The last two and a half years have been tough for small businesses including franchises.
While many franchisees were given concessions during extended lockdown periods, some franchisors did not provide concessions or seek concessions from landlords on behalf of their franchisees.
Difficult trading periods after lockdowns, staff shortages and increasing expenses have forced a number of franchisees to consider whether they are able to "get out of their franchise agreements".
Franchisees are also questioning whether they can "de-badge" or "de-brand" and operate their own businesses in competition with the franchisor.
This is a complex question and involves both legal and financial considerations about whether you "should" get out of the franchise agreement and whether you "can" get out of the franchise agreement. If you "can" get out of the franchise agreement, a further consideration is whether you will be subject to an enforceable restraint of trade.
Should I get Out of My Franchise Agreement? - Franchise vs Small Business - Things to think about
Can I get out of my Franchise Agreement?
Can I operate my own business in competition with the franchisor?
Should I get out of my Franchise Agreement?
If you are thinking about operating your business outside of the franchise network, in addition to seeking legal advice about whether you can get out of your franchise agreement, you should also seek accounting or financial advice.
While financial reports may on their face look healthier without royalties or advertising fees, that is only part of the story. It does not take into account the benefits (in particular revenue) received from the franchisor's branding and marketing. Consequently, you need to consider whether the business' revenue will substantially decrease if the business is not operated under the franchisor's brand. This includes a consideration about brand value and additionally a consideration about the value of any marketing (including local marketing) undertaken by the franchisor.
If the revenue earned by the business is derived from the franchisor's brand and the products or services offered by the brand, then financial modelling should be prepared to consider whether the business is viable without the franchisor's offering.
Another financial consideration is the cost of goods or services. Is the franchisor passing on the benefit of larger buying power? Can you purchase the goods and services required to operate the business at a lower price than what you are paying as a franchisee? Benefits are not always passed on directly. For example some franchisors will pay rebates into the marketing fund.
Remember that even if you can get out of your franchise agreement and operate a competing business, you may not be able to offer exactly the same products or services and you may not be able to use the customer information that you obtained while operating the business as a franchise.
Another consideration is the value of the franchisor's support. This can range from the value of the business systems and processes developed by the franchisor, to the value of IT platforms used by the franchisor, to the value of one on one personal support provided by the franchisor.
If your analysis indicates that you "should" get out of your franchise agreement, you then need to assess whether you "can" get out of your franchise agreement.
Can I get out of my Franchise Agreement?
It is difficult to get out of your franchise agreement if the franchise agreement has not expired.
The first thing to do is check your franchise agreement to find out the expiry date.
If your franchise agreement has already expired you may be operating your business on "holding over", and you may be able to provide notice of termination (holding over provisions generally allow one months' notice of termination).
If your franchise agreement is current and you do not want to operate the franchise business until the expiry date, there are two main methods for getting out of your franchise agreement:
- selling your franchise business; and
- negotiating an exit with the franchisor (including under clause 26B of the Franchising Code of Conduct (the Franchising Code)).
The right to sell your franchise business will depend on the terms of your franchise agreement, the operations manual and the Franchising Code. If you are able to sell your franchise business you will generally need to pay the franchisor a transfer fee and enter into a surrender deed.
If you don't think that you will be able to sell the franchise business (or if the franchise agreement does not give you the right to sell the franchise business) clause 26B of the Franchising Code allows you to propose an early termination of the franchise agreement to the franchisor, and the terms on which the early termination will occur.
Remember, even if you can get out of your franchise agreement there will be provisions of the franchise agreement that continue to apply after the franchise agreement ends. These provisions may prevent you from operating a business which is similar to or competes with the franchisor.
Can I operate in Competition with the Franchisor?
A franchise agreement will usually contain a restraint of trade clause to stop you from competing with the franchisor after the franchise agreement has ended.
However, except for franchise agreements where New South Wales law is applicable, a restraint of trade clause cannot be enforced unless it is reasonable.
"Reasonable" in relation to restraint clauses means that the restraint provides no more than adequate protection to the person who is trying to enforce the restraint (in this case the franchisor).
Often, franchise agreements contain fairly standard restraint clauses which may not take into account the particular circumstances of the business. This may lead to the restraint clause being unreasonable and unenforceable.
It is also common to see cascading provisions included in restraint of trade clauses in franchise agreements.
The idea of a cascading provision is that those parts of the restraint clause that are considered to be unreasonable are deleted from the clause.
In addition to a restraint clause, franchise agreements will contain clauses that protect the franchisor's intellectual property. Some intellectual property clauses are quite basic and others are quite detailed, protecting customer data and supplier information.
If you are wanting to establish a similar business to that operated under the franchise network (or if you are wanting to simply de-badge and continue operating your business) you will need to consider the impact of any intellectual property clauses in addition to restraint of trade clauses.
Takeaways
- Check the expiry date of your franchise agreement;
- Even if you can get out of your franchise agreement consider whether you should get out of your franchise agreement;
- If you want to "de-badge" or operate a competing business have a franchise lawyer look at the provisions of the franchise agreement in particular the restraint of trade provisions;
- Get financial advice as well as legal advice.
Disclaimer
The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.
