Do you have to stay in your franchise for a full term?

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What are the reasons for a franchisee to exit their business early? Image: wordpress.comFranchise agreements generally specify the length of time, or term, for which they will run. Usually, this is then the length of time for which a franchisee must operate the business.

However, in some circumstances a franchise agreement can end early. We look at some of these situations below.

During the cooling off period

A franchisee can exit a franchise agreement within seven days of first entering into the agreement or paying any non-refundable amounts, a period known as the cooling off period.

If you are having doubts about a franchise agreement you have just entered into, do not delay and discuss the situation with your advisors. The time limits are strict and it is important you do not let them lapse due to delay.

It is important to remember that if you withdraw from the agreement during the cooling off period that the franchisor is entitled to retain their reasonable costs. This means that you may not get a full refund of monies paid to the franchisor.

Selling a franchise

Another common way a franchise agreement’s term can end early is sale of the franchise.

Selling or transferring a franchise can be an excellent way for a franchisee wanting to exit the network to realise value from their investment and to ensure continuity of the business. Generally franchisors do not oppose sales, however, there are a few things to be aware of:

  • A transfer request will need to be given to the franchisor, to which the franchisor cannot unreasonably withhold consent. If the franchisor does not object within 42 days, the request is taken to be granted.
  • There may be a transfer fee or other terms that apply. The franchise agreement will generally spell these out.
  • Appropriate sale agreements and deeds of release and indemnity should always be entered into, to ensure the new franchisee bears all responsibility for the franchise moving forward.
  • Any outstanding bank guarantees should be returned to the outgoing franchisee and replaced by the new franchisee and any personal guarantees should be discharged as part of the sale.

For franchisees looking to exit their franchise, sale of their business is generally the best way to realise value.

By mutual agreement

Another way a franchise agreement can be brought to an end early is by mutual agreement between the franchisee and franchisor. In some cases the business may even be bought back by the franchisor, although there is no obligation on the franchisor to do so.

Although this will generally not realise as much value as a sale to a third party, this can be the right option for franchisees wanting to exit a network without a ready buyer. It is important, however, to note a few important considerations:

  • If you are the lessee under a lease to the business premises, the lease will either have to be terminated with the consent of the landlord or assigned to the franchisor. Similarly, any supply agreements and other contracts entered into during the course of the business will have to be dealt with.
  • It is important to ensure that no personal liabilities, guarantees or bank guarantees are left outstanding.
  • It is crucial that appropriate documentation is entered into (including with any landlord) to document the sale or termination.

As long as the arrangement is documented properly, a mutually agreed exit or buy back can be a good way for a franchisee to exit a franchise.

If the franchisor goes out of business

Business is risky and not every franchise succeeds. Sometimes, unfortunately, a franchisor can become insolvent or even go out of business, leaving the question of what happens to the franchise network and whether franchise agreements are terminated early.

Such situations are generally very complex and will depend upon legal advice, but some important considerations include:

  • If the franchisor holds a head lease over the premises, the franchisee may lose their right to occupy the premises. A continued right to operate may often be negotiated with the landlord.
  • The franchisee may lose the right to use the brand and rebranding may need to be discussed and considered with the franchisor to keep the business operating.
  • If the franchisor supplies stock, software or marketing and training support, the franchisee will generally lose this support and will need to find alternative suppliers.
  • Even though the franchise may be at an end, the franchisee’s obligations to suppliers, landlords, employees, banks and other creditors will generally remain. It is therefore important for franchisees to consider alternative arrangements to keep the business operating.
  • It is important to note that a franchisor going into administration does not automatically spell the end of the franchise. If the franchisor, operated by administrators, continues to meet its obligations, the franchise may continue operating.  

Franchisees should contact their legal advisors and review the terms of their franchise agreements in such circumstances to explore what options may be available.

If the lease ends

In some situations, for example, where the premises are damaged beyond repair or the lease term is less than the franchise term, a lease may end earlier than the franchise agreement and the franchisee may find themselves without premises. The franchise agreement will generally spell out what happens in such circumstances and how alternative premises can be located.

If appropriate premises cannot be found, it may be necessary to end the franchise agreement early. The considerations outlined above for termination by mutual agreement will apply and should be considered.

If the franchisee is in default

Unfortunately, sometimes franchisees find themselves unable to comply with their franchise agreements and in default of their terms.

Franchise agreements will spell out what happens in case of default, including when the franchise agreement can be terminated. Franchisees should do everything to avoid default, as the franchisee will generally be liable for the franchisor’s damages and losses as a result, including for lost royalties.

If a franchisee is struggling to comply with their franchise agreement, it is best to urgently seek legal advice and to open negotiations with the franchisor about remedying the problem.

Get expert advice

While franchise agreements will normally run their full term, in some situations franchise agreements can end early. Depending upon the circumstances, the likely consequences and value realised from the business will, however, differ.

Franchisees in these situations should consult their advisors and consider carefully what option will best allow them to exit the franchise and end their franchise agreement early.

Tomas Melicharek

Tomas Melicharek is a corporate lawyer with a focus on mergers and acquisitions and experience across a wide range of commercial transactions.  View More...
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