Terminating a franchise agreement: how to get it right
Facing the final curtain … said Frank Sinatra. Franchise agreements can and do end in all sorts of circumstances.
Like any event of finality, it brings with it mixed emotions, concerns and sometimes dispute between the parties dependant on the circumstances.
Although it can be an agreed event, it often arises out of unhappy circumstances where the franchisee may be in breach of its obligations, has abandoned the business or the franchise has run its term and there is no option.
The agreement may come to an end and the franchisor may have decided not to grant a further term to the franchisee. This can be driven by a variety of high level complex reasons, both commercial and strategic for the franchisor.
Division 5, Clauses 26 to 29 of the Franchising Code of Conduct (the Code) cover rights of termination but there are some golden rules that franchisors need to keep in mind in exercising their rights.
7 golden rules for franchise termination
1. Ask yourself if the decision is a lawful one; do you have that right in the agreement? Are you complying with the Code’s notice obligations?
2. Are you acting in good faith and for a legitimate commercial purpose?
3. Will this decision not to renew or to terminate likely lead to dispute or even litigation?
4. Will the failure to renew or termination be something that may impact on future prospective franchisees, that is, does it give the impression that this franchisor likes to churn its franchisees?
5. Have you sought legal advice before making the decision to terminate?
6. Don’t send termination notices in house that may later be seen a defective and failing to comply with the Code.
7. Before termination have you attempted to resolve the dispute with the franchisee face to face or utilise the dispute resolution provisions under the Code and seek mediation?
Apart from a franchisee right to cool off within seven days of the earlier of entering into the agreement and making any payment under the agreement the franchisee has no other right to terminate the agreement unless there is an express contractual right in the agreement.
The cooling off period only applies for the first term and not on a transfer, extension of the term or renewal of an existing franchise agreement of an existing agreement.
I have on occasion assisted franchisees to negotiate special exit rights where:
- The franchisor assigns or transfers its rights during the term, or
- Where the franchisee is bringing in his own goodwill and business into and under the franchise but wants the right to exit if things do not work out.
I should say negotiating these special early exit rights for a franchisee is unusual and many franchisors will not entertain them.
Franchisor termination rights
Clause 27 Breach – this clause applies where there is a breach by the franchisee and requires the franchisor to give reasonable notice (up to 30 days) in writing of the breach, what needs to be done to remedy the breach, and state if the breach is not remedied the franchisor proposes to terminate.
If the breach is remedied the franchisor cannot terminate the agreement.
Clause 28 Termination – no breach by franchisee
This applies where the franchisor terminates a franchise agreement in accordance with the agreement, before it expires and without the franchisee’s consent.
In this case the franchisor must give reasonable notice of the proposed termination and reasons for it.
It should be noted this is really a procedural clause and does not require the franchisee to be in breach.
There are however civil penalties for the franchisor if they fail to comply, of 300 penalty units.
A franchisor seeking to rely on this termination right may be met with a threat of an injunction and allegations that they are acting unconscionably and not in good faith under the Code, so using this termination right should be considered carefully.
Clause 29 Termination – special circumstances
These termination rights apply and give the franchisor the right to terminate, immediately and without written notice on certain events where:
- the franchisee no longer holds a license required to operate the business; or
- becomes bankrupt or insolvent under administration or externally administered; or (see comments below)
- is deregistered by ASIC; or
- abandons the business or relationship; or
- is convicted of a serious offence; or (note this is not defined)
- operates the business in a way that endangers public health or safety; or
- acts fraudulently in operating the business.
Points to note:
1. These circumstances must be set out in the agreement.
2. The right to terminate for an insolvency event has been affected by the new Ipso Facto provisions introduced on 1 July 2018 into the Corporations Act 2001 (Cth) as part of the Federal Governments insolvency reform package. This gives companies a stay on termination of a contract on certain insolvency events.
These new reforms are complex and apply to most contracts (there are certain exclusions) entered into on or after the 1 July 2018.
There is some uncertainty how this will impact on the franchise sector and consideration needs to be given to the drafting of new franchise agreements and monitoring franchisees’ financial health far more closely by franchisors before they go into an insolvency event which may then restrict the franchisors rights to step in and take control of their franchise and or terminate the agreement.
The stay on termination also extends to companies that enter into overseas contracts and even if they are not governed by Australian law.
It is important to also note Clause 29 (2) provides that the agreement can be terminated by the parties by agreement, but only if this right is expressly set out in the agreement. There is no implied right, it has to be expressly set out in the agreement.
End of term
The other issue we see that causes a dispute is where there is a further option and the franchisor does not agree to grant the further term which can of course have a huge financial impact on the franchisee and their ability to recoup any goodwill they may have generated.
The main concerns over end of term arrangements relate to:
- The issue of the who holds the lease when the franchise term ends
- The buyback provisions of the franchisee’s stock and equipment
- The restraint of trade non-compete provisions that prevent the franchisee from conducting a business in competition with the franchisor
- End of term arrangements are one of the largest areas of dispute in the franchising sector.
This is an area that franchisees do not focus on of course when going into the franchise but they need to be made aware of the exit rights and obligations.
There have been philosophical arguments raised from one extreme where there has been calls for a franchise term to never end unless terminated for cause or by agreement to leaving things as they presently are.
There were concerns raised before the Parliamentary Inquiry that the Code does not give franchisees enough protection from franchisors making arbitrary or unreasonable decisions to terminate for breaches or churning franchisees and making a profit.
This was addressed to some extent by the introduction of good faith requirements in the Code implementing the end of term arrangements under the changes to the Code in 2015.
Termination can be complex and can cause dispute and damage so it needs to be carefully considered and both franchisors and franchisees need to understand their rights and obligations and ensure they seek proper specialist legal advice