When Relationships Go Wrong

Rob Tiffen and Natalie Carman of Birketts highlight how a franchisee can terminate a franchise agreement

The majority of franchises operate successfully, with good relations maintained between the franchisor and franchisees. In fact, it’s this unique relationship between franchisor and franchisee that contributes to the success of the industry.

However, there is always a risk that the commercial relationship between franchisor and franchisee will break down to such an extent that a franchisee seeks to terminate the franchise agreement.

In order to lawfully terminate a franchise agreement, a franchisee must either have an express contractual right to terminate or a right to terminate as a matter of law.

Most franchise agreements have either no express rights for a franchisee to terminate their agreement or very limited ones. If the agreement does allow a franchisee to terminate the agreement, the franchisee should take legal advice on how they can use this to their benefit correctly. Often, these clauses are technically difficult and there can be traps for the unwary.

If the agreement does not allow a franchisee to terminate, a franchisee must rely on a right to terminate the agreement having arisen as a matter of law. The two usual ways to terminate a franchise agreement as a matter of law are either repudiatory breach or rescission.

Repudiatory breach

If one party to a contract acts in a way that’s significantly different to the way in which they are obliged to act, so that the benefit the other receives from the contract is radically different, they may have acted in repudiatory breach of contract. The other party can accept that and bring the contract to an end. 

Usually, poor performance or weak support by the franchisor is not enough to show that the experience a franchisee has had with the franchisor is sufficiently different to the franchisor’s contractual obligation to amount to repudiatory breach.

Also, if a franchisor’s conduct is repudiatory, the franchisee must act on that quickly. If a franchisee takes any steps that are consistent with the contract continuing (such as paying the franchisee fee, for example) it’s likely the franchisee will have lost the right to bring the agreement to an end by having affirmed (albeit impliedly) the contract.

Rescission

The other common argument franchisees use to try to bring their franchise agreement to an end is rescission. This is available if the franchisor misrepresented something about the nature of the franchise (usually financial performance).

If this is established, a franchisee can claim damages and elect to have the contract rescinded, and the court will make an order to put the parties into the position they would have been in if the contract was never entered into.

However, the majority of franchise agreements include an ‘entire agreement’ clause, which on the face of it is a disclaimer that would prevent a misrepresentation claim for either damages or rescission.

This clause is only enforceable if a court considers it reasonable, but whether or not a judge thinks it’s reasonable is notoriously difficult to predict. A franchisee will also lose the right to rescission if, after they’re aware of the misrepresentation, the franchisee affirms the contract (similarly to the position with repudiatory breach).

Wrongful termination by a franchisee

If a franchisee does not have a legal right to terminate the franchise agreement, there’s a risk that termination would amount to wrongful termination.

If a franchisee wrongfully terminated the agreement, they would be exposed to a damages claim, which is likely to be the franchise fee for the remainder of the term of the agreement (subject to the franchisor taking steps to minimise its loss, such as by finding a replacement franchisee for the relevant territory).

As an additional warning, if a franchisee wrongfully terminates the agreement, they would remain subject to the post-termination restrictions in it. The franchisor could also look to exercise its post-termination rights, such as step-in rights, to take the business over.

It’s likely that any fees the franchisor collects on behalf of the franchisee post termination will be retained to offset any damages the franchisor claims the franchisee owes.

What should a franchisee do?

If a franchisee is considering terminating their franchise agreement, they should monitor the situation with the franchisor and act quickly if the franchisor fails to comply with any of its obligations. It’s crucial to a claim for repudiatory breach that a franchisee acts in this manner.

An alternative for the franchisee if they want to leave the network is to explore selling the franchise to a third party, as often this is the least painful way of resolving problems between the franchisor and franchisee.

Most importantly, they should be taking advice from a specialist franchise lawyer. This area is fraught with difficulties and the slightest wrong move can have potentially disastrous, unintended consequences.

About the authors

Rob Tiffen is a senior associate and Natalie Carman is a solicitor at Birketts.