When Is a Breach Serious Enough to Terminate a Franchise Agreement?

Knowing when to terminate a franchise agreement can be difficult. Franchising in Australia is a heavily regulated industry, so there are strict protocols to follow. However, not all breaches will allow either party to terminate the franchise agreement. This article will discuss when franchisors and franchisees have the right to terminate.

What Is a Franchise Agreement?

A franchise agreement is typically a written contract between a franchisor and franchisee. Each franchisee will be part of the franchisor’s network of businesses. The franchisor gives the franchisee the right to: 

• use their intellectual property;
• use their trade marks; and
• operate the business in accordance with the franchisor’s processes and knowledge. 

The franchise agreement should be drafted in accordance with the Franchising Code of Conduct (FCC). Subsequently, there are many similar terms that will likely form part of a franchise agreement. These generally include:

• length or term of the agreement;
• a franchise territory;
• intellectual property inclusions and permitted uses;
• supplier requirements;
• purchase and royalty fees; and
• ongoing restraints of trade and confidentiality terms.

What Is a Breach?

A breach of contract is when a party does not comply with the contract or fulfil the terms of the agreement. With respect to a franchise agreement, a breach will include failure to deliver on the terms of the agreement. Breaches can even include failure to comply or meet certain standards in the franchisor’s operations manual.

What Are Common Breaches by Franchisees?

Franchise agreements are lengthy documents and have many clauses, creating multiple legal obligations on franchisees. This means that there are many ways a franchisee can breach the agreement. Some common examples include:

• late payment of franchise and royalty fees; 
• failure to provide audit and accounting information;
• use of different suppliers other than the franchisor;
• operating outside the franchisee’s allocated territory;
• running a separate business in the same industry to compete with the franchise business; and
• misuse of the franchisor’s intellectual property and branding.

Certain clauses of a franchise agreement will continue to operate after the franchise agreement has ended. Therefore, franchisees can also be in breach after the agreement has ended. Common examples of these clauses include:

• restraint of trade clauses preventing franchisees from operating in the same industry and area; and 
• confidentiality clauses to protect the customer base of the franchise business.

When Can a Franchisor Terminate? 

Under the FCC, franchisees must be given the opportunity to rectify any breaches of the agreement before the franchisor can terminate it. Franchisors must serve a written notice on the franchisee and allow up to 30 days for the franchisee to fix the breach. The notice must set out the breach and how the franchisee can rectify it. If the franchisee fails to fix the breach, the franchisor may terminate the agreement.

In particular situations, the FCC allows a franchisor to terminate a franchise agreement immediately. These circumstances include when the franchisee:

• no longer holds a license required to operate the franchise business;
• becomes bankrupt or insolvent;
• company is deregistered with ASIC;
• abandons the franchise;
• is convicted of a serious offence;
• is fraudulent in connection with the franchise business; and
• endangers public safety.

What Are Common Breaches by Franchisors?

Parties typically draft franchise agreements in favour of the franchisor to protect their interests. Subsequently, it is uncommon for franchisors to be in breach of their agreements. However, franchisors should be aware if they promise ongoing support to franchisees and marketing services and do not provide it, this could be grounds for the franchisee to issue a notice of dispute with the view of terminating the franchise agreement.

Franchisors are more likely to be in breach of their obligations under the FFC, which may give rise to termination of the franchise agreement. Some common breaches of the FCC include failure to:

• provide (audited) marketing fund financial statements each year;
• provide an updated version of their disclosure document to a franchisee upon request; and
• follow breach and termination provisions of the FCC.

When Can a Franchisee Terminate?

Generally, there will be no clear breach of the franchise agreement that will allow franchisees to terminate. However, suppose the franchisor has made misrepresentations, over-promised elements of the business or failed to comply with the FFC. In that case, the franchisee may be able to use this to negotiate an early termination of the agreement by following the dispute resolution procedure set out in the FCC and franchise agreement.

Practical Considerations When Terminating a Franchise Agreement

When considering terminating a franchise agreement, it is important to consider the practical steps that will need to be taken, in addition to the legal ones. If a franchisor is terminating the franchise agreement, they will need to consider:

• what will happen to the premises following termination? This includes considering the franchisor or franchisee is on the lease, if there is a step-in deed and whether the franchisor can take back the premises;
• if the territory is successful and high value;
• how the franchisor will prevent franchisee access to their intellectual property and if the software licensing and database access can be cut-off;
• what other steps will need to be taken to prevent the franchisee from operating the business and passing it over to a new business; and
• how damaging the breach is to the network.

Key Takeaways

In order to terminate a franchise agreement, there must be a breach of the agreement or FCC. Franchisors must follow the breach and termination procedures in their franchise agreement and FCC. Additionally, franchisees should be aware that they have up to 30 days to rectify a breach notice. Further, if you are concerned about the timing of termination, you should seek legal advice. For assistance reviewing your franchise agreement and disclosure document to get help rectifying a breach or ensure you can terminate your agreement, contact LegalVision’s franchise lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions