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What happens when a franchisee decides they want to leave their franchise business? While they vary, most franchise agreements do not allow a franchisee an easy way out of their agreement. Most franchisees will face some costs. However, there are some options available. This article will discuss these options and explain what a franchisee needs to weigh up when deciding how to exit their franchise business.

Option 1: Leave the Business Within Seven Days

If a franchisee decides to leave the business early, most franchise agreements allow the franchisee to simply end the agreement in the first seven days without any consequences. This is called a ‘cooling off period’. After this period, franchisees will likely breach the agreement if they attempt to break the contract and may be forced to pay compensation.

Option 2: Attempt to Sell the Franchise

The second option is to attempt to sell the franchise. Either the franchisor or a new franchisee can buy the business. Many franchise agreements set out how a franchisee can do so.

There are two important terms found in franchise agreements that franchisees must follow:

  1. the franchisor has a first right of refusal. This means that a franchisee must offer the business to the franchisor first. If the franchisor refuses, then the franchisee can offer the franchise to a different buyer; and
  2. the franchisee must obtain the franchisor’s consent. Before offering the business to a different buyer, the franchisee must obtain written consent from the franchisor. The franchisor cannot refuse to give their consent unreasonably.

It’s important that any agreement to sell the business includes a condition that the franchisor’s consent must be given before it can be sold. Similarly, if the premises are leased, then the franchisor needs to obtain the landlord’s consent to sell the business.

Both the franchisor and the landlord should be notified before the sale process commences, to ensure no issues arise once the process begins.

What Are The Costs?

Naturally, there will be costs involved in selling the franchise. These include:

  • sales agent fees;
  • advertising fees; and
  • landlord fees to transfer the lease (if the premises is leased).

When it is sold, the franchisee may also be required to pay a fee, known as an assignment fee, to the franchisor. This fee may be a fixed amount of money or a percentage of the sale price. The franchisee may also need to pay capital gains tax. This is something that should be discussed with a tax adviser.

Option 3: Walk Away and/or Negotiate an Exit

Simply walking away from the franchise is not advisable. When leaving the franchise business is the only option, a franchisee should carefully read their franchise agreement to find out what happens if they breach it.

Liquidated Damages Clauses

Most franchise agreements will state that a franchisee must pay a certain amount of money if they breach their agreement. This includes when a franchisee ends their agreement early. These are known as liquidated damages.

There are a number of ways that this amount of money can be calculated. For example, the franchisee may need to pay the total cost of the business fees until the franchisor can find a new owner. It is important to obtain legal advice on this issue.

The franchisor will not be able to ask for an amount of money that is unreasonable. To be considered reasonable, it must be a genuine estimate of how much money the franchisor is expecting to lose from the franchisee’s broken agreement.  

If it is unreasonable, this can be a point of negotiation for leaving the franchise.

What Steps Should a Franchisee Take to Leave Their Franchise Early?

The steps that should be followed where a franchisee plans to leave the franchise are:

  1. seek legal advice. It is important to understand how the termination provisions of the franchise agreement operate before any steps are taken. If you have a complaint against the franchisor that gives rise to a legal claim, you may be able to get out of the franchise and get some or all of your money back.
  2. send a formal notice of intention to end the franchise agreement to the franchisor. Notify them of the anticipated ‘end date’ and request that they respond within a reasonable time.
  3. if you need to pay compensation for breaking the agreement, request a breakdown of the cost (a ‘payout figure’) from the franchisor.

Where the franchisor asks for a lump sum payout figure, a franchisee should consider negotiating paying in installments if they are in a difficult financial position. If this kind of agreement is reached, it should be documented in a settlement agreement.

If leaving the franchise business before the end of the lease, this must be communicated to the landlord as they will need time to find a new tenant for the premises.

Key Takeaways

Overall, when considering whether to leave a franchise business, it is important to:

  • consider all your options carefully;
  • evaluate the consequences of leaving the franchise without any notice; and
  • seek legal advice before making any decision.

Although some cost will likely be involved in leaving the franchise early, a franchisee that follows the steps set out in this article will be better off in the long term. If you have any questions, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

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