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The Franchising Code of Conduct clearly sets out the legal requirements for terminating a franchisee.

You issue a breach notice, wait 30 days, and if the franchisee does not remedy the breach, you (generally) have the right to terminate under the Franchising Code of Conduct.

In practice, however, franchisors often swing from one extreme to another when terminating franchisees. Either they procrastinate and allow debts to accrue to dangerous levels before taking action, or they issue breach notices and terminate franchisees at the slightest provocation.

Neither strategy is beneficial for the franchisor or the franchise network as a whole. So how should the franchisor decide when and how to end a franchise agreement with a franchisee? 

Visit the Franchisee

A representative from head office should visit the franchisee. An act of non-compliance reveals little information other than the fact a breach occurred. A franchisee may not have paid the franchise fee as a result of:

  • oversight;
  • temporary cash flow problems;
  • a major business crisis; or
  • a major personal crisis (e.g. a marriage breakup or family emergency).

Speaking with the franchisee can quickly get to the root of the problem and provide a much better understanding of the full picture behind the breach.

Can the Franchisee Turn the Situation Around?

Can the franchisee turn the situation around with the franchisor’s support and a mutually agreed action plan? This is a critical decision for the franchisor. Unnecessarily terminating franchisees is expensive and drives down morale in the whole network. On the other hand, delaying the termination of a hostile franchisee could drain resources chasing outstanding debts. It’s ultimately a commercial decision as to what works best for the franchise network.

What Should the Franchisor Do After They Make Their Decision?

Certain actions automatically flow from this decision.

The Franchisee Can Turn Themselves Around

The franchisor should have both parties sign a formal written action plan. If a suspension of levies (or rent) takes place as part of the arrangement, the franchisor should ensure that any agreement would not get other franchisees offside. The franchisor should also include a provision in the agreement that outlines the effects of breaching the action plan. For instance, all levies which the franchisee owes are due and payable. The agreement should also be strictly confidential.

The Franchisee Cannot Turn Themselves Around

If the franchisor decides that the relationship has broken down for whatever reason, they should take steps to plan for sale or termination.

The franchisor should issue a breach notice, after which point the parties can discuss whether the franchisee can sell the franchise. Take care that the franchisee does not interpret the breach as the franchisor forcing them to sell. The reason for encouraging sale is to save franchisees from losing their investment. Franchisors should clearly explain that they are trying to help solve a difficult problem.

If the franchisee can achieve a sale, the franchisor should make every effort to assist in that process. Again, parties should document the arrangement in writing and address the following:

  • advertising the business for sale;
  • who will determine the price;
  • what that price will be (taking into account the current difficulties of the operation and how long the sale process will take).

What Should the Franchisor Do if the Franchisee Cannot Sell?

If the franchisee cannot sell the franchise, then (and only then) should the franchisor terminate the relationship.

Buying Back Assets

First, the franchisor must decide whether it is worth taking over the franchise business post-termination. Sometimes, the franchisor assumes that they can take over the business without compensating the franchisee. The franchisor does not need to buy the business as a going concern, but the franchisee agreement will determine how the franchisor can purchase the business’ assets and at what price.

If the franchisee has spent $400,000 on the fit-out of the store, it’s unreasonable for the franchisor to expect that they can take over the business for nothing. The franchisor should review the franchisee agreement carefully before termination, and budget for the buy back of key assets.

Taking Over the Lease

The franchisor should also consider what happens with the lease. If the franchisor has the head lease and has subleased or licensed it to the franchisee, it’s much easier to take over the business. If the franchisee holds the lease, the franchisor may not even have this option, and they face the risk of the franchisee rebranding the store and becoming a competitor. The franchisor should ensure the franchisee understands their restraint of trade clause, and that they will enforce this after termination.

***

If you are a franchisor and have any questions or need assistance terminating a franchisee, get in touch with our specialist franchise lawyers on 1300 544 755.

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