Franchise Agreement – Termination

Can a franchisor end a franchise agreement?

It is common for franchisors to set out, in the franchise agreement, those circumstances when they are entitled to terminate a franchise agreement.  Termination is often reserved only for those circumstances which truly justify it, such as the following:

(a) where the franchisee threatens to cease, or does cease, trading;

(b) where there has been foul play on the part of the franchisee such as by misreporting profits from which a royalty fee is calculated; or

(c) there has been misuse or abuse by the franchisee of the intellectual property owned by the franchisor; or

(d) there are repeated breaches of more minor clauses of the franchise agreement which have not been rectified following notice by the franchisor.

These are not exhaustive examples – it is open to the parties the franchise agreement to decide what circumstances should exist before termination is a remedy which is available.   With most franchise agreements, it is case that the franchisee is in a “take it or leave it” scenario when deciding whether to sign up to the agreement – so, it is more a case of appreciating what circumstances exist that justify termination as opposed to seeking to understand and negotiate them.

Whether a franchise agreement can lawfully be terminated therefore often depends on two key aspects:

(a) whether the franchise agreement provide the right, in any given circumstances, to terminate the agreement; and

(b) whether the circumstances addressed by the specific termination clause have materialised.

In terms of whether the circumstances exist, this is often a matter of fact which the franchisor must be able to prove if challenged to do so by the franchisee.  If it cannot do this, it risks a finding by a court that the franchise agreement has been unlawfully terminated.

Whether the termination clause covers the specific factual circumstances relied upon by the franchisor depends on the wording of the clause itself.  Sometimes, the position is clear, although often, it is not and there is scope for argument.  A court does not seek to side with one party of another when determining this issue of construction.  Instead, it looks at the wording in the specific clause relied upon and considers this in the context of the franchise agreement as a whole.  It would seek to put itself in the position of a reasonable observer, possessed of the facts of the franchisor and franchisee at the time of entering into the franchise agreement and, applying commercial common sense, interprets and applies the clauses.  This general principle of construing contracts and their clauses has been set out by the House of Lords in Investors Compensation Scheme -v- West Bromwich Building Society [1997] UKHL 28.

However, certain clauses in the franchise agreement may be construed in different ways.  Indemnities, for example, or clauses which seek to exclude or limit a franchisor’s liability may be interpreted by a court contra proferentem, which means against the person relying upon them (often the franchisor).  Where this rule is applied, it means that any doubt is usually resolved in favour of the franchisee.  Whether this remains the law is arguably debatable in light of the judgment of the House of Lords decision in West Bromwich.

What are the consequences of termination?

This depends on whether it was lawful or not.  Assuming it was lawful, the franchise agreement will usually set out the consequences of the termination and it is common place that the following obligations would apply to the franchisee, requiring it to:

(a) stop trading in the franchise business;

(b) return any operations manuals, documents and other property owned by the franchisor (sometimes, this can extend to property owned by the franchisee, especially in the case of stationary using the franchise trade name);

(c) transfer customer contracts and details to the franchisor or its nominated third party (perhaps another franchisee); and

(d) cease operating with the franchise industry and be prevented from competing with the franchisor for a period of time.

A wrongful termination may lead to the innocent party having a substantial claim.  As franchise agreements can be for a lengthy period, often 10 years or more, the risks of a wrongful termination can be costly.

A franchisor that wrongfully ends a franchise agreement may be met with a lost profit claim for the remaining franchise term and possibly a claim for the value of the business had the franchisee been able to sell it at a later time.  Quantifying the value of such claims can be difficult and it is important to seek expert advice from experienced solicitors in this regard.

A franchisee that wrongfully terminates may be met with a claim by the franchisor for lost royalties for the remaining term of the franchise agreement.  Depending on the terms of the franchise agreement, it may be possible for the franchisor to increase its claim by seeking a sum for the lost sale opportunity following a termination.

Next Steps?

In addition to making a claim for damages, a disgruntled franchisor may seek to prevent a franchisee from breaching post-termination covenants in a franchise agreement by seeking interim injunctions from the court.  Any franchisee which potentially finds itself in this situation should seek advice urgently, as once an injunction application is issued against it, there will be the difficult question of who should be liable for the legal costs of seeking the injunction.  Those costs, at the interim stage, and within only days of making the application, can be in the region of £15,000 plus VAT or more.   Steps can be taken to reduce the risks to franchisees of this occurring by engaging with the franchisor and seeking to address matters in such a way that make it less attractive to make that kind of application and articulating a case properly is key to achieving this.