A franchise relationship, as with a marriage, can come to an end. How can the two parties withdraw from a relationship in which they have freely shared each other’s business plans and secrets with a degree of fairness? How can the franchisor ensure that the departing franchisee does not become a competitor to himself and the franchisees remaining in the system?
A franchise relationship is one, which should be capable of subsisting over a long period of time. Nevertheless there will be occasions when it comes to an end.
How does a franchise relationship come to an end?
This can arise in a number of ways:
- There may be a breach of the franchise agreement by the franchisor.
- There may be a breach of the franchise agreement by the franchisee. Usually the agreement will provide for the franchisee to be given the opportunity to remedy this breach before the franchisor will terminate.
- Where, at the end of an agreement for a fixed term, the franchisee, who may hold a right of renewal, may choose not to exercise that right.
- The franchisee may sell the business and the purchaser may be granted a new franchise agreement if that is permitted.
- The interests of the franchisor and franchisee on termination are similar, although viewed from a different angle. Each is concerned to safeguard his commercial and financial interests.
- The franchisor will be concerned to safeguard his commercial interests so that he can appoint a replacement franchisee.
- On the other hand, the franchisee will be concerned to recover as much as he can financially, and to minimise the extent to which his future business activities will be restricted by the fact that he was a franchisee.
Most well-drafted franchise contracts will spell out clearly what is to happen upon the termination of a franchise contract for whatever reason.
The post-termination provisions of a franchise contract can usually be broken down into two categories:
- The first category will deal with those aspects which are concerned with the serverance of the relationship and the protection of the franchisors name and goodwill.
- The second category will deal with the method by which the franchisor will seek to protect his franchise’s know-how, trade secrets, and business methods so as to prevent the departing franchisee from unfairly making use of them in order to compete with the franchisor and the other franchisees.
The objectives of the first category are usually secured in the following way:
- The franchisor will be anxious to ensure that customer contact and continuity of service is maintained with the customers of the departing franchisee. In this respect, a well-drafted franchise contract will provide for the transfer of existing contracts between the franchisee and his customers to the franchisor together with any necessary financial adjustments.
- To complete the change of the visible public image reflecting the franchisors name and goodwill, the franchisee will be required to take certain steps such as:
Steps to complete the change
- Make application to the appropriate authorities to cancel any trademark licence which may be recorded with them relating to the use by the franchisee of the franchisor’s trademarks or service marks.
- When appropriate, change the fascia, décor and shopfitting of premises and the livery of any vehicles.
- Return all advertising, packaging, marketing and promotional material associated with the franchise.
- Cease to use stationary, literature, etc. bearing the franchisors trademarks and service marks, trade names and other reference to the franchise.
- Return operations manuals.
- Cease to use the franchisors system.
- Cease to use the franchisors copyright material.
The objectives of the second category are usually secured in the following way:
- The franchise contract will contain promises on the part of the franchisee which are commonly known as covenants in restraint of trade and non-competition covenants. For example, it is customary for the franchisor to extract a promise from the franchisee in the franchise contract that the franchisee will not compete with the franchisor, or any other franchisees within a certain area and stated period after termination.
- The franchisor will be anxious to ensure that the franchisee does not disclose any confidential information imparted to him and/or use it in competition with the franchisor or any of his franchisees.
Difficulties arise in relation to the imposition of restraints on the future business activities of the franchisee and the extent to which they may become competitive with the business of the franchisor and his other franchisees.
It should be appreciated that to some extent each franchisee is concerned that a fellow franchisee should not break away and engage in unfair competition, making use of the knowledge acquired as a former franchisee.
The fixing of reasonable periods of time and area of operation has to be done by reference to what is permitted by law, the nature of the business and its area of operation. Obviously, the criteria applied for a retail shop in a densely populated city will be different from those which apply to a mobile phone operation in a sparsely populated rural area.
By and large, most terminations, even for breach, can be settled between franchisor and franchisee in a civilised way. Once the relationship has broken down an amicable parting is usually capable of achievement and will provide the best solution for a franchisee whose business may be bought, either by a franchisor or by a prospective franchisee who is interested in taking it on.
Sale of stock
Where property does not play a significant part in the operation of a particular franchise, the franchise contract may nevertheless require the franchisee to sell to the franchisor all his equipment, stock of products, etc.
Such provisions operate for the benefit of both parties. They enable the franchisor to ensure that the franchisee is divorced from the franchise system.
The franchisee, on the other hand, is able to obtain a fair price (if the content is properly drafted) for his equipment and stock. These would otherwise be of little use to him, given the nature of the non-competition and restraint of trade covenants which are invariably found in franchise contracts.
As we have seen, the end of a franchise relationship need not be as traumatic as some people appear to believe. If the franchise is subject to a well-drafted contract, there is no reason why both parties should not know precisely where they stand in such a situation and be able to part amicably.
However, this subject does provide yet another illustration of the need by both parties to have a contract which has been professionally prepared by an experienced franchise lawyer and specifically for the franchise in question with the objective of covering such eventualities as are foreseeable in that particular franchise.