On What Grounds Can A Franchise Agreement Be Terminated?

In the dynamic world of business franchising, the relationship between a franchisor and a franchisee is foundational yet often complex. This relationship, governed by a franchise agreement, can face challenges leading to termination. Below are the common grounds for termination of a franchise agreement:

Franchisee’s Failure To Pay The Franchise Fee

The failure of a franchisee to pay franchise fees is a significant breach of the franchise agreement, carrying considerable implications for both the franchisee and the franchisor. This breach affects the contractual relationship and can lead to various legal and financial outcomes.

A franchise agreement allows a franchisee to operate under a business’s license, often requiring them to pay a franchise fee and a certain percentage of profits as royalties. This fee structure is fundamental to franchising models like McDonald’s and Shell. The franchise agreement, typically governed by the Federal Trade Commission and state-specific regulations, outlines each party’s obligations, including financial commitments​​.

Non-payment of franchise fees can lead to the termination of the franchise agreement. Franchisors may terminate the agreement if the franchisee fails to pay the initial fee, keep up with royalty payments, or contribute to brand funds, especially in repeated offenses. This termination is not just about the unpaid fees; it also pertains to maintaining the integrity of the franchising system and the financial stability it requires​​.

The failure of a franchisee to pay fees often indicates broader issues with their business operations, potentially leading to bankruptcy. In such scenarios, franchisors face a choice between terminating the franchise agreement, which could lead to costly litigation or adopting more lenient measures. Deferral or workout agreements provide an alternative, allowing franchisors to manage the obligations of a struggling franchisee. 

These agreements can restructure conditions, postpone certain actions, and provide flexibility for the future; a promissory note may be issued for past-due receivables with a payment schedule. This approach aims to gradually get the franchisee back on track while ensuring ongoing payments​​.

In challenging situations, franchisors might allow the closure of unprofitable franchise locations or offer conditional debt forgiveness, particularly for high-profile or otherwise successful franchisees. Deferral agreements can impose stricter conditions than franchise agreements, like more frequent financial reviews or required business improvements. Such measures help franchisors maintain control over the franchise operation and safeguard their brand reputation​​.

Prompt and clear communication regarding non-compliance with the franchise agreement is essential for franchisors. Failing to promptly address non-payment issues could lead to waiver and estoppel defenses by the franchisee. These defenses challenge the franchisor’s right to exercise remedies under the agreement, arguing that a tacit agreement has been formed due to the franchisor’s inaction. To avoid such scenarios, franchisors should formally document any relief or deferral agreements, thus maintaining their rights under the original franchise agreement​​.

Franchisee’s Insolvency

Franchisee insolvency is a critical issue in franchise relationships, with far-reaching implications for franchisors and franchisees. Understanding these implications requires a detailed look into bankruptcy processes and the legal nuances involved.

Franchisees contribute significantly to the U.S. economy, but financial distress can lead to bankruptcy. They primarily file under Chapter 11 for reorganization or Chapter 7 for liquidation. Chapter 11 allows franchisees to restructure debts while maintaining their business and franchise agreement. In contrast, Chapter 7 is typically chosen by those wishing to cease operations and involves an appointed trustee to liquidate assets. Franchisees may attempt to retain, terminate, or transfer their franchise agreement during these processes​​.

Franchisors, when dealing with bankrupt franchisees, pursue various goals. These include maintaining desired units in their system by asking a restructured franchisee to assume the franchise agreement or supporting the transfer of this agreement to a third party approved by the franchisor. 

In certain situations, franchisors may negotiate modifications to the existing franchise agreement to retain the franchise, obtain reaffirmation agreements, or take collateral securing payments and performance under the franchise agreement. Another key aspect is protecting their trademarks, intellectual property, and brand reputation, which may involve seeking court orders in bankruptcy proceedings​​.

Franchisors can collect due amounts from bankrupt franchisees through various means, such as dividends from bankruptcy proceedings, royalties, and “cure” payments concerning the assumption or assignment of franchise agreements. They may also seek court-sanctioned releases or statements to eliminate or limit liability arising from the franchise agreement​​.

The legal framework of franchisee bankruptcy includes several key aspects. The franchise agreement becomes part of the debtor’s bankruptcy estate upon filing under Chapter 7 or 11. However, if a franchisor has effectively terminated the agreement pre-bankruptcy, it does not become part of the estate.

Given these complexities, it is prudent for both franchisors and franchisees to hire the best franchise law firms. The automatic stay in bankruptcy prevents franchisors from enforcing actions against the debtor/franchisee without court approval. Moreover, the franchise agreement may be subject to assumption, assignment, or rejection based on bankruptcy court approval​​.

A Chapter 11 franchisee seeking to assume a franchise agreement must cure all outstanding defaults, provide adequate assurance of future performance, and compensate the franchisor for any losses due to defaults. This can be a significant challenge for franchisees, especially when the franchisor objects to the assignment of the agreement to a third party​​.

Safeguarding Your Interests

Terminating a franchise agreement involves various legal considerations, ensuring the interests of both franchisors and franchisees are protected. This process requires adherence to the specific provisions of the franchise agreement and applicable laws.

Franchise agreements, being contractual, contain specific provisions for termination. Common reasons for a franchisor to terminate include the franchisee’s failure to meet contractual obligations such as paying royalties, maintaining brand standards, or unauthorized changes to the business model. Conversely, franchisees may terminate the agreement if the franchisor fails to provide adequate support or breaches the contract in other significant ways​​.

Sometimes, the franchisor and franchisee may mutually agree to terminate the agreement. This usually occurs when the business partnership is no longer beneficial or sustainable due to market changes or shifts in business direction. Awareness of rights and obligations under the franchise agreement is crucial for both parties to navigate potential disputes and legal ramifications of such a termination​​.

Breach of contract is a primary reason for termination, and this can occur when either party fails to meet the agreed-upon terms. Upon identifying a breach, the aggrieved party must provide clear, concise notice outlining the specific terms violated and allow the breaching party adequate time to rectify the problem. Communication and support during this rectification period are vital, as termination can be costly and time-consuming for both parties​​​​​​​​​​.

Consulting with legal experts specializing in franchise law is recommended, particularly in complex scenarios such as franchisor breaches. This advice is crucial for understanding the termination clause, managing potential claims, and ensuring compliance with laws and regulations. Sometimes, terminating a franchise agreement may lead to court proceedings, underscoring the importance of legal expertise in navigating these processes​​.

Intellectual property issues can arise during the termination of a franchise agreement. It’s essential to understand the implications of changes to licenses and permits relating to intellectual property, such as trademarks and patents, as these can affect business operations and legal standing​​.

Financial considerations, including compensation claims and the impact on franchise fees, must be carefully assessed when terminating an agreement. If a franchisor terminates the agreement unfairly or without proper cause, the franchisee may claim compensation for losses. Initial and ongoing fees and royalties are also affected by termination, impacting the franchisor’s revenue and financial planning​​​​​​.

Navigating the termination of a franchise agreement requires a nuanced understanding of the contract and relevant legal principles. Whether you’re a franchisor dealing with non-compliance or a franchisee facing insolvency, it’s essential to approach these situations with professional legal support. If facing such challenges, consider consulting with experienced franchise law experts to protect your business and legal interests.

Please follow and like us:

Leave a Comment