External factors such as a market downturn can impact a franchisee’s profits. Having to pay weekly franchise fees during these tough times can feel like an impossible task. Although it’s unlikely that you can terminate your franchise agreement in these circumstances, there are other options. We set out some solutions to consider below.
Terminate Under the Franchise Agreement
It’s rare that a franchise agreement would allow a franchisee to terminate the franchise agreement at its sole discretion because of a market downturn or poor performance. This is more likely in mobile or home-based franchises and can occur where:
- the franchisor wants to protect its reputation in the market; and
- the costs to the franchisor are minimal (i.e., it does not hold the head lease).
There are clauses in the franchise agreement that the franchisee should consider. Importantly, not all franchise agreements will contain these clauses, and even when they do appear, their operation and effect can vary. For these reasons, you should consider getting legal advice before acting.
Dispute Resolution Procedure
Some franchise systems have internal dispute resolution or complaints handling procedures to work through issues that arise. In this case, your franchise agreement should set out the process.
The Franchising Code of Conduct that applies to all franchisors and franchisees in Australia also contains a dispute resolution procedure. Typically, your franchise agreement will refer to the dispute procedure in the Code, namely:
- There is a requirement for one party to notify the other of the dispute in writing. They must set out the nature of the dispute, the desired outcome, and the action required to settle the dispute.
- The parties then have 21 days in which to attempt to resolve the dispute directly.
- If the matter remains unresolved after the 21 days, either party can request mediation. Both parties must attend mediation to comply with the Code.
Termination By Mutual Agreement
Some franchise agreements will state that parties can terminate by mutual agreement and set out how you can request this. Invoking this clause could have significant ramifications. It’s then important to understand what effect it will have under your franchise agreement before agreeing to terminate.
Conditional Right to Terminate
Your franchise agreement may give you the right to terminate the agreement at a particular time, or following a specific event. For example, a franchisee may have a right to terminate if:
- the franchisor implements a substantial change to the system; or
- they are required to relocate their business to continue operating.
Conditional clauses will be specific to your franchise system, and applicable only when the condition is clearly established.
Right to Terminate Following Franchisor Breach
Although uncommon, some franchise agreements will explicitly give you the right to terminate the agreement following a breach by the franchisor. Usually, this clause requires that the franchisor breached a ‘material provision’ and that you give the franchisor a period (e.g., 30 days) to remedy the breach before terminating the agreement.
You have an implied right of termination where the franchisor has not complied with a key term (i.e. they have ‘repudiated’ the franchise agreement). Identifying and proving the substantial breaches by the franchisor justifying your termination, however, may be an issue.
Discuss Temporary Franchisor Concessions or Assistance
A franchisor is more likely to offer temporary concessions or assistance during a market downturn rather than allowing you to terminate the agreement.
Franchisors don’t want franchisees to fail. Remember that your contact details remain on the disclosure document and so prospective franchisees can get in touch. Franchisors want you to be an enthusiastic cheerleader for the network! Also, franchisors must list the number of handbacks and terminated franchisees in the next disclosure document. This can be a sobering prospect if a wave of franchisees are hitting the wall at the same time.
A franchisor may offer royalty free or reduced royalty concessions, or onsite support. There is no limit as to what a franchisor can do to help a franchisee. For instance, franchisors have offered royalty free periods during shopping centre renovations to counteract the reduction of foot traffic. This provided franchisees with the breathing space needed to continue operating smoothly.
Negotiate an Exit or Franchisor Buy-Back
Even without a mutual termination clause, it is possible to negotiate a termination and exit directly with the franchisor. This is sometimes the result of the dispute resolution process detailed above. The franchisor has no obligation to agree to a negotiated exit.
However, a negotiated exit may be best to avoid a costly and time-consuming dispute that may interfere with the running a franchise system or cast a negative light on the brand. In these situations, the franchisor may “buy-back” the business’ assets from the franchisee and agree to a termination of the franchise agreement. This is certainly not ideal for the franchisee — you are likely selling back to the franchisor at a significant discount and losing the opportunity to recover your full investment. Nonetheless, it may be the best attainable outcome when faced with few alternatives.
Upon reaching an exit agreement, you may be required to sign a termination agreement or settlement deed. As you may have ongoing obligations after signing this agreement, it is best first to obtain legal advice.
A franchise agreement will not ordinarily give you the right to terminate due to a market downturn or other factors. However, there are options when you find yourself in this situation. If you have any questions or need assistance with terminating your franchise agreement, get in touch with LegalVision’s franchise team on 1300 544 755.
Was this article helpful?
We appreciate your feedback – your submission has been successfully received.