Grounds for Termination of Franchise Contract (General View)

Image result for termination of contractOne of the challenges in drafting a contract is the termination clause. The right to terminate a contract is, in practice, often the most important aspect of the law of contract, yet this significance is often concealed in contract texts.[1]  In general, there are two common grounds for terminating the franchise contract, namely (i) termination by provisions in the franchise contract and (ii) termination by legislation. The second ground is usually used to terminate agreements without termination clause. Therefore, either party is able to propose the termination of the contract if the agreement infringes certain legislation.

  1. Franchise Contract with Termination Clause

Termination in Cooling Off Period

It is unusual for a franchisee to be given an early right to terminate. In practice, often the existence of the franchise is in a weak position compared to the franchisor. However, the cooling-off period allows the franchisee to terminate the franchise agreement within a specified period after entering the agreement, or prior to the payment of any non-refundable money. Some jurisdictions take the view that a cooling-off period is a necessary protection that gives a franchisee the chance to “back out” of an executed franchise agreement.[2] For instance, Australia requires some sort of cooling off period after the execution of the franchise agreement during which the franchisee can withdraw from the relationship.[3]

Termination with no Breach by Franchisee

In general, this circumstance occurs when a franchisor terminates the agreement before it expires and without the consent of the franchisee. Before terminating the franchise agreement, the franchisor shall give reasonable written notice of the proposed termination, and reasons for it, to the franchisee. The right to end a contractual relationship must be found in the express text of the agreement, may arise by necessary implication to give effect to parties’ intentions, or be predicated on the other party’s fundamental breach. In the modern franchise context, the right to terminate is invariably found in the text of the franchise agreement, although it can also arise – in narrow circumstances – by implication of law. [4]

In some states in the USA, there is an obligation of the franchisor to repurchase inventory of franchisee upon termination of franchise. For example, under the Wisconsin Fair Dealership Law a franchisor shall repurchase all inventories sold by the franchisor to the franchisee for resale under the franchise agreement at the fair wholesale market value. Under the California Franchise Relations Act, where a franchisor terminates a franchise other than in accordance with the Act, he shall offer to repurchase the franchisee’s resalable current inventory at the lower of the fair wholesale market value or the price paid by the franchisee. Similar statutory protections of the franchisee’s investment exist in Connecticut, Iowa, Michigan, Washington, and Minnesota.[5]

Breach of Franchise Agreement by Franchisee

Franchise agreements usually give to the franchisor very extensive express power to terminate the agreement, and many different situations in which the Franchisor is allowed to terminate. The general mechanism is that a franchisor is required to give notice to the franchisee, and the notification to the franchisee to terminate the franchise agreement with the franchisee should be reasonable. On that case, the key then shifts to the franchisor to decide whether to terminate the franchise agreement. The franchise agreement typically provides a mechanism for doing so.[6]

A franchisor wishing to terminate the franchise agreement earlier (before the end of the term in the franchise agreement) will typically rely on the default and termination provisions of a franchise agreement. For instance, the franchisee conducted infringements such as non-payment of royalties, failure to achieve minimum performance or failure to provide periodic report. The default and termination provisions also usually set out what acts or omissions of the franchisee are curable or non-curable.[7] Mostly the agreement will be terminated if the franchisee has done a serious breach. A breach is considered “serious” if and when the continuation of the business relationship between the parties has become completely impossible.[8]

As an example according to American Law, a case of breach of contract by franchisee between 7-Eleven, Inc. v. Chaudhry [2002] was summarized as follows – A convenience store franchisor sued its franchisee for breach of three separate franchise agreements, fraudulent conveyance, and unfair trade practices stemming from the franchisee’s failure to maintain a minimum net worth of $10,000 per store. When 7-Eleven terminated the franchises, it conducted changeover audits that revealed unpaid balances on the three open accounts and fraudulent transfers of inventory among the franchisee’s stores. The court granted 7-Eleven summary judgment, based on the franchisee’s failure to respond to requests for admissions and its lack of opposition to the motion, and awarded 7-Eleven damages and legal fees of $567,930.64.[9]

Breach of Franchise Agreement by Franchisor

In many different situations, the franchisee has rights to terminate the franchise agreement as well. The general mechanism is that a franchisee is also required to give a notice to the franchisor. Moreover, in order to terminate a franchise agreement for breach by the franchisor, the Franchisee must show that the franchisor has breached a condition of the Franchise Agreement or fundamentally breached the terms.

The franchisee is required to show that the franchisor broke key terms of the franchise agreement. The breach of the franchise agreement has to be extensive.  So much so that it becomes practically impossible for the franchisee to continue operating the franchise. For instance, the franchisor failures to provide training and support as agreed, fraud with respect to potential profits, failure to protect the franchisee’s business opportunity or territory.[10]

As an example according to American Law, a case of breach of contract by a franchisee between Mathis v. Exxon Corp. [2002] was summarized as follows – The franchisee (Mathis) alleged that Exxon had set gasoline prices at a level to drive them out of business and replace them with company-operated retail outlets. The franchise contract was terminated, and the jury awarded the franchisees $5,723,657, exactly 60 percent of the claimed overcharge. The trial court also awarded plaintiff’s attorney fees in the amount of $2,289,462, or 40 percent of the damages.[11]

  1. Franchise Contract with No Termination Clause

The circumstances in which a franchisor may terminate a franchise agreement are generally governed by termination clauses in the franchise agreement. However, there are also some franchise contracts with no termination clause, and the termination of this kind of agreement is usually based on expiry of agreement or legislation of the state.

 Expiry of Franchise Contract

It is common that the franchise agreement will terminate at the end of term if either the franchisee or the franchisor does not wish to renew it. Indeed franchise agreements usually grant rights to the parties for a significant period of time, ten or twenty years often with the right to renew. Even longer terms are often seen. Such lengthy terms are justified by a number of reasons. For instance, local laws sometimes establish that rental agreements for the unit franchise premises must have certain terms which necessarily influence the term of the agreement.[12]

There are some countries that impose a minimum term for the franchise agreement. A minimum term ensures that the franchisee has a chance to recoup its initial investment into the franchised business. In Malaysia, the franchise agreement must be for a minimum period of five years. In Italy the term is three years. The Indonesian legislation requires a minimum term of 10 years for Master Franchise Agreements.[13]

Legislation on Franchise Contract

Nowadays, the franchise business system has obtained wide attentions of many states. The attention of the states then encourages them to regulate franchise with special requirements, as the absence of franchise legislation obviously gives a detrimental effect on the position of the parties, particularly in the position of the franchisee.  For instance, because franchising is not legislated for a particular problem, in some South American countries, a franchise agreement may be terminated without invoking any cause in the absence of legislation to the contrary covering distribution or agency agreements.[14] In the USA, because of the huge franchisor-franchisee imbalance of power and massive franchise fraud. 18 states have passed franchise investment or similar laws. These laws’ main purposes were to prevent franchise fraud and to address this imbalance.[15]

Therefore, although the parties did not provide any termination clause in their contract, the contract can still be terminated automatically on the basis of special circumstances as mandated in the state’s legislation, such as:[16]

  • Franchisor no longer holds a licence that the franchisee must hold to carry on the franchised business;
  • Franchisor or franchisee become bankrupt, insolvent under administration or an externally‑administered body corporate; or
  • in the case of a franchisee that is a company—become deregistered by the government;
  • Franchisee voluntarily abandon the franchised business or the franchise relationship;
  • Franchisor or franchisee is convicted of a serious offence;
  • Franchisor or franchisee operate the franchised business in a way that endangers public health or safety;
  • Franchisee acts fraudulently in connection with the operation of the franchised business.

 

Bibliography

[1] J. Birds, R. Bradgate & C. Villiers, Termination of contracts (Contract law series), at 3, (1995)

[2] See J. Sotos, supra note 8, at 9

[3] (https://www.accc.gov.au/publications/the-franchisee-manual/the-franchisee-manual/ understanding -your-agreement/cooling-off-period), last visited (03-10-2016)

[4] J. Lisus & A. Ship, Restrictions on Unilateral Termination of Franchise Agreements, Canadian Business Law Journal, at 114, (2010)

[5] J. Sotos, Recent Trends in Franchise Relationship Laws, the IBA Annual Conference, at 10, (2011)

[6] (http://www.lawworks.ca/franchise-law-blog/ending-the-franchise-relationship/terminating-a-franchise -agreement-a-primer/), last visited (04-10-2016)

[7] Curable defaults refer to defaults of the franchisee which he can diffuse, repair, or cure. The franchisee can get out of trouble by complying with curing requirements set out in the franchise agreement and, by doing that, avoid being terminated. Non-curable defaults refer to defaults of the franchisee which he or she cannot cure.  Having committed non-curable defaults, the franchisee cannot cure those defaults.

[8] C. Sunt, Termination of Franchise Agreements in Belgium—Legal Pitfalls, Franchise Law Journal 5.1 , at 3, (1985)

[9] W. A. Scott, J. H. Wolf, & A. P. Hillman, Franchising from A (Arbitration) to T (Termination), Franchise Law Journal, at 193, (2013)

[10] (http://business-law.lawyers.com/franchises-franchising/franchise-termination.html) last visited (03-10-2016)

[11] See W. A. Scott, J. H. Wolf, & A. P. Hillman, supra note 11 at 193

[12] Gardner et all, Key Issues When Advising Master Franchisees and Area Developers (and Franchisors), International Journal of Franchise Law, at 11, (2013)

[13] J. Sotos, supra note 8, at 9

[14] O. Marzorati, Termination of the Franchise Relationship, International Business Lawyer 25, at  217 (1997)

[15] H. Y. Lederman, Franchising and Franchise Law: An Introduction, Michigan Bar Journal, at 3, (2013)

[16] (https://www.accc.gov.au/business/franchising/ending-a-franchise-agreement) last visited (03-10-2016)

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