Franchise Termination Explained
Franchise Termination. Although franchisees generally do not understand or believe this, in the world of commercial real estate there are many forms of commercial leases that do have a set "end" date. However, unlike a typical commercial lease, the franchisor’s right to terminate the Franchise Agreement is not subject to any "end" date. In fact, the franchise relationship is generally perpetual absent a breach of the Franchise Agreement by the franchisee. Or in the past, mutual termination may have been agreed upon between the franchisee and the franchisor.
There are many reasons why a franchise agreement is terminated. For example, among other things, it could be an economic decision made by the franchisor because they no longer feel that your store is generating enough revenue to be part of their franchise system. Along those lines, the franchisor could determine that that market area has become over-saturated with their brand or simply not performing to their expectations. The franchisor could make the business decision to terminate under the age-old business belief you can have too much of a good thing.
There are also situations where the franchisor could terminate the franchise agreement for cause. Some of the more prevalent causes for termination are: (1) failure to maintain adequate books or submit them as required; (2) failure to pay the required fees; or (3) selling retail merchandise at unreasonably high or non-competitive prices.
Regardless as to the reason for the termination, the franchisor must follow the applicable law, which may confer certain rights on the franchisee. This is of particular note in respect to a termination without cause situation.
As you may know, the Federal Trade Commission (FTC) and many states require franchisors to provide certain disclosures to prospective franchisees in order for the franchisee to become franchisee. These disclosure requirements fall under the disclosure rule (FR 436) of the FTC Franchise Rule .
The purpose of this disclosure requirement is to ensure that the prospective franchisee can and will have a franchise business that they can pass along to their children or sell when they retire or want a change. If proper disclosures were not made to the franchisee or they were not adequate, many states recognize sans expiration a seller enabled to rescind (see the description of rescission).
The effect of termination can put the franchisee or franchisor in a bind if the franchisor is not complying with the law with regard to disclosure and rescission. While it is clear that the FTC does not require franchisors to provide prospective franchisees with the opportunity to rescind their Franchise Agreements for disclosures made after October 21, 1978, a Franchise Agreement that was executed on or after that date is considered an offer by the franchisor to sell prospective franchisors a franchise in the absence of the disclosure requirement. Thus, if a franchisor does not make the necessary disclosures, the FTC and most states consider the franchisor to have offered to sell a franchise to prospective franchisees as of October 21, 1978 without complying with the FTC Franchise Rule requirements. While there are different results regarding when the FDA and, therefore, the individual states consider the franchise to be sold, there are many states that take the position that the franchisee has an indefinite period in which to cancel the Franchise Agreement and will be permitted to do so at any time between the date the disclosure materials were supplied to them and the time a renewal franchise contract is offered to be extended to them.
If you have received a termination or rescission letter from a franchisor, do you know if they complied with the disclosure requirements? If not, you may be able to replace your franchise contract as a result of the franchisor’s failure. Even if they have complied with the required disclosure, you may wish to have an attorney review all facets regarding the franchise termination as you may have a right to recover your lost sales if the franchisor over the years forced you to mix and commingle your products with the franchisor’s.
Key Components of a Termination Notification
When it comes to making a termination effective, there are at least two important practical considerations: first, the language used in the termination notice must convey the appropriate tone; and second, the terms and conditions, if any, contained in the franchise agreement must be considered prior to issuing a termination notice.
With that in mind, here is a short and non-exhaustive list of the most common terms and conditions to consider from the franchise agreement when crafting a termination letter:
- Terms for terminating must be consistent with the terms under which the franchisor can terminate the franchisee;
- The specific grounds for termination must be stated;
- The letter must state the time period during which the franchisee has to remedy any default, or affirm termination if there is a failure to remedy the default within the specified time period;
- Notice requirements must be followed;
- Consideration should be given to the form of the letter, as well as the mode of transmission (e.g., fax or e-mail);
- A termination notice should be signed by the individual(s) responsible for enforcing, administering, and/or interpreting the enforcement policy contained in the franchise agreement;
- The termination should not be dischargeable in bankruptcy, and should state that a termination "is not a discharge under the Bankruptcy Code";
- Any refund or miscellaneous amounts from the franchisee should be referenced in the letter; and
- Compliance with local law must be considered, in addition to your own corporate policies and procedures.
Exhibiting restraint in the same letter containing the termination may help insulate franchisor from allegations of acting in bad faith during the termination process and may prevent the promulgation of new franchise legislation. Sometimes the better course of action is to delay the sending of a termination notice until after mediation or other proceeding, although that approach has its own risks. In short, each situation is unique and should be evaluated accordingly.
Legal Implications and Considerations
In addition to the business and emotional aspects of franchise relationship terminations, the freedom to terminate is also subject to strict legal limits imposed by state and federal franchise and business opportunity laws. A franchise agreement "of course can be terminated or allowed to expire upon the mutual consent of both parties, however, there are relatively few requirements that must be met before a franchisor may unilaterally terminate or refuse to renew its franchise agreement." Thomsen v. 7-Eleven, Inc., 147 F.3d at 951. The remedies available for a wrongful termination or a failure or delay in processing operational license applications can be severe. Franchisors should do everything possible to avoid litigation related to terminations.
Despite the inherent asymmetry in a franchisor-franchisee relationship, when an "at will" franchise relationship terminates, the terminating party must do so in accordance with applicable laws that may provide thirty (30) or sixty (60) days’ notice. Even where the franchisor has "good cause" to terminate based upon noncompliance with one or more provisions in the Franchise Agreement, such as nonpayment of royalties, terminating the franchise relationship must be done in accordance with franchise laws. At least one state, Hawaii, has created a private right of action for damages, other than the ordinary breach of contract damages, sustained by a franchisee or subfranchisee as a result of a franchisor’s bad faith failure to renew a franchise agreement or a franchisee’s bad faith termination of a franchise agreement. Similar laws exist in other jurisdictions and a franchisor should consult carefully with counsel familiar with the franchise statutes in the states that it operates in.
The failure to comply with the statutory termination requirements can impose monetary penalties and give rise to private causes of action sought by the terminated franchisee. The franchisor may also be liable for any actual damages suffered as a result of the unauthorized termination under a regular breach of contract theory. Where the franchise agreement contains a choice of laws clause, the law of another state may apply – regardless of where the termination takes place.
Sample Franchise Termination Notification Template
A well-structured franchise termination letter consists of an introduction with an opening statement of the intent to terminate, a main body which includes the legal and factual bases for such termination, and a closing which will provide the terminated franchisee with directions regarding the disposition of its assets, actions that must be taken upon receipt of any remaining inventory and supplies, and contact information for the franchisor. Following is a suggested structure:
Date
Addressee
CC
RE: Termination of Franchise Agreement for territory
Dear Franchisee ,
I regret to inform you that FranchiseCo has elected to terminate your Franchise Agreement effective immediately by operation of the late payment default provisions of Article ___ of your Franchise Agreement. You are hereby advised that FranchiseCo is waiving any and all additional defaults and is not electing to terminate your Franchise Agreement on any other grounds.
We would like to take this opportunity to thank you for the contributions you have made to our system during your term as our franchisee. If you would like a reference from us in the future, please let us know.
In your last days with us, we would like you to complete your requirements under the Franchise Agreement.
The Franchise Agreement requires you to:
Please advise us of your plans for completing the above requirements. We would like to schedule an early date for completing these tasks if you are able to do so.
If you have immediate questions, don’t hesitate to contact _______________ at ____________.
Sincerely,
Name
Title
Franchise Termination Common Pitfalls
Even when not managed "in house", termination-related matters trigger special oversight of outside counsel to ensure that matters proceed smoothly. Terminations are one of the fraught times in franchises, so it is little surprise they generate more than their share of mistakes. Here are some of the most common:
1. Ending Relationships Formally.
Just because a franchisee has cornered themselves into a bad situation does not mean that the resulting relationship deserves to go down in flames. Formal cut-offs terminate business relationships, while they still have the potential to be mediated. Carefully consider and avoid any unnecessary post-termination litigation.
2. Making Published Statements.
While this may be unavoidable depending on the circumstances, a final published statement about why a franchise was terminated can signal to prospects that you do not honor contractual commitments or pursue claims for breach of those agreements. This essentially places you on the same difficult path as an employment or creditor "lift letter."
3. Terminating at the Wrong Time.
There is always a point of no return in a bad relationship. The time to terminate is neither at the first hint of trouble nor after the relationship has irreparably deteriorated. Involving experienced counsel early in the process is one way to avoid this problem and deal with the franchisee’s efforts to heal a decaying relationship.
4. Empowering the Franchisee/Former Franchisee.
There is a rare exception to the "bad news" approach above, which is not to burn one’s bridges. With some franchisees and/or former franchisees, it is useful to keep them engaged in the business so they are unable to use even insignificant events to claim damages. thus, while you may treat a terminated franchisee with little if any communication, a marginal former franchisee may remain engaged; even as a quiet industry stakeholder.
5. Ignoring the Issue.
Sometimes franchisees are allowed to wither on the vine, rather than being cut off. If they are actually contributing in some way to your network, consider niching these marginal units. Such units allow experimentation with market penetration to some extent, but are best handled with an offensive, proactive plan.
Effective Tips and Strategies
Maintaining a professional and respectful tone is crucial in all communications, including the termination letter. Avoid using confrontational or hostile language that may provoke an emotional response. Remember that your objective is to end the relationship on amicable terms, if possible. Be prepared for various responses from the franchisee. They may accept the decision, seek counsel, attempt to negotiate a settlement, or respond with lawsuits and claims for damages. Consider including a settlement offer or a mutually convenient time frame for the franchisee to vacate the premises . This can help mitigate potential backlash and sometimes leads to beneficial conclusions. Remain calm and professional if the franchisee reacts emotionally. The franchisee may feel anger, betrayal or denial. Authoritative reasoning is best in these situations, and it’s essential to remember that you maintain the legal upper hand. One option to consider is providing an option for facilitated dialogue where both parties can communicate their points of view in a structured manner. This may be a sensitive approach, but it can lead to mutually beneficial outcomes.