December 14, 2017

How to get out of a franchise

Franchise

By Luke McKavanagh, Peter Rouse and Jashan Singh.

A franchise agreement is a legally binding commitment for the term of the franchise with restrictions on exiting early. Franchisors and franchisees must follow different steps if they believe they have grounds to unilaterally terminate the agreement. This will always depend on the circumstances.

What can franchisees do to end the franchise agreement?

Franchisees may wish to end a franchise agreement early for a variety of reasons. The business may not be as successful as hoped, or the franchise system may have failed to meet expectations. There are multiple options for getting out of the franchise agreement. Each come with their own risks and consequences and should be assessed on personal circumstances. Few are straightforward.

(a)   Cooling-off

Under the Franchising Code of Conduct (Code), franchisees have a 7 day cooling-off period to terminate a franchise agreement without giving a reason. The right must be exercised within 7 days of entering into the agreement or making a payment under the agreement, whichever the earlier. This doesn’t apply to the renewal, extension, variation or transfer of an existing agreement. For example, somebody buying an existing franchised business won’t have the right to cool-off.

If a franchisee terminates during cooling-off then the franchisor must refund any money paid by the franchisee within 14 days, less the franchisor’s reasonable expenses.

(b)   Sale of business

If a franchisee wishes to sell their business, a franchisor cannot unreasonably withhold consent to the sale. The franchise agreement will set out the conditions for a transfer. If these are followed and the franchisee establishes that the buyer can perform the obligations under the agreement to an equal standard, the franchisee is generally free to sell their business.

The existing franchise agreement will either be assigned to the buyer, or more commonly, the buyer will enter into a new franchise agreement with the franchisor. The outgoing franchisee and franchisor should enter into a written agreement to formally terminate the franchise relationship.

With exception to the cooling-off period or selling the business, a franchisee’s right to otherwise terminate a franchise agreement is limited.

(c)   Breach by the franchisor

The Code doesn’t grant franchisees the right to terminate a franchise agreement if the franchisor is in breach. However, some franchise agreements may allow a franchisee to terminate in some circumstances. This could include when the franchisor is in material breach of the agreement and has failed to remedy that breach within a specified time. Unless the agreement provides this express right, franchisees must rely on other legal rights which are set out below.

(d)   Walking away

Closing the doors early and abandoning a franchised business is not advisable. Franchisors will normally have the right to pursue the franchisee for damages. The landlord would have this same right if there’s a lease involved. If the franchisee’s directors have given a personal guarantee, then walking away could expose the personal assets of the guarantors to risk. Walking away should be an absolute last resort, and only after exhausting all options with an administrator or liquidation consultant.

What can franchisors do to end the franchise agreement?

Franchisors generally have greater flexibility in their ability to terminate a franchise agreement.

(a)   Franchisee breach

If the franchisee has breached a provision of the franchise agreement, the Code allows franchisors to terminate the agreement if:

1. the franchisor gives the franchisee a written notice:

(a)  setting out the provision which has been breached;

(b)  setting out what is required to remedy the breach;

(c)  providing a reasonable time to remedy the breach (which need not be more than 30 days);

(d)  stating the franchisor proposes to terminate the franchise agreement if the breach is not remedied; and

 2. the franchisee fails to remedy the breach accordingly.

If the franchisee remedies the breach, franchisors cannot rely on that breach to terminate the agreement.

(b)   Immediate termination

There are also certain circumstances under the Code which entitle a franchisor to immediately terminate a franchise agreement if the franchisee:

(1) no longer holds a licence which they must hold to carry on the business

(2) becomes bankrupt or insolvent;

(3) if a company, becomes deregistered by ASIC;

(4) voluntarily abandons the business or the franchise relationship;

(5) is convicted of a serious offence;

(6) operates the business in a way that endangers public health or safety; or

(7) acts fraudulently in connection with the operation of the business.

Franchisors would need a strong basis and reliable grounds for making the decision to terminate a franchise agreement for these reasons.

(c)   Contractual termination

The Code also permits franchisors to terminate a franchise agreement where the franchisee hasn’t committed a breach, but only if the agreement contains this express right. The franchisor must provide the franchisee with reasonable notice and reasons for the termination.

Note that such provisions could be found by a Court to be an unenforceable “unfair contract term” under the Competition and Consumer Act 2010. Franchisors would need justifiable reasons for terminating a franchise agreement using such a provision.

Are there other ways to end a franchise agreement?

There are various other legal remedies available to both franchisors and franchisees to bring a franchise agreement to an early end. The following are some common grounds, however others may be available depending on the situation.

(a)   Mutual termination

Franchisors and franchisees can mutually agree to bring a franchise agreement to an early end. This should always be done in writing.

If franchisees initiate the request, franchisors generally require an exit payment. It is reasonable for franchisors to be compensated for losing out on franchise fees they would otherwise receive if the franchise agreement had run its full term. Franchisors may instead agree to buy back the business from the franchisee, but usually for under market value.

Franchisors are often free to on-sell the business to a new franchisee once the termination is formalised. The former franchisee generally has no right to the sale proceeds.

(b)   Dispute resolution

If a dispute arises between the franchisor and franchisee and the dispute resolution procedure under the franchise agreement or the Code is initiated, it will often be mediated. Sometimes the resolution may be an agreement to terminate the franchise agreement. Mediation can assist the parties to negotiate a mutual exit if the franchise relationship is beyond repair.

(c)   Litigation

If litigation is commenced, a Court may be asked to bring a franchise agreement to an end or to treat the agreement as if it had never existed. There are many different reasons why a party to a franchise agreement may commence litigation, which can often follow an unsuccessful mediation. Some common grounds are misleading and deceptive conduct, misrepresentations, failure to adhere to the Code and repudiation. Court proceedings are costly and the outcome can never be predicted.

What are the consequences of ending a franchise agreement?

If a franchise agreement is terminated and the franchisee is found to be at fault, a franchisor may ask a Court for an order for damages equal to the monies the franchisor would have expected to receive had the franchise agreement run for the balance of its term.

Franchise agreements normally otherwise outline what happens when the agreement ends. Franchisees will generally be restricted from using the franchisor’s brands and intellectual property, and will be bound to a restraint of trade.

Franchisors and franchisees should factor in these considerations and be mindful of the repercussions before acting to terminate a franchise agreement.

There are also penalties if franchisors or franchisees breach the Code. Breaches of some provisions will attract penalties of up to $63,000 per breach, and these breaches may lead to infringement notices issued by the ACCC for $10,500 per breach. Compliance with the Code must therefore be taken seriously.

Finally, always obtain legal advice on your options before taking steps to terminate a franchise agreement so that you are fully aware of any unintended consequences.

Need advice  Talk to the Franchising team at Rouse Lawyers. Contact us today!