While it is possible, there are limited circumstances under which a franchisee can 'get out of a franchise agreement'.
Franchise agreements have a set term. When you enter into the franchise agreement, you agree to operate the franchise business, for the term of the franchise agreement. The date that the term of the franchise agreement ends is called the expiry date.
Generally, a franchisee must operate a franchise for the term of the franchise agreement, however there are some circumstances in which the franchise agreement can be ended early (that is, before the expiry date).
1 - Cooling off - franchise agreements must include a mandatory cooling off period of a least 14 days.
2 - Sale - a franchise agreement will set out the process for you to sell your franchise business to an incoming franchisee.
3 - Request For Early Termination - under section 54 of the Franchising Code of Conduct you can request an early termination of the franchise agreement - although the franchisor does not have to agree to the early termination.
4 - Termination - in very limited circumstances you may be able to terminate the franchise agreement for the franchisor's conduct.
If you want to stop operating your franchise business, the first thing you should do is check your franchise agreement to find out the expiry date (if you don't have a copy of your franchise agreement, ask the franchisor for a copy).
The expiry date will be set out in the schedule to your franchise agreement.
If your franchise agreement has already expired you may be operating your business on "holding over", and you will be able to provide notice of termination (holding over provisions generally allow one months' notice of termination, although you will need to check the exact terms of your franchise agreement).
If your franchise agreement has not expired, then you will need to either operate the franchise business until the expiry date, sell your franchise business, or end the franchise agreement early.
The most common method for getting out of your franchise agreement is to sell the franchise business.
The right to sell your franchise business will depend on the terms of your franchise agreement, the operations manual and the Franchising Code of Conduct (the Franchising Code).
If you are able to sell your franchise business, the franchisor will need to approve the purchaser and you will normally be required to pay the franchisor a transfer fee and enter into a surrender deed (the franchisor may also have the right of first refusal to purchase your franchise business).
The franchisor does not have to approve the purchaser of your franchise business, and section 49(6) of the Franchising Code sets out some of the circumstances in which a franchisor can reasonably withhold consent.
Remember, even if you can sell your franchise business 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.
For more information about selling your franchise business, we have the following resources:
The legal and financial aspects of selling your franchise business
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) section 54 of the Franchising Code (previously clause 26B of the Franchising Code) allows you to propose an early termination of the franchise agreement to the franchisor.
If you propose an early termination of the franchise agreement, the proposal must set out the reasons for the proposed termination, and the terms on which the early termination will occur.
The franchisor must then provide a substantive written response to the proposal within 28 days.
If the franchisor refuses to agree to the proposed early termination of the franchise agreement, the franchisor must include the reasons for the refusal.
Importantly, while the franchisor must act in good faith, the franchisor is under no obligation to agree to your request.
A franchise agreement will normally contain specific rights which allow a franchisor to terminate the franchise agreement. Although, the right for a franchisee to terminate the franchise agreement is likely to be limited to the mandatory cooling off rights prescribed by the Franchising Code.
Under section 50 of the Franchising Code, provided that a franchisee has not opted out of cooling off provisions, a franchisee can terminate a franchise agreement within 14 days of executing the franchise agreement (or within 14 days of receiving leasing information from the franchisor or an associate of the franchisor if that information is provided after the franchisee has entered into the franchise agreement and the franchisor or an associate of the franchisor is providing the franchisee with an occupancy right).
The Franchising Code does not provide a franchisee with any other automatic right to terminate the franchise agreement.
If the franchisor has repudiated the franchise agreement you may be able to terminate the franchise agreement at common law (the law that is developed through precedent and case law).
Additionally, if the franchisor has engaged in conduct that is misleading or deceptive there may be an argument that you have the right to terminate the franchise agreement, depending on the circumstances of the case.
An ancillary question that needs to be considered if you have entered into a lease directly with the landlord and you want to stop operating the franchise business, is whether you can get out of your lease.
In addition to checking the expiry date of your franchise agreement, you should also check the expiry date of your lease. Again the expiry date of the lease is likely to be set out in the schedule to your lease.
Unfortunately, we see situations where a franchisee has entered into a lease directly with the landlord, and has rights to get out of the franchise agreement (due to the franchisor's conduct), but does not have the same rights in relation to the lease.
This is often the case where the franchise is new, the franchise business isn't profitable and the lease still has many years until expiry.
In those situations, we need to negotiate directly with the landlord to come to some agreement.
If you are able to sell the franchise business, then your lease will be assigned to the incoming franchisee, or the incoming franchisee will enter into a new lease with the landlord.
We see many franchisees who simply want to de-badge or de-brand and operate a similar business from the same site or in the same territory as their franchise business.
If you are thinking about operating a similar business from the site or territory of your franchise business, 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.
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.
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.
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.
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.