Franchising is an on-going business relationship and, as with any relationship, sometimes the parties decide to part company.
It is not always because the relationship has broken down; it may be due to retirement or illness of the franchisee or even new opportunities. However it may be that the relationship is not the “right fit” or the franchisee is dissatisfied with the franchisor’s performance or the financial return on investment.
In any situation where the franchisee wants to exit the relationship the starting point is the Franchise Agreement. A well drafted agreement will contain various provisions which identify the rights of both parties in these circumstances.
Given that the franchisee will have invested both capital and time into the venture, the preferred mechanism for exiting the arrangement is usually by way of sale. This offers the franchisee the best opportunity to maximise their return on investment.
Typically the Franchise Agreement will require the franchisee to first offer the business to the franchisor. It is only when the franchisor is not interested in acquiring the franchise that the franchisee will be able to go to the market. At this point it is important that the franchisee locates a business broker who is familiar with franchise systems. They will understand that the franchisor will need to approve the new franchisee. The franchisor will assess the suitability of any prospective purchaser considering the criteria that they would apply to any new franchisee. It is critical that at the outset the franchisee and broker understand the franchisor’s requirements. Often a transfer fee is payable and typically the franchisor will also want the prospective franchisee to sign a new Franchise Agreement on the current terms. The new Agreement may be more onerous than the terms on which the departing franchisee operated the business. It may also extend to requiring the new franchisee to undertake a new fit-out of the franchise premises.
So what options, if any, does a franchisee have in the event that the franchisor does not want to re-acquire the business and the franchisee is not able to sell the franchise to a third party?
The Franchise Agreement will be for a specific term, often five years. If there is no market because the franchise hasn’t been successful it might be best to consider closing at the end of the current term provided that the business can continue to operate without incurring losses in the intervening period! If this option is pursued the franchisee will need to contemplate how plant, equipment and stock is disposed of amongst other issues. Sometimes the Franchise Agreement will contain a provision requiring the franchisee to offer the plant and equipment to the franchisor on agreed terms. But beware the terms may provide for a price that is less than market value. The provisions may also enable the franchisor to take over the premises from which the franchise has been operating. While this might be useful - for example if the lease period had not expired - in some circumstances the franchisee may want to retain the premises to open a new venture. Unless the franchisor elects not to enforce its right to take possession of the premises the future plans of the franchisee may be disrupted. In all cases it is likely that the franchisee will be restrained from opening a competing business from the premises. Almost without exception a Franchise Agreement will contain a restraint of trade clause prohibiting the franchisee from competing for a period of years from the end of the franchise within a specified area (which could be related to both your franchise as well as the premises of other franchises).
If the business is not profitable, continuing until the end of the franchise term may not be an option. If the business is trading insolvently the franchisee could consider closing the doors to avoid potential personal liability to creditors. However this may result in liability to the franchisor for breach of the Franchise Agreement.
It is important to review the Franchise Agreement to see if there are circumstances which provide leverage in any negotiation for release from the on-going provisions of the Franchise Agreement. It is imperative that the franchisee obtain legal advice as to their rights and remedies if they are to minimise the risks associated with a relationship breakdown. If the parties are members of the Franchise Association the mediation service provided by the Association can be a useful vehicle to negotiate a mutually acceptable outcome.
While it is not always possible to end a franchise relationship and remain “friends”, it is always the preferred result! Whatever the reason for the “breakup” it is essential that contractual obligations and their implications are considered by the franchisee before embarking on any exit strategy.
For more information about the legal aspects of franchising contact our specialist franchising team, or call Claire Bryne - franchise team leader on +64 4 916 7483