Franchise termination refers to the process of ending a franchise agreement between a franchisor (owner of the business) and a franchisee (owner of a specific location or unit of the business).
Termination can occur for various reasons, including breach of contract, failure to comply with franchise standards and guidelines, bankruptcy, or mutual agreement.
The termination process typically involves the franchisor sending a notice of termination letter to the franchisee, followed by negotiations or legal action to resolve any issues that may arise.
The termination may result in the closure of the franchisee’s business or the transfer of ownership to another individual or entity.
Why franchise termination is an important issue for franchisors and franchisees alike:
Franchise 101: There are a number of reasons for failed franchises.
A franchisor might terminate a franchising agreement due to poor performance, non-compliance with the franchise agreement, or even termination by the franchisor’s parent company.
For franchisees, the impact of breach of contract damages can be significant, ranging from loss of income to loss of reputation.
Understanding how to get out of a franchise agreement when necessary is important. However, the termination of a franchise agreement can have significant financial and legal implications for both parties involved.
The legal and financial implications of franchise termination:
The franchisor may lose a source of revenue and brand presence, while the franchisee may lose their investment and livelihood. Therefore, it is important for both parties to approach the termination process with care and consideration.
Franchise agreements typically include specific clauses outlining the termination process, including steps that must be taken before termination can occur. It is important for both parties to follow these steps and consult with legal counsel to ensure that their rights are protected. Understand that regardless of the contract terms, there may be state/commonwealth laws that restrict or bar such terms from being enforced upon their citizens and in-state franchise businesses.
When Can a Franchise Relationship be Terminated?
When considering franchise termination, it is important to understand the grounds for termination.
The grounds for termination typically include:
- Noncompliance with the franchise agreement: A franchisor may terminate a franchise agreement if the franchisee is not in compliance with the terms and conditions of the agreement, or due to a material breach of contract.
- Failure to pay fees or poor performance: Franchisors may terminate a franchise agreement if the franchisee’s performance and financial obligations do not meet their standards or expectations.
- Changes in the industry: Occasionally, a franchise may have to terminate an existing franchise agreement due to changes in industry regulations or the franchisor’s business model.
- Termination by a parent company: Franchisors may terminate existing franchise agreements due to decisions made by their parent company.
It is important to understand the grounds for franchise termination, as it can help a franchisee to avoid termination and, if necessary, to develop a dispute resolution plan. Be sure to document any breaches or violations by the franchisee.
Moreover, if the franchisor terminates the agreement due to a change in its strategic marketing goals, you will likely be entitled to a settlement from the franchisor reflecting the value of your franchise business at the termination date.
Notice Requirements for Franchise Termination
When it comes to notice requirements, a franchisor should provide a timely written notice (franchise letter) of the intention to terminate, cancel, or refuse to renew the franchise.
This notice should:
- Set forth the alleged violations under the franchise agreement.
- Provide 60 days’ notice before cancellation, termination, or non-renewal is permitted (this time period may vary in the contract terms and state/commonwealth requirements).
- A franchisor cannot contract around the terms of any applicable statute regarding termination notice.
A franchisor must comply with all notice requirements to avoid potential franchisee lawsuits.
The Franchise Termination Process
Wondering how to terminate? There are specific steps that a franchisor must take for proper legal termination:
- Identify the violation of system standards: You will need to gather all relevant information relating to the franchisee violation with the franchise agreement: obtain this information by reviewing inspection and incident reports, looking over all related email correspondence, and interviewing relevant personnel involved in the violation.
- Decide if the violation warrants default or termination: Consider if the franchisee’s conduct is significant enough to warrant a violation by default or by the termination of the franchise agreement.
- Place the franchisee in default: Take time to review the specifics of the franchisee default. Then determine whether the violation is of the type that provides the franchisee with an opportunity to cure (resolve) the violation.
- Properly deliver the notice of default: Determine how, where, and when to deliver the default. State franchise laws set forth time guidelines. In many cases, the default is not considered to be effective without a confirmed receipt of the notice. Check all franchise laws by state.
- Give the franchisee time to cure a violation: Timing is important. The franchisor must give the franchisee time to cure the default. However, does the franchise agreement provide for an incurable default if the franchisee is habitually violating the agreement?
As mentioned earlier, there are potential costs and consequences of franchise termination for both the franchisor and the franchisee. Keep all of this in mind.
But also note that franchisees also have the right to terminate an agreement, which the franchisor has breached. Oftentimes, the agreements give little or no attention to this potential event. Yet, franchisors have contractual obligations, which, if ignore or broken, will open them up to termination and liability.
Alternative Dispute Resolution for Franchise Termination
In some cases, termination may be avoided through alternative dispute resolution (ADR)(mediation and/or arbitration). Mediation between parties having good faith can often lead to a mutually beneficial resolution without having to go through costly and time-consuming legal proceedings. Here are more specifics about the two forms of ADR:
- Mediation: In mediation, an independent person called a “mediator” helps both sides dispute their claims. They aid them with communication and understanding each other and the contract terms, and if possible, reach an agreement that pleases both parties. The mediator does not take a position (side) in the matter. They are simply there to help aid a solution. A resolution is not imposed on either party.
- Arbitration: In arbitration, it is agreed that a neutral arbitrator (one or more persons) has the authority to make a decision about the dispute. This may allow for franchise operations to continue, which could benefit all parties. However, it may result in termination with an award of damages, and oftentimes attorneys fees and costs, on the losing party.
The benefits of using ADR methods to avoid costly and time-consuming litigation:
ADR is a less formal and less expensive method of resolving disputes. It is far less time-consuming than a civil trial.
Arbitrators should have franchise experience, which will assist in reaching a just resolution.
ADR has the added benefit of allowing people to have an opportunity to decide exactly how and when their dispute will be resolved.
The process of franchise termination is a serious one, and all attempts should be made to avoid it if possible.
- Both franchisee and franchisor should employ all efforts to adhere to the franchise contract.
- The parties should keep one another apprised of any issues before a conflict arises.
- The parties should work amicably within the franchisee agreement to maintain the franchise relationship.
Furthermore, the franchisee should be sure to review the agreement before signing and ask questions to ensure all necessary steps and procedures are followed.
Adhering to all of the above should ensure the franchisee avoids franchise termination. This will help maintain a successful relationship with the franchise. Doing so is beneficial for both franchisors and franchisees alike, as it allows them to work together to grow the business and reach their objectives.
However, sometimes a franchise business fails. If issues arise, seek legal advice before termination to avoid potential legal disputes or to enable an exit strategy that is less costly and less stressful for both parties.
Reach out to Kilcommons Law with any concerns you may have about your contractual obligations. We will assure that you understand your franchise rights. We are here to assist you understand the franchise business model and franchise laws from the start, as well as mediate or arbitrate any possible disputes at affordable rates.
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