Franchise agreement — exit considerations

Franchise agreements are carefully drafted in favour of the franchisor to ensure protection of the brand and business long after a franchisee exits the franchise. With the downturn in the economy and increasing costs we are seeing many instances of exit events, be that breach and termination or franchisees simply wanting to leave. Also, many franchisors are remodelling and adjusting pricing structures leading to difficult negotiations and risk.

Pre-exit considerations

Before an exit event, a franchisor should carefully consider their options. For example, are there proper grounds for termination; are renewal conditions met or does the franchisee want to leave. What does the franchise agreement say in each of these instances?

It is important that the contractual terms agreed between the franchisor and franchisee are adhered to, as often we come across situations where termination has not been properly followed, or the franchisee does not realise that on expiry or termination the business might revert to the franchisor for a nominal sum, with restrictions then applying to prevent the franchisee from trading in a similar business or even from the franchise premises.

Other considerations that complicate matters are how the franchisee holds their property and what rights the franchisor has about the property interest. Some franchisors and franchisees poorly manage the property aspects and are unaware of the precise terms which apply. For example, does the franchisor have the right to seek an assignment; have a restriction on the title or the property owner to the franchisee tenant. Thinking these points through are especially important prior to seeking to negotiate an exit.

Important clauses

Some of the key clauses to consider when thinking about exit are:

• the initial term clause — how long does the franchise agreement last for and has this date passed (if so, does this give any rights to terminate on short notice — who can trigger these)?
• the renewal term clause — how early should notice be given before the end of the initial term?
• are the renewal conditions likely to be met?
• the termination clause — are there any breach grounds that can be relied on to terminate?
• the consequences of the termination clause — what are the implications of termination — a right to buy the franchisee’s business; how is price determined, etc?
• are any damages due from the franchisee and are there any losses?

Franchisor default

Franchisors must ensure they conduct their own contractual obligations imposed by the franchise agreement, such as training, advice, commercial support and the provision of franchise intellectual property for use by the franchisee. Failure to perform by the franchisor will lead to the franchisee arguing breach/loss at the exit point. The franchisor should consider these aspects as part of the pre-exit review so that strategies can be deployed to defeat any such claims.

Post-termination

During the life of the franchise agreement, franchisors generally share a vast amount of confidential/commercially sensitive information and licence their intellectual property. This is protected within the franchise agreement by way of restrictive covenants and confidentiality terms so it cannot be used by the franchisee once they have exited the franchise. During the exit process, the restrictions should be reviewed, and the franchisee reminded of their obligations. 

We do, however, come across situations where the restrictions have not been drafted properly rendering them useless. If the restrictions are unreasonable (e.g., drafted too widely) they will be unlawful, and the franchisor will not be able to demonstrate that they are reasonable to protect the franchisor’s legitimate business.

For more information, see our article on post-termination restrictions.

Action taken after the end of a franchise agreement needs to be properly thought out and planned to ensure that any future business conducted does not risk infringing any restrictions that might continue to be imposed by the franchise agreement, despite its end.