Backing Out: How to exit a franchise relationship

April 25, 2013

This article was originally written for and published in Cabinet Maker.

Question:
I think that my franchisee has developed his area as much as he can.  If I want to get rid of him, what should I be thinking about?

Answer:
Given today’s economic pressures on businesses, thoughts by franchisors about ending franchises is entirely understandable and natural.  Unlike the lobster that enters the pot, franchisors should have at least one eye to the future as to when it may suit the franchisor to exit the franchise relationship.  

In order to get to the exit, the starting point is to look at the franchise agreement.  Hopefully it is in writing.  However, it does not have to be – a franchise could have been granted orally or (very unlikely) by conduct. 

If it is in writing, what does it say about ending the relationship?  The key provisions are likely to be:

  • the term or duration.  Often a period of notice is to be given.  But be careful – does the franchise agreement require that notice can only be given at particular times.  For example, at the end of a calendar year?  Alternatively, does the agreement specify that notice must be given so as to expire on a particular date?  

These are important issues if a claim for damages for failure to give proper notice is to be avoided.  

  • Performance.  Hopefully when the franchise agreement was written you specified what you required the franchisee to do by way of performance.  Hopefully too you have been monitoring the franchisee’s performance in order to avoid any argument that you have waived your rights if the franchisee has been underperforming.  

Do the provisions in the franchise agreement which are concerned with performance enable you to manage out the franchisee?  If so, thought needs to be given.  First, as to how to do it!  Second, as to over what period of time it may happen.  This can be important when weighing up the urgency for you to end the franchise as against the cost of doing so as against the plans that you need to make to replace the franchise with an operation which you own.  

  • Events of termination.  Put bluntly, has the franchisee committed an event of termination?  If so, does the franchise agreement require that the franchisee be given a period of time in which to remedy the breach?  Alternatively, is the breach of such a nature that it is incapable of remedy?  

Following on from these questions, it is necessary to consider whether the breach gives rise to a claim for damages or if it brings the agreement to an end.  

  • Consequences of termination.  Hopefully the franchise agreement is clear as to what are the consequences of termination.  What steps have to be taken by the franchisee to close down or, better still, transfer the franchise to you?

The provisions setting out the consequences of termination should also set out your rights.  In particular, whether you can require the franchisee to sell the franchise to you and on what terms.  

The franchise agreement can also be expected to set out what is to happen after the franchise agreement has ended in terms of the ability of the ex-franchisee to compete with you.  However, it is at this point that things can become interesting from a legal perspective following a very recent decision by the European Court.  

The European Court was asked to consider a non-compete restriction on the franchisee in a franchise agreement which had been terminated by the franchisee.  The restriction was stated to last for one year following termination and prevented the franchisee from competing with the franchisor in any part of the territory which had been covered by the franchise agreement.  

Following termination the franchisor tried to enforce the restriction.  However, the Spanish court which was asked to issue an enforcement order was concerned as to whether the restriction was enforceable under EU law.  In this respect the starting point is to consider whether the restriction is permitted by the EU regulation which exempts franchise agreements under EU competition law.  

The EU regulation refers to a restriction limited to “the premises and land from which the buyer [franchisee] has operated during the contract period”.  

Unsurprisingly the court was concerned with the meaning of “premises and land”.  Was the phrase to be interpreted to include the territory granted under the franchise agreement?  Or was it to be interpreted literally as being the place or physical space from which the franchisee had operated the franchise?  

In view of the purpose of the EU regulation, the European Court gave a literal interpretation and rejected the argument that the restriction applied to the whole of the territory.  

As a result, the ex-franchisee was not restricted from competing with the franchisor in the territory.  

It follows that you are absolutely right to think about what is best for your business given your feelings about your franchisee.  But it is also right to give thought as to how you exit the relationship and what may follow it.


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