Franchisees often want to terminate franchise agreements for various reasons. For example, the business might not be performing well, the franchise relationship might have deteriorated, or the franchisee may want to try something new. However, before attempting to terminate a franchise agreement, franchisees should consider the legal issues and risks. This involves examining the franchise agreement and relevant laws. Here are the key issues for a franchisee thinking about how to terminate a franchise agreement.
Does the Franchise Agreement Allow Termination?
Most franchise agreements are for a fixed term and rarely include a clause that allows the franchisee to terminate at will. This means the franchisee must comply with the agreement for its entire term. Accordingly, terminating the agreement early usually breaches the contract.
However, some franchise agreements do have clauses allowing the franchisee to terminate. These might include an ‘at will’ clause, where no reason is needed to terminate, or a clause allowing termination under specific circumstances. Here, franchisees should carefully review their franchise agreement to understand their rights.
Consequences of Terminating Without a Contractual Right
If a franchisee terminates without a contractual right, the franchisor may file a claim against them. Terminating the agreement early is often a breach of contract, and the franchisor can claim damages. Some agreements specify the amount of these damages, often linked to the fees that would have been paid if the franchisee had completed the term. Even without such a clause, the franchisor can still pursue damages. In Australia, damages for breach of contract aim to compensate the injured party (the franchisor) for the loss incurred. The goal is to place the injured party in the position they would have been in if the contract had been performed as agreed.
Additionally, unilateral termination without a contractual right may be seen as a repudiation of the contract. Repudiation occurs when one party makes it clear they do not intend to comply or cannot comply with the contract.
Other Legal Considerations
Franchisees should consider several other legal issues before terminating the agreement:
Restraint of Trade Provisions: These typically prevent franchisees from competing with or soliciting customers or employees after the agreement ends. Franchisees considering operating independently should carefully review these provisions. The law concerning restraint of trade clauses is complex, and franchisees should seek specialist advice from a franchise lawyer.
Confidential Information: Most franchise agreements include clauses preventing the use of the franchisor’s confidential information and intellectual property after termination. This typically includes client lists and similar, which can limit what the franchisee can do post-termination.
Obligations on Termination: The franchise agreement will likely outline practical obligations, such as returning manuals and resources to the franchisor and allowing the franchisor to acquire the franchisee’s assets, like equipment.
Guarantee and Indemnity Provisions: These clauses extend legal liability to individuals. Even if the franchise agreement is terminated and the franchisee entity is liquidated, the guarantor may still be legally liable. An indemnity agreement ensures the indemnified party is protected from specific risks or liabilities. Guarantors commonly provide an indemnity in favor of the franchisor, meaning they will compensate the franchisor for any loss arising from the franchisee’s breach.
Other Security: Most franchise agreements contain clauses providing security to the franchisor. Besides guarantee and indemnity provisions, they can include PPSA provisions, granting the franchisor a security interest over the franchisee’s assets. Sometimes, the franchisor has the right to lodge a caveat over the guarantor’s real property.
It is crucial to be well-informed and seek proper advice before taking any action if you are a franchisee considering termination.
Key Takeaways:
- Review your franchise agreement to understand your termination rights.
- Assess the potential legal consequences of terminating without a contractual right.
- Consider other legal issues, including restraint of trade, confidentiality, termination obligations, and personal liability.