To get out of a franchise agreement, consider your options carefully

Table of Contents

A franchise agreement is a legally binding commitment for the term of the franchise with restrictions on exiting early.

Franchisors and franchisees must follow different steps if they believe they have grounds to unilaterally terminate the agreement. This will always depend on the circumstances.

What Can Franchisees Do to End the Franchise Agreement?

Franchisees may wish to end a franchise agreement early for a variety of reasons. The business may not be as successful as hoped, or the franchise system may have failed to meet expectations.

There are multiple options for getting out of the franchise agreement. Each comes with its own risks and consequences and should be assessed on personal circumstances. Few are straightforward.

Let’s look at some of the options.

Cooling-off Period

Under the Franchising Code of Conduct, franchisees have a 7 day cooling-off period to terminate a franchise agreement without giving a reason.

The right must be exercised within 7 days of entering into the agreement or making a payment under the agreement, whichever the earlier.

This doesn’t apply to the renewal, extension, variation or transfer of an existing agreement. For example, somebody buying an existing franchised business won’t have the right for a cooling-off period.

If a franchisee terminates during cooling-off period, the franchisor must refund any money paid by the franchisee within 14 days, less the franchisor’s reasonable expenses.

Sale of Business

If a franchisee wishes to sell their business, a franchisor can not unreasonably withhold consent to the sale.

The franchise agreement will set out the conditions for a transfer. If these are followed and the franchisee establishes that the buyer can perform the obligations under the agreement to an equal standard, the franchisee is generally free to sell their business.

The existing franchise agreement will either be assigned to the buyer, or more commonly, the buyer will enter into a new franchise agreement with the franchisor.

The outgoing franchisee and franchisor should enter into a written agreement to formally terminate the franchise relationship.

With exception to the cooling-off period or selling the business, a franchisee’s right to otherwise terminate a franchise agreement is limited.

Breach by the Franchisor

The Franchising Code of Conduct doesn’t grant franchisees the right to terminate a franchise agreement if the franchisor is in breach. However, some franchise agreements may allow a franchisee to terminate in some circumstances.

This could include a material breach of the agreement by the franchisor if they have failed to remedy that breach within a specified time.

Unless the agreement provides this express right, franchisees must rely on other legal rights which are set out below.

Walking Away from a Franchise Agreement

Closing the doors early and abandoning a franchised business is not advisable. Franchisors will normally have the right to pursue the franchisee for damages.

The landlord would have this same right if there’s a lease involved.

If the franchisee’s directors have given a personal guarantee, then walking away could expose the personal assets of the guarantors to risk.

Walking away should be an absolute last resort, and only after exhausting all options with an administrator or liquidation consultant.

What can Franchisors Do to End a Franchise Agreement?

Franchisors generally have greater flexibility in their ability to terminate a franchise agreement.

Breach Notice from Franchisor

A breach notice is a document you should never ignore — fail to act on it and your business may be at risk.

Formal breach notices are generally issued once a franchise dispute escalates and a conciliatory resolution cannot be achieved.

However, this is not always the case because some franchisors may resort to issuing a breach notice straight away.

What is a Breach Notice?

Under the Franchising Code of Conduct, a franchisor is permitted to terminate a franchise agreement if they give you a breach notice and you fail to remedy your breach in accordance with the requirements of the notice. A breach notice is the first step in the termination process and used as a formal warning that your business is non-compliant.

A breach notice must:

  1. specify the provision of the franchise agreement which has been breached;
  2. set out what you are required to do to remedy the breach; and
  3. provide a reasonable time for you to remedy the breach.

If the franchisor wishes to rely on the breach notice to terminate the franchise agreement, the notice must also state that the franchisor proposes to terminate the franchise agreement if the breach is not remedied.

If you fully remedy your breach in accordance with the requirements of the breach notice, then the franchisor cannot rely on that breach to terminate your franchise agreement.

If you fail to comply with all conditions of the breach notice, the franchisor is entitled to terminate your franchise agreement.

Remember that there are certain circumstances under the Code which entitle a franchisor to immediately terminate a franchise agreement without following the breach notice process, such as fraudulent behaviour.

I’m in a Franchise Dispute and Have Received a Breach Notice: What Should I do? 

Receiving a breach notice can be distressing, but don’t panic.

You should read the breach notice carefully together with your franchise agreement and note the deadline that has been given to remedy the breach.

The breach notice should clearly specify what you have allegedly done wrong and how that constitutes a breach of the franchise agreement.

Make sure you fully understand exactly what the franchisor wants you to do to remedy the breach.

If they want you to do two things but you only do one of those things within the deadline, that’s still grounds for the franchisor to terminate your franchise agreement because a breach must be remedied in full.

Sometimes to remedy a breach is as simple as paying an overdue payment or stocking approved products.

If the breach is an ‘easy fix’ then you should fix it immediately. As the saying goes, pick your battles because refusing to remedy a breach on principle because you are trying to prove a point will place your business in jeopardy.

Once you remedy the breach then you should provide the franchisor with evidence of your actions.

If you dispute the alleged breach or don’t believe the action required or the time given to remedy is reasonable, then that’s when you should try to negotiate a resolution with your franchisor and seek legal advice.

What is a ‘reasonable’ time to remedy a breach will depend on the circumstances. Seven days may be reasonable to pay an overdue account and one day to clean a dirty store.

In any case, the franchisor does not need to give you more than 30 days to remedy a breach (which can be problematic if the breach relates to failure to achieve ongoing KPIs or meet minimum performance criteria).

If you don’t think the franchisor has provided enough information in the breach notice to substantiate their allegations, then you should immediately ask them to provide more information.

If you are unable to resolve the issue with the franchisor, then you are entitled to invoke the franchise dispute resolution procedure under your franchise agreement or under the Code.

This procedure means that you and the franchisor must try to resolve the dispute, failing which, either of you can call for a mediation.

Be mindful that invoking this procedure does not prevent a franchisor from terminating a franchise agreement in the interim if the breach notice isn’t complied with.

No matter what you decide to do, communicating with the franchisor in a conciliatory manner is key.

Sometimes breach notices are the result of simple misunderstandings and other times they can be meant to trigger an aggressive response. Remain reasonable and professional.

Is the Franchisor Acting in Good Faith?

The Code requires both franchisors and franchisees to act in good faith towards each other.

Importantly, ‘good faith’ does not prevent a party from acting in their legitimate business interests. Just because the franchisor has issued a breach notice does not necessarily mean they are failing to act in good faith.

Remember that when you signed the franchise agreement you agreed to comply with the terms of the agreement and the franchisor’s policies, systems and procedures — the franchisor is entitled to enforce this.

Breach Notice: What are the Consequences?

Failing to remedy a breach in accordance with a valid breach notice will entitle the franchisor to terminate your franchise agreement. This will normally mean you lose your right to operate (or sell) the franchised business.

The franchisor may have grounds against you for damages. It also puts your personal assets at risk if you’ve provided a personal guarantee to the franchisor.

Be mindful that a breach notice can impair your future ability to renew the franchise agreement. It’s a condition under many franchise agreements that the franchisee ‘substantially complies’ with the franchise agreement to be entitled to renew the agreement.

Even if you remedy your breach, the fact that you breached the franchise agreement in the past could entitle the franchisor to refuse to renew it in the future.

Terminating a Franchise Agreement

There are also certain circumstances under the Code which provide a franchisor with options of immediately terminating a franchise agreement if the franchisee:

  1. no longer holds a licence which they must hold to carry on the business;
  2. becomes bankrupt or insolvent;
  3. if a company, becomes deregistered by ASIC;
  4. voluntarily abandons the business or the franchise relationship;
  5. is convicted of a serious offence;
  6. operates the business in a way that endangers public health or safety; or
  7. acts fraudulently in connection with the operation of the business.

Franchisors would need a strong basis and reliable grounds for making the decision to terminate a franchise agreement for these reasons.

Terminating a Franchise Agreement Under the Terms of the Contract

The Code also permits franchisors to terminate a franchise agreement where the franchisee hasn’t committed a breach. This will apply only if the agreement contains this express right.

The franchisor must provide the franchisee with reasonable notice and reasons for the termination.

Note that such provisions could be found by a Court to be an unenforceable unfair contract term under the Competition and Consumer Act 2010.

Franchisors would need justifiable reasons for terminating a franchise agreement using such a provision.

Other Ways to Terminate a Franchise Agreement

There are various other legal remedies available to both franchisors and franchisees to bring a franchise agreement to an early end. The following are some common grounds, however other avenues may be available depending on the situation.

Mutual Termination

Franchisors and franchisees can mutually agree to bring a franchise agreement to an early end. This should always be done in writing.

If franchisees initiate the request, franchisors generally require an exit payment. It is reasonable for franchisors to be compensated for losing out on franchise fees they would otherwise receive if the franchise agreement had run its full term. Franchisors may instead agree to buy back the business from the franchisee, but usually for under market value.

Franchisors are often free to on-sell the business to a new franchisee once the termination is formalised. The former franchisee generally has no right to the sale proceeds.

Dispute Resolution

If a dispute arises between the franchisor and franchisee and the dispute resolution procedure under the franchise agreement or the Code is initiated, it will often be mediated.

Sometimes the resolution may be an agreement to terminate the franchise agreement.

Mediation can assist the parties to negotiate a mutual exit if the franchise relationship is beyond repair.

Litigation

If litigation is commenced, a Court may be asked to bring a franchise agreement to an end or to treat the agreement as if it had never existed.

There are many different reasons why a party to a franchise agreement may commence litigation, which can often follow an unsuccessful mediation.

Some common grounds are misleading and deceptive conduct, misrepresentations, failure to adhere to the Code and repudiation. Court proceedings are costly and the outcome can never be predicted.

What are the Consequences of Terminating a Franchise Agreement?

If a franchise agreement is terminated and the franchisee is found to be at fault, a franchisor may ask a Court for an order for damages equal to the monies the franchisor would have expected to receive had the franchise agreement run for the balance of its term.

Franchise agreements normally otherwise outline what happens when the agreement ends. Franchisees will generally be restricted from using the franchisor’s brands and intellectual property, and will be bound to a restraint of trade.

Franchisors and franchisees should factor in these considerations and be mindful of the repercussions before acting to terminate a franchise agreement.

There are also penalties if franchisors or franchisees breach the Code.

Breaches of some provisions will attract penalties of up to $63,000 per breach, and these breaches may lead to infringement notices issued by the ACCC for $10,500 per breach.

Compliance with the Code must therefore be taken seriously.

Finally, always obtain legal advice on your options before taking steps to terminate a franchise agreement so that you are fully aware of any unintended consequences.

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