The ACCC regulates the Franchising Code of Conduct (the Code), which is a mandatory industry code that applies to the parties to a franchise agreement.
Franchise agreements are often for a term of five years or more. Getting into one is easy enough, however, getting yourself out of one is less straightforward.
FRANCHISEE INITIATED EXIT
Generally, franchise agreements do not provide a franchisee with an ability to terminate the franchise agreement. The one obvious exception to that rule is that if you change your mind shortly after entering into the agreement, the Code provides for a seven day cooling-off period. This would be reflected in your franchise agreement.
Once outside the cooling-off period, your options to exit the franchise are limited, but include:
- Surrendering your franchise back to the franchisor
- Transferring/selling to a third party with the franchisor’s consent
- Establishing a franchisor breach of the franchise agreement
Surrender to the franchisor
Surrendering your franchise to the franchisor is the easiest and fastest way to exit your franchise agreement. They are under no obligation to entertain it, but it may be that the franchisor is open to the idea of allowing you to exit as they might want to take over the business themselves, or, they may have other potential franchisees available to take it over.
However, you should be aware that a surrender will often require you to make an exit payment to compensate the franchisor for future lost franchise fees/royalties. On the other hand, if you have contributed financially to a fit-out of the business premises you may be able to set-off that amount against any exit payment the franchisor may wish to impose.
Either way, you will asked to sign an agreement surrendering your franchise agreement from a particular date. The Deed of Surrender will usually contain a release of the franchisee entity (whether corporate, trust or individual) and its guarantors from their obligations under the franchise agreement. Of course, you should obtain legal advice if you are not clear about any aspect of your exit.
Transfer/Sale to a third party
Rather than surrendering your franchise to the franchisor, you may wish to sell your business on the open market. Division 4, Part 24 of the Code permits you to request a transfer (sale) of your franchise. Again, there will be a clause in your franchise agreement that reflects what the Code says about transfers.
Essentially, the process is like this:
1) give the franchisor written notice of your proposed transfer and provide all the necessary information for them to make an informed decision about it.
2) The necessary information will include you telling the franchisor:
- When the proposed transfer/sale is scheduled to take place;
- Who the proposed transferee is;
- What experience (if any) the transferee has in operating a similar business;
- What capacity they have to meet the financial obligations that come with the franchise;
- If you are the tenant of the franchise premises, whether the landlord consents to an assignment of the lease to the proposed transferee.
3) Once armed with all the necessary information, the franchisor must not unreasonably withhold its consent to the transfer. There are a list of reasons in Division 4, Part 25 of the Code that explain when a franchisor may reasonably withhold consent, but the main ones are:
- The proposed transferee is not appropriately experienced in the type of business the franchisor operates, or, is not likely to be able to meet the financial obligations of the franchise;
- You are in breach of your franchise agreement in some important way and it has not (and will not) be remedied before the proposed transfer.
When you have the franchisor’s consent (and the landlord’s if required) it is then recommended you engage a lawyer to help you with preparing the paperwork. You will need to enter into a Contract for the Sale of Business with the proposed purchaser and you may also have a Deed of Termination with the franchisor. A solicitor experienced in franchise law is best placed to negotiate the terms of those documents on your behalf.
Establishing a franchisor breach
While your franchise agreement will generally not contain a specific right for you to terminate your franchise agreement, it may still be possible if the franchisor is in breach of an essential term of the franchise agreement, or, is in breach of the Australian Consumer Law by, for example, misrepresenting the profitability of the franchise business to you prior to you entering into the franchise agreement.
If you are in that position, you can use the dispute resolution procedure prescribed in your franchise agreement to, eventually, give notice of a termination. Your ability to do that will depend on the seriousness of the franchisor’s breach and whether they have done anything to remedy the breach.
In the event that you have terminated your franchise agreement for a franchisor’s breach, you may then start court proceedings against the franchisor and seek damages caused by the breach. For example, you might seek to recover the money you have lost by investing in the franchise and future profits you might have otherwise made but for the franchisor’s breach.
Again, those will be matters on which you should first obtain legal advice.
As a last resort, you may simply want to close the doors of your business and walk out. However, please note that if you do that, you potentially face the following actions:
- The franchisor immediately terminating your franchise agreement, as the franchisor is entitled to do according to the Code;
- The franchisor pursuing you for the fees it would otherwise receive during the remainder of the term of the franchise agreement;
- The landlord pursuing you for breaking the lease and for rent and outgoings until the end of the term of the lease; or
- If the franchisor is the tenant on the lease, you being pursued by the franchisor under the licence or sub-lease that you hold with them for unpaid rent and outgoings until a new franchisee is secured.
FRANCHISOR INITIATED EXIT
The circumstances in which a franchisor may terminate a franchise agreement are more straightforward. A franchisor may have a right written into the franchise agreement whereby it can terminate upon giving the franchisee a written notice that explains the reasons for it. More commonly, a franchisor’s right to terminate the agreement will arise from either:
- Franchisee breach of the agreement.
- Special circumstances.
When a franchisee is in breach of one or more obligations under the franchise agreement, the franchisor must send the franchisee a written notice under the Code that:
- Explains the nature of the breach under the franchise agreement.
- Tells the franchisee what it needs to do to remedy the breach.
- Allows a reasonable period (up to 30 days) to remedy the breach.
- Tells the franchisee that the agreement will be terminated if the breach is not remedied.
If the breach is remedied in accordance with the notice then the franchisor cannot terminate the agreement. If there is a dispute about the nature of the breach, a franchisee may have the dispute referred for mediation under the dispute resolution process contained in the Code.
A franchisor is not obliged to follow the process above when there are special circumstances, such as:
- When the franchisee does not hold the relevant licence to operate the franchise.
- When the franchisee becomes insolvent.
- When the franchisee abandons the business.
- When the franchisee is convicted of a serious offence.
- If the franchisee is operating the franchise in a dangerous manner to public health/safety.
- If the franchisee commits fraud in his capacity as franchisee.
- When the franchisee agrees to terminate.
It should also be noted that the Code does not give franchisees an automatic right to renew or extend their franchise agreement or enter into a new agreement after the initial term has expired. Whether that right exists will depend on the specific terms of the franchise agreement as negotiated by the parties. In that sense, if an agreement has no right to renew written into it, the franchise agreement will terminate naturally at the end of its term.
A FINAL WARNING – INSOLVENCY
Finally, both parties to a franchise agreement should be wary of how insolvency might affect them. Generally, a person or a company is insolvent if it cannot pay its bills as and when they fall due. For a franchisee, the immediate problem if you become insolvent is that the franchise agreement will permit the franchisor to immediately terminate the agreement. If a franchisor becomes insolvent it may have a wide range of disastrous consequences for franchisees, including:
- You could lose your right to trade using the franchisor’s brand;
- You could lose the right of occupation under sub-leases or licences where the franchisor holds the head lease.
- You could remain liable to suppliers, landlords, staff and lenders after your ability to trade is lost.
Whether you are franchisee or franchisor, if you are a director of an insolvent company, you may be personally liable for the debts accrued by the company during the period in which you allowed the company to keep trading while it was insolvent. The law provides several solutions to potential insolvency situations, so it is imperative that you get expert legal and accounting advice if you think you are on that path.
Blake Palmer, Partner – Head of Litigation
Blake Palmer is Partner at Baybridge Lawyers where he leads the Litigation Practice. Blake was admitted in 2002 and practiced as a solicitor for a decade before being called to the NSW Bar in 2011.
Blake has practiced exclusively in the area of litigation throughout his legal career. His principal practice areas are commercial litigation, equity and contract, competition and consumer law, construction, insolvency, mediation and alternative dispute resolution.
Head of Litigation
02 9232 3511