How do you get out of a franchise?

By Sarah Stowe | 22 Sep 2017 View comments

Inside Franchise Business: Franchisees wanting to leave their businesses have optionsIt’s easy to get in, not always so easy to get out. But understanding the rules around exiting a franchise helps.

If your business is failing

So, you shopped around and selected a franchise system that you believed would be suitable for you your family and lifestyle. You did your research, spoke to other franchisees and made the great leap of faith, and the doors are open for business.

The investment to get up and running was substantial with franchise and training fees, fitout and equipment costs, lease costs, security deposits and stock.It is a large financial commitment and the funds are secured over your home, so there is a lot at risk!

You and your partner are working 100 hours a week but you can’t seem to draw a salary even after the first 12 months of trade. The working capital that was recommended by the franchisor was under estimated and was gone in three months. Meanwhile the fixed overheads continue rolling in rent, outgoings, cost of goods, staffcosts every week.

If a family crisis affects the business

Business is going reasonably to plan and all is well, when you have an unexpected personal issue, illness or other changed family circumstances, which mean that you now have to look at exiting the franchise.

What to think about when you have to exit your franchise

There are many franchise systems that act responsibly and support their franchisees. Franchisors have a vested interest to ensure their franchisees success, but they are generally not in the business of letting franchisees out of their contracts early without some form of compensation. A franchise agreement is a fixed term contract and there is no early right to exit unless the parties agree.

Even where the franchisor goes in liquidation, this does not entitle a franchisee to terminate or exit the franchise as the liquidator will try to sell off the franchise rights and they will expect the franchisees to continue operating and to meet their obligations under the franchise agreement.

How do you get out of the business which is costing you money and eating into your own finances every week, or exit when your circumstances have changed?

These are your options:

  1. Sell the franchise
  2. Franchisor buy back
  3. Walk out
  4. Dispute resolution and mediation
  5. Negotiating an exit

1. Selling the franchise

Selling the franchise to a third party approved by the franchisor for the best possible price generally only happens where the business is operating profitably. It’s a buyers’ market, no purchaser will be generous, and there are hundreds of franchises on the market.

To be in the best position to sell and maximise a return, ensure your financials are up to date and leases and material contracts signed and current.

A buyer will not care how much you paid to get into the business.That also does not establish its value at the time of sale. Buyers will only offer what they consider to be the market value of the business and the assets based on its recent trading history and performance.

The benefits of selling: The franchisee will (depending on where they are on the unhappiness cycle), release themselves from ongoing operating costs and liabilities.

It may be the best option to enable you to move on, having had an experience not to be repeated. You may crystallise a loss but if you are left with a manageable debt and don’t lose your home over it, that is not a bad outcome realistically. Selling the franchise, walking away from lease costs and personal guarantees and recovering any security deposit or bank guarantees may be a better option than holding out to recover goodwill that no one will likely pay.

The message here is, if a vendor, be realistic. Don’t overvalue your business, if you really want to be on the market and have a reasonable chance of selling. Ensure all your documents are in order, your lease signed, options exercised and your financials are up to date.

2. The franchisor buy back – why would they?

Most franchisors are not in the business of buying back their franchise. The franchisor may be open to it to recover a poor performing site in a strategic location or because they see value in maintaining the site and brand presence.

They may be prepared to pay something for that but they won’t be generous or pay “fair value” or market value. They will want to pay the least amount possible which is generally the written down value of the plant and equipment and stock less any money then owing by the franchisee.

Anything more than that should seriously be considered, if you have exhausted all other options.

The benefit of a buy back: The franchisee is released from ongoing obligations and liabilities under the lease and franchise.

Again, you may crystallise a loss but if you are left with a manageable debt and don’t lose your home over it, that is an unhappy but not a bad outcome. Removing the fitout involves making good any damage and the value of the fitout is minimal after it is removed so again this is an option to consider.

3. The walk out – abandonment

This will crystallise a loss and expose a franchisee to an allegation of breach of the franchise agreement and a claim for loss and damage by the franchisor. The franchisee will also generally be subject to a restraint of trade, and not be able to operate a similar business in competition to the franchise business.

There have been recent cases (Civic Video) where the Courts sided with the franchisor, and made orders in their favour for loss and damage, where the franchisee abandoned the business.This option is often the last resort where a franchisee is trading insolvently and having to dig into their own funds and savings each week to pay overheads, staff and suppliers to keep the doors open.

Get legal advice before you act and walk out the door as the risk and likely end cost will be substantial as most franchisors will pursue the directors personally under the guarantees.

The risk: It exposes the franchisee and their personal assets. Once you walk out it’s just the beginning, you will not know what your eventual exposure will be for some time.

The benefit: You relieve yourself from an unhappy and stressful environment and it may enable a franchisee to take up a better income earning opportunity elsewhere.

4. Dispute resolution or mediation

If a dispute arises, you should contact the franchisor representative directly, and discuss the issues and attempt to find a practical and compromised outcome.

Ensure any discussions are confirmed in writing, so there is a recorded history of attempts made to resolve the issue. The franchisor representatives are well trained in not putting things in writing, so follow up your discussion with an email to them which can then be relied on later if need be.

If a franchisee is unable to resolve matters by direct discussion and negotiation with the franchisor’s area or state manager, the issue should be taken to a higher level and if possible to one of the directors of the franchisor company. It is often the case that once a director is aware of a legitimate complaint, that has not been dealt with appropriately at a lower level the matter may be resolved.

Where there is a substantial issue and no adequate response the Franchising Code of Conduct enables either party to activate the dispute resolution provisions, under the Code and seek mediation.

5. The mediation

The benefits of mediation are:

  • The franchisor is required under the Code to attend the mediation and devote their attention to your matter.
  • Each party must act in good faith to try to resolve the dispute under the Code. This obligation is now entrenched in the Code.
  • An independent mediator, objective of the parties is engaged (usually an experienced lawyer or barrister) who can identify the legal issues, and assist the parties to find commercial solutions.
  • The mediation process means that the franchisee has a chance to focus the franchisor’s attention solely on their issues on that day.
  • All matters at mediation are discussed in confidence and cannot be used in later proceedings. The parties can therefore speak openly and consider practical outcomes.
  • Irrespective of a successful outcome at the mediation the franchisee will better understand the franchisor’s position, and hopefully vice versa and other strategies and options can then be considered.
  • The resolution is in the hands of the parties, not a third party (i.e. a judge).
  • It is far less costly than proceedings in Court.

What else you should consider before you plan your franchise exit

Once the dispute resolution process is activated, it does not prevent a franchisor from terminating a franchise however, it is arguable that a franchisor should not terminate a franchisee, where there is a legitimate dispute once the dispute resolution process is activated. To do so may be considered unconscionable conduct by a franchisor and a breach of the obligation to act in good faith under the Code.

The mediation process can simply buy the franchisee time to think and plan.

The focus at franchise mediation tends to fall into two categories:

  1. Raising operational issues, breaches or failures by one or other party of their obligations and resolving those issues so both parties can get on with business; or
  2. Focusing on an exit plan and the terms of exit, on the basis the relationship has irretrievably broken down and each party feels it best to go their separate ways.

You may also consider a written complaint to the ACCC. If the issue affects several franchisees in the system, the ACCC may be interested in investigating and stopping any breach or unlawful behaviour of the franchisor. This can be useful leverage if the ACCC has taken action, or orders have been obtained against a franchisor in the Federal Court, or undertakings given by the franchisor to the ACCC or to Court.