor must give reasonable notice that it proposes to terminate the agreement because of the breach; tell you how to remedy the breach; and allow a reasonable time to remedy (not more than 30 days).
 
If the breach is remedied, the franchisor cannot terminate because of that breach. On the other hand, if the breach is not remedied the franchisor may terminate and you will lose the business. The franchisor may sue to recover unpaid royalties plus interest and legal costs.

Termination without notice
Franchisors may terminate a franchise agreement without notice in special circumstances including; if you no longer hold a required licence, become bankrupt or insolvent, voluntarily abandon the business, are convicted of a serious offence, operate the business in a way that endangers public health or safety, are fraudulent in connection with operation of the business or you agree to termination.

If you are in such poor financial circumstances that another creditor begins winding up proceedings against your company and it is placed in liquidation or issues bankruptcy proceedings against you  and you are declared bankrupt the franchisor is not obliged to give Notice to Remedy. Similarly if you abandon the business the franchisor is not obliged to give notice.

Sell your business
You have a right to transfer your franchise agreement with the written consent of the franchisor, which may not be unreasonably withheld, so consider marketing the business for sale; a different operator may be able to generate profit.

The franchisor might be prepared to buy the business back from you. It is prudent to execute a Deed of Release when you leave the system to limit potential disputes in the future.

Mediation
Franchisors and Franchisees may issue a Notice of Dispute, which sets out the nature of the problem; the outcome they want and what action they think will settle the dispute. If you are unable to find a solution within three weeks either party may refer the matter to a mediator or contact the mediation adviser for an appointment. The parties must attend the mediation and try to resolve the dispute.

You can find useful information on dispute resolution at http://www.mediationadviser.com.au/.

Preventing the problem
Of course the best way to avoid this situation is to be prepared from the start. Before you sign up to a system you should;

1. Carefully review the prepayments, establishment costs and other payments set out in the disclosure document;
2. Ask existing franchisees about whether the estimates of costs provided in the disclosure document are accurate. Have they incurred unexpected expenses?
3. Ask your accountant to run multiple profitability projections based on optimistic, moderate and conservative sales figures, higher and lower wage expenses and the like.
4. Conduct local area market research. Demographics will vary from area to area and a franchise that is making good profit in one area may do poorly in another. For example, a reputable lawn mowing franchise that is making a good profit in a suburban residential neighbourhood may not do well in an inner city suburb, unless you can secure a contract for the golf course.
5. Ensure you have enough working capital to run the franchise in its formative stage, taking into account the payment commitments of the business.