Basics on Franchise Agreements
Franchise agreements have a lot to say. It’s not uncommon for the typical franchise agreement to be 50-100 pages long and contain several addenda.
Franchise agreements are exhaustive because they address franchisees’ fears at a substantially high level of detail. The franchise agreement is intended to address what the franchisee can and cannot do. It addresses how the franchisee will be successful within the confines of the system. When you agree to the terms of the franchise agreement you are essentially agreeing to dedicate time and sincere effort to pursuing the system’s success on behalf of the franchisor.
A franchise agreement is a contract, and a franchisee may be allowed to terminate the franchise agreement – with some consequences, of course. Termination or non-renewal are the easiest routes a franchisee can take to end the franchise relationship but significant time and effort are required.
The most advantageous time to refer to the franchise agreement is when looking to pursue termination . Franchise agreements are usually drafted with this process in mind. There will be provisions which set forth the standard for termination and the steps which must be followed in order to meet that standard. Franchise agreements will also generally require that the franchisor follow the same process for non-renewal or termination. Franchisors who fail to follow their franchise agreement’s terms with any other franchisee may not be able to rely on the franchise agreement with your franchise in the event you seek to terminate the agreement.
The worst time to refer to the franchise agreement is when you are seeking termination itself. More than likely, if you have gotten to this point in your franchise relationship you are likely already out of compliance with your franchise agreement. Specifically, you are probably in violation of the franchise agreement’s standard for termination.
In the next session we discuss why it is important to change your mindset before terminating your franchise agreement.
When You Can Legally Terminate a Franchise Agreement
Although this may sound simplistic, the ability to terminate a franchise agreement depends on the grounds for such termination. A franchisor has no obligation to accept a franchisee’s termination if such termination does not comply with the contractual requirements for termination or if there is no lawful basis for such termination. Under the Federal Trade Commission’s franchise disclosure requirements, franchisors must provide a disclosure document in which they describe limited circumstances in which a franchise may terminate a franchise agreement without penalty. Many state franchise laws provide similar requirements for state franchise disclosures.
A franchisee has the right to terminate a franchise agreement under certain grounds that do not necessarily require "cause." These grounds usually include financial duress, loss of a competitive advantage and territorial encroachment. A franchisee also has the right to recover damages against a franchisor if such franchisor: (1) commits fraud; (2) breaches the franchise agreement; and (3) otherwise acts in a way that is unfair or deceptive (like making material misrepresentation or concealing facts).
Pre-Termination Steps to Consider
Before proceeding to terminate the franchise agreement, you should first make certain that you are justified in your termination of the franchise agreement under the terms and provisions of the franchise agreement. In addition to the grounds for termination enumerated in the franchise agreement, a franchisor may be required to terminate the franchise agreement in accordance with the law, provided the law so permits it. While it may be possible that a franchisor terminates a franchise agreement and is not in compliance with the law, such termination could be found to be a breach of the franchise agreement and possibly be the subject of a lawsuit against the franchisor by the franchisee, based upon the facts of such situation.
In order to conduct a reasonable review of your options before terminating the franchise agreement, you should consider consulting with an attorney as to whether you are justified in your termination of the franchise agreement. In addition, you may be required to negotiate with the franchisee in good faith before terminating the franchise agreement. Such negotiation may be required to be conducted through mediation. In addition, state law may only permit a franchisor to terminate its franchise agreements by following statutorily set procedures. If such a procedure is followed and the relationship still breaks down, the franchisor may be able to avoid a lawsuit by the franchisee, based upon your status as a franchisor, state regulations governing the termination of franchise agreements, and the specific terms of the franchise agreement.
How to Write the Termination Letter
When issuing a termination letter, it is critical to draft a clear and concise letter to the other party. The letter should state the reason for the termination, and reference any specific clauses in the underlying franchise agreement that are applicable to the termination itself. The letter should provide a timeline for when the termination will be effective and should specify any obligations the terminated party may have to them. For example, if the termination was a failure to pay amounts owed under the franchise agreement, the termination letter should clearly set forth all amounts owed and include an unambiguous statement that all monies must be paid in full by a date certain in order for the franchisee to have a continued role in the agreement.
Here is an example of a termination letter:
Dear XYZ Franchisee,
The franchisor, XYZ Brand, LLC, has terminated your franchise and/or license agreement for the XYZ [Type of Business] effective at the end of business on ___________________, because you failed to reopen your location after the XYZ Brand voluntary reorganized following the pandemic.
Specifically, your XYZ Brand license and/or franchise agreement with us requires that you comply with all of our rules and policies, including those pertaining to your hours of operation and the physical location of your XYZ Brand location. As you know, the franchisor developed the XYZ Brand rules and policies in order to ensure that the franchisee is successful, and that the XYZ Brand remains strong and successful as a whole. We take this aspect of our agreement very seriously. Failure to comply with, or conform to, our rules and policies constitutes an event of default and gives the franchisor the right to terminate your agreement and take possession of your assets. By way of example, we take a dim view of failure to pay rent and employees during our voluntary-mandated closure and three-month wait to reopen as the COVID crisis continues. It is vitally important that you comply with our route and time of business restrictions so that all franchisees have the ability to succeed in this trying and competitive environment. Franchising is a partnership, and we all suffer together if franchisees fail to conform to the rules and policies that are designed to advance all of our interests and ensure that the XYZ Brand is a name that stands for quality of service and products.
The franchisor has, unfortunately, terminated your license and/or franchise agreement effective at the end of business on ___________ because of your failure to comply with our rules and policies. Please be advised that you are no longer authorized to engage in any XYZ Brand business, whether at your location or otherwise. If you are found to be operating an XYZ Brand location after the effective date of this termination, legal action will be considered.
Very truly yours,
XYZ Brand, LLC
Termination Letter Template
[Franchisor]
[Address]
[City, State ZIP]
[Date]
[Owner]
[Franchised Business]
[Address]
[City, State ZIP]
Dear [Owner]:
I hereby terminate the [Franchise Agreement and/or other applicable agreements] between [Franchised Business] and [Franchisor] dated [Effective Date], and any [ancillary agreements, leases, or other agreements] between [Franchised Business] and [Franchisor] within the ten (10) days of [Firing Date], as required by Sections [#] and [#] of said agreements. I do not intend to provide the five (5) day notice required by Section [#] . [Franchised Business] waives the five (5) day notice and elects to accept immediate termination of the [Franchise Agreement and/or other applicable agreements].
I have instructed my attorneys from [Law Firm] to copy you with this correspondence. My attorneys will be contacting you to coordinate the return of any property of [Franchisor], including but not limited to supplies, products, equipment, fixtures, signs and promotional materials.
I reserve my rights as to all claims or defenses available to me and my successors or assigns in any litigation involving [Franchised Business].
Consequences of Terminating a Franchise Agreement
Termination of a franchise agreement can have a considerable impact on an existing franchisee. There are contractual remedies and potential non-contractual remedies available to the franchisor if the franchisee terminates the franchise agreement prior to expiration. If a franchisee terminates a franchise agreement, many franchise agreements will allow the franchisor to collect amounts equivalent to future royalties that would have been paid over the remainder of the franchise agreement. The future royalties are calculated based on the franchisee’s average level of sales multiplied by the average royalty percentage. In addition, the franchisee could be required to account for franchise fees associated with expansion of the franchisee’s territory that the franchisee might pursue should it not have been a franchisee at the time. The franchisee could also be required to pay liquidated damages.
If the franchise agreement has a liquidated damages provision, this is typically the franchisor’s sole remedy. However, if the franchise agreement provides for any other damages, the franchisor can pursue any one or all of those remedies. Liquidated damages are calculated as follows: (i) the royalty base at the time of termination multiplied by (ii) the number of months remaining in the contract period multiplied by (iii) the royalty rate in the contract. These amounts are considered unliquidated damages and may well exceed the liquidated damages provided for in the franchise agreement. In other words, courts have found that a franchisor should be made whole for its losses so that franchisor doesn’t suffer from the early termination of the agreement.
Aside from contractual remedies, a franchisee could be exposed to tort liability for tortious interference with contract if the franchisee solicits and employs other franchisees or existing non-franchisees in a manner that interferes with the franchise agreement. A franchisee may also be liable for injunctive relief since a disclosure to third parties upon termination may create a threat of confusion and give rise to trademark infringement liability. The franchisee’s use of the franchisor’s trade name or trademark pursuant to the franchise agreement likely gave the franchisee a reputation within the system and among the public relating to that business. If not properly terminated, the goodwill that was developed could be lost by the franchisor if the franchisee continues to operate a similar or identical operation.
The franchisee could face a lawsuit from the franchisor if it sells its assets to another competitor. If the sale to a competitor is made for the sole purpose of trying to get around the contract with the franchisor, the court may well have a difficult time determining if damages are appropriate in that instance. If the former franchisee attempted to transfer its assets to a new franchisee and the franchisor terminated the franchise agreement because of the assignment or transfer, a court may award lost future profits to the terminating franchisor.
The legal ramifications could extend into state regulatory procedures if a federal court determines that there has been a breach of fiduciary duty. A court in a state with an FTC-like regulation has the power to provide whatever penalties it considers necessary to carry out the intent and purposes of the statute. The court may award the public reimbursement of its loss and it can also award the franchisor the amount of loss sustained. A state has the power to do whatever is necessary to protect the interest of the public, the state, and the franchisor.
The above-mentioned consequences do not take into consideration the detrimental impacts on the franchisee’s reputation with respect to future franchising opportunities. Many large franchisors will consider the history of the failed relationship with a franchisor before establishing a relationship with that franchisee.
Why You May Want Legal Help
It is always a good idea to consult with a franchise consultant or an attorney experienced in franchise matters if you wish to terminate a franchise agreement. I have often received many helpful and practical tips from franchise consultants. An attorney experienced with and knowledgeable in the franchise laws and regulations can provide you with specific analysis of the relevant facts and applicable law and represent you in negotiations with your franchisor , where helpful.
Franchisee Associations are another helpful source of advice and support in your dealings with the franchisor. In addition to providing advice, you may be able to obtain the services of an attorney at a reduced rate through the Franchisee Association.