Termination of Franchise Agreements

Termination of Franchise Agreements

Franchising is one of the most popular ways to do business in New Zealand.  Generally, things go well for both the franchisor and the franchisee:  the franchisor receives the benefit of ongoing fees from the franchisee and the franchisee receives the benefit of the hard work done by the franchisor in developing a business concept and building up goodwill in the brand.

Often, however, things do not go quite so well, and this can be a particular problem for a franchisor where the term of the franchise agreement is long, often up to 10-20 years.  With such long terms, it may not be practical for the franchisor to wait out the term of the agreement if there is a problem with a franchisee.  The question arises for franchisors as to how to terminate successfully in such a situation.

Clearly, the franchise agreement will be the first port of call to determine the franchisor’s rights and remedies.  A well drafted agreement should contain certain clauses for the franchisor to be able to terminate readily, including if:

  • the franchisee fails to pay any money to the franchisor (eg franchise fees or contributions to an advertising fund);
  • the franchisee fails to reach and maintain minimum standards;
  • the franchisee attempts to assign its interest in the franchise agreement without the franchisor’s consent;
  • the franchisee is convicted of any criminal offence;
  • the franchisee becomes mentally incapacitated;
  • the franchisee breaches any of the terms of the franchise agreement (where the breach is not remedied within a specified remedy period);
  • the franchisee damages the franchisor’s brand;
  • a receiver is appointed to the franchisee company.

Whatever the cause of termination, it is important that the franchise agreement clearly provides for the franchisor to retain control of the business in the event the franchise agreement comes to an end.  This can be achieved by:

  • ensuring the return of all documents supplied (eg manuals and client lists or any material bearing the franchisor’s trade marks);
  • requiring that the franchisee stop trading using the business systems and the franchise name;
  • providing for the franchisor to have control of telephone numbers and other contact details so that clients can directly contact the franchisor;
  • restricting the franchisee from engaging in any competitive activity for a period of time after termination (ie a restraint of trade);
  • permitting the franchisor to take back stock – the franchise agreement should set out a mechanism for determining the price that should be paid for such stock.

Depending upon the nature of lease arrangements for the outlets from which the franchisee carries on business, the franchise agreement should also entitle the franchisor to take up a lease of relevant premises, or cancel any sublease to the franchisee.

A franchisee can also find itself in a position where it wishes to terminate a franchise agreement.  Many franchise agreements will not have specific provisions providing for termination by the franchisee and the franchisee’s only remedy where the franchisor is in breach of the franchise agreement is to terminate pursuant to the Contractual Remedies Act 1979.  Often the franchisor will not negotiate on the terms of the franchise agreement but if the franchisee does have some ability to negotiate, then clauses can be included to allow the franchisee to terminate where:

  • the franchisor has breached the franchise agreement by failing to carry out its obligations as franchisor and fails to remedy that breach within a specific period of time;
  • the franchisor is placed in liquidation or receivership.

The franchisee should also consider the consequences of termination.  Will the franchisee be entitled to a refund or rebate of any franchise fee payable?  Will the franchisee be permitted to operate a similar business post termination notwithstanding a restraint of trade in the franchise agreement?  Will the franchisee be able to sell stock and other assets on hand to recoup some of its investment?

If the franchisor has been placed in liquidation, a franchisee’s ability to recover any refund or rebate may be limited.   Any restraint of trade contained within the franchise agreement should arguably not apply where the franchisee has terminated the franchise agreement for cause.  Likewise, a franchisee should have freedom on termination to sell stock and other assets to generate funds to cover bank and other debt.

While a franchisor and franchisee should be committing to a franchise arrangement with confidence that it will succeed, it is important that careful thought be given to the consequences of any necessary termination.  For those involved in franchising, the question should be asked – how good is your franchise agreement and does it contain the clauses you need?

Naturally, the same applies to similar types of commercial arrangement (eg a supply, distribution or licence agreement) and similar issues should be considered.