How To Terminate A Franchise Agreement

Contents

Terminating a Franchise Agreement is a significant decision, and the implications of such a step should be thoroughly considered. As a franchisor, it’s crucial for you to understand the ways in which your franchisee might terminate the agreement, as well as the ways you could initiate termination yourself.

This article will explore the methods of terminating an agreement, as well as alternatives to, and prerequisites for, termination.

An essential preliminary point is that both you and your franchisee are required to act in good faith in any dealings related to your franchise agreement. This means parties must ‘exercise their powers reasonably and not arbitrarily or for some irrelevant purpose’.

An action will not be considered in good faith if a party acts with an ulterior motive, or undermines or denies the other party the benefits of a contract. This obligation cannot be excluded by the agreement, and breaching this requirement can result in significant legal consequences. This obligation extends to attempts to terminate the franchise agreement.

When Can A Franchisee Terminate A Franchise Agreement?

Franchise agreements can be terminated by the franchisee in several different ways.

Cooling Off Period

The New Zealand Franchise Association’s Code of Practice allows a franchisee to terminate a franchise agreement within a specified cooling-off period after signing or after the first payment under the agreement.

Regarding the payment, you might be entitled to retain some of the franchisee’s money but only if a term allowing this is included in the franchise agreement and the money is for ‘reasonable expenses’. These ‘reasonable expenses’ could include costs such as training or administrative expenses, depending on the agreement.

Franchise Agreement Term

Most franchise agreements do not provide for early termination. However, some may include a clause giving the franchisee an option to terminate. This is often contingent upon the occurrence of specific events, such as a natural disaster or significant change in business circumstances.

Franchisees will likely seek to include such a clause in their franchise agreement. It is important to have a specialist lawyer review the agreement before signing, and potentially negotiate the inclusion of an early termination clause, depending on the nature of your business and the franchisee’s situation.

Franchisor Breach

If a franchisor breaches the agreement, it does not automatically grant the right to terminate. A franchisee might have to continue operating the franchise until the agreement’s expiry.

However, the agreement can include a clause that permits termination based on a breach, such as late payment of royalties. Without such a term, a franchisee will need to follow the dispute resolution procedure outlined in the agreement or seek legal recourse. This is a less certain path to termination and heavily depends on the specifics of the case.

When Can A Franchisor Terminate A Franchise Agreement?

Breach By Franchisee

A franchisor cannot terminate an agreement for every breach. To determine whether an action for termination would be justified, it is essential to seek legal advice.

This legal advice should clarify:

What are the specific terms of the franchise agreement?
Is the franchisee in breach of one or more of these terms?

Both of these will naturally depend on the wording of the terms and the context in which a breach is alleged. A common breach could involve misuse of the franchisor’s intellectual property. Before taking further action, the franchisee must be given an opportunity to rectify the alleged breach.

The franchisor must:

Provide the franchisee with reasonable notice in writing, indicating the franchisor’s intention to terminate the franchise agreement due to the breach; and
Inform the franchisee what is required to remedy the breach; and
Allow the franchisee a reasonable time to remedy the breach.
1. ‘Reasonable time’ is based on the situation, though it does not have to exceed 30 days. If ‘reasonable time’ is defined elsewhere in the agreement, that period can be applied here.

If the above procedure is followed, a termination notice can be issued after the ‘reasonable time’ has elapsed, potentially allowing you to terminate the franchise agreement.

However, if the breach is rectified as required, the franchisor cannot terminate the franchise agreement based on that particular breach. Additionally, failure to follow this process could result in legal penalties.

No Breach By Franchisee

A franchisor can also terminate the agreement without a breach by the franchisee. This is permissible where the franchise agreement includes an express right to terminate and reasonable written notice of the termination, along with the reasons for it, has been provided.

Special Circumstances

There are situations where the standard termination procedures, including the requirement for ‘reasonable notice’, do not need to be followed.

These can include:

Loss of the franchisee’s licence required to operate the business
Bankruptcy or insolvency
De-registration (if they are a company)
Abandonment of the franchise or franchise relationship
Conviction of a serious offence
Operation of the business in a manner that endangers public health or safety
Fraudulent operation of the business

It is important to note that the franchise agreement must explicitly permit termination for these reasons for them to be enforceable.

Disputes

If a dispute arises regarding a proposed termination, the internal dispute resolution procedure of the franchise agreement or the applicable legal dispute resolution mechanism will apply. Regardless of the method, both parties must attempt to resolve the dispute.

Efforts to resolve the dispute should be made in a reconciliatory manner, which includes:

Attending and participating in meetings at reasonable times
Not taking actions that could damage the reputation of the franchise system
Being clear about your intentions at the start of the process
Adhering to any confidentiality obligations during and after the process.

Other Ways To Terminate A Franchise Agreement

Dispute Resolution

As mentioned, there is a dispute resolution process, either through the agreement itself or through a mandated legal process. If successful, this may lead to a mutual agreement to terminate the franchise agreement.

Litigation

Either the franchisor or franchisee can initiate litigation to end an agreement. This could be for various reasons, all dependent on the specifics of each case.

One example might be misleading or deceptive conduct by either party. Litigation is often costly and time-consuming and should be a last resort after other solutions have been exhausted.

Mutual Termination

The termination of a franchise agreement doesn’t necessarily have to be contentious. Your franchisee may have valid reasons for wanting to terminate the agreement, which you may find acceptable. If they initiate the request, you can negotiate an exit payment or propose to buy back the business from the franchisee.

This method of termination is governed by the parties to the agreement and cannot be completed without mutual consent.

The Consequences Of Terminating A Franchise Agreement

If termination is successful and the franchisee is at fault, you may seek damages equivalent to the revenue you would have received had the franchise agreement continued to its intended conclusion.

You should also consider including a restraint of trade clause or restrictions on the use of intellectual property in the franchise agreement. This protects your business and provides a legal recourse if the franchisee violates a term.

Key Takeaways

There are various ways either you or your franchisee can terminate a franchise agreement, and the specifics will usually be highly fact-dependent. Deciding to terminate a franchise agreement is a serious step and should not be taken lightly. Legal advice is recommended before taking such action.

Including a termination clause in the franchise agreement can provide some certainty if certain conditions are not met. It is common for franchise agreements to be drafted in favour of the franchisor to protect their interests.

Franchising Resources

Laws around franchising can be complex, and it is an area of law that often requires expert legal assistance. We have several resources to guide you through various stages of the franchising process, such as:

Need Help?

Terminating a franchise agreement is a significant step that should always be carefully evaluated. The facts and context of each case should be reviewed by a specialist lawyer before proceeding. The legal framework is also subject to amendments and changes that can affect the outcome of your actions.

At Sprintlaw, we can assist you with reviewing and creating the initial franchise agreement to ensure better outcomes for your business, as well as providing legal advice on the agreement’s termination. You can reach out to us at [email protected] or contact us on 0800 002 184 for an obligation-free chat.

Will Tinney

Will is currently completing his Juris Doctor at the University of Melbourne and is interested in helping to provide equitable and efficient access to legal resources.

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