Business Law

Franchise Termination

A franchise agreement is a contract in which the owner of franchise business (the "franchisor") grants a license to a business operator (the "franchisee"), which allows the franchisee to run a business under franchisor's name. The franchisee is authorized to use and market goods or services under the franchisor's trademarks, service marks, and trade names, for a specific length of time.

The relationship can be beneficial to both parties. For example, the franchisee can sell goods that have instant name recognition and an established market, and the franchisor gets paid for the right to use its name and possibly royalties based on the franchisee's profits.

But, one of the critical parts of almost any franchise agreement deals with how, when, and by whom the franchise can be terminated, and what the parties are required to do, or not permitted to do, after it's terminated.

Before you sign a franchise agreement, it's vital that you understand the franchise termination provisions of the contract and how they work. A franchise agreement can be a complicated document, so depending on your business skills and experience, it might be a good idea to consult an experienced business law attorney to make certain the agreement protects your business interests and goals.

Termination by the Parties

Generally, a party to a contract can:

  • Suspend its performance under the agreement when there is a "material breach" of the contract by the other party, and
  • Terminate the agreement when there is a material breach and it's not cured or "fixed" within a reasonable time after a demand for cure has been made

A material breach is the non-compliance with a provision of the contract that, in effect, destroys the value of the contract or deprives a party of a benefit of the contract. For example, if a restaurant franchise agreement requires the franchisee to erect a sign with a large, bright yellow "M" of a specific design, and the franchisee instead uses a blue "M," it is likely a material breach because the franchisor has been denied contract benefits, such as reduced public exposure and profits.

In addition, many states have laws that govern franchise relationships, and they typically bar termination by the franchisor prior to the expiration of its stated term except for "good cause." The definition of "good cause" varies considerably from state to state, but generally the franchisor must give the franchisee written notice of any defaults that can be cured and a reasonable opportunity to correct them. Rarely do such laws restrict the franchisor's termination for material breach.

Events that often permit termination by the franchisor include the franchisee's:

  • Bankruptcy or insolvency
  • Criminal conviction
  • Loss of necessary licenses or leases
  • Failure to follow the franchisor's requirements regarding where the franchise store is located, the appearance of the franchise's building, signs, employee uniforms, or any one of dozens of other business operations
  • Failure to pay royalties to the franchisor or to report revenue
  • Failure to correct defaults after notice and an opportunity to cure, such as, in the example above of the restaurant franchise, not changing the blue "M" to the yellow "M"

The franchisee can terminate the contract in situations such as the franchisor's:

  • Failure to provide training and support as agreed
  • Fraud or misrepresentation with respect to potential profits
  • Failure to protect the franchisee's business opportunity or territory by, for example, allowing another franchise to open in the franchisee's territory
  • Bankruptcy or insolvency

Of course, notwithstanding the parties' ability to end the contract, the franchise agreement can terminate under other circumstances, such as when the contract term expires or when the franchisee does not exercise his or her right to renew the franchise- if the contract in fact gives the franchisee the option to renew after the original contract expires.

Post-Termination Do's and Don'ts

Franchise agreements should (and usually do) specify what the parties can and can't do after the franchise agreement terminates (or expires), such as:

  • Requiring the franchisee to stop using the franchisor's trade name, trademarks, etc., and changing the appearance of its business to make it dissimilar to the franchisor
  • A provision barring the franchisee from competing with the franchisor in the area for a specific period of time, commonly known as a "covenant not to compete" or "no compete clause"
  • Payment of all outstanding amounts due
  • Repurchase rights for branded inventory, that is, goods that have the franchisor's trademarks, trade name, or service marks on them
  • Return of the franchisor's manuals
  • A provision barring the franchisee from using the franchisor's trade secrets, such as recipes and customer lists

Questions for Your Attorney

  • Is the only way I can get out of a franchise agreement early is if the franchisor commits a material breach?
  • Can I transfer my franchise to someone else, and do I need the franchisor's permission to do it?
  • As a franchisor, after a contract is terminated, how can I guard against being liable for something a franchisee did before the contract terminated?
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