29/05/2009

What options are available to a franchisee who wants to get out of their franchise agreement?

There are many reasons why a franchisee may want to end a franchise relationship. Perhaps the franchised business is under performing, or the franchisee wants to relocate to a new city or State, or their health or that of a loved one is bad or the competition has got too tough. 

Generally, franchise agreements are for a fixed term and are difficult to get out of.  A franchisee can get out of the franchise in a number of ways:

• selling back to the franchisor
• selling to a buyer who they locate
• selling to a buyer the franchisor locates
• terminating because of a breach by the franchisor
• terminating without cause

Usually, a franchisee cannot terminate the franchise agreement unless the franchisor is in a material breach of the agreement. In the absence of a material breach of the agreement by the franchisor, a franchisee will generally need to continue trading and complying with the franchise agreement to avoid a claim for breach of contract by the franchisor.

Where a franchisor is not prepared to terminate an agreement, it may be necessary for the franchisee to continue operating until a purchaser of the business acceptable to the franchisor can be found. Some franchisors may help source a purchaser for the business, but generally this would be the franchisee’s responsibility.

If a franchisee terminates without good cause the franchisor may be able to recover damages from the franchisee.  Those damages would amount to the payments that the franchisor would have received from the franchisee if the franchise had continued.  Over a long term this could be very substantial and enough to lead to the bankruptcy of the franchisee.

Note, however, that the franchisor has an obligation to mitigate (ie keep to a minimum) any damages suffered as a result of such breach of contract. This could put pressure on a franchisor to find a suitable substitute franchisee to take over the business.

Once a purchaser of the franchised business is found, the franchisee will need to comply with the transfer provisions in the franchise agreement. This may include giving the franchisor the option to buy the business on the same terms as those offered to the proposed purchaser.

Generally, a franchisor cannot “unreasonably” withhold consent for the transfer of a franchised business. The Franchising Code of Conduct (the “Code”) sets out circumstances in which it is reasonable for a franchisor to withhold consent, and includes such things as when the transferee is unlikely to be able to meet financial obligations under the franchise agreement or fails to meet selection criteria of the franchisor.   

If there is a dispute under the franchise agreement or the Code, either the franchisee or the franchisor can start the procedure under Part 4 of the Code to resolve the dispute. Part 4 of the Code provides for internal dispute resolution followed by mediation if necessary. This procedure is intended to be faster and less expensive that taking legal action in respect of the franchise agreement.

If you are considering entering into or terminating a franchise agreement and require assistance, please contact the commercial lawyers at Townsends Business & Corporate Lawyers on 8296 6222.