It is an unfortunate fact of running a franchise network based on a royalty income stream, that from time to time a Franchisor will uncover evidence of franchisees under reporting the gross income of their businesses. In these circumstances, Franchisor's wish to understand their rights to terminate the Franchise Agreement for fraud. Although, each matter will need to be considered on a case-by-case basis, a broad overview of the key principles in terminating for fraud is as follows:
- Fraud is a very serious allegation and there is a high onus to establish it. Prior to termination, the Franchisor must be completely satisfied that it is in a position to prove fraud in Court.
- Assuming that evidence of fraud exists, the entitlement to terminate will typically be based upon:
- Contractual rights:
- typically by reliance upon an express right to do so in the Franchise Agreement; and
- also based upon the existence of implied terms requiring the parties to deal honestly with each other.
- Repudiation - Fraudulent conduct is also likely to amount to the franchisee indicating an intention no longer to be bound by the terms of the Franchise Agreement. Such conduct could be characterised as repudiatory which the Franchisor could then use as a basis to bring the Franchise Agreement to an end.
- There are a number of potential constraints on the right to terminate for fraud. These include:
- Where it would be unconscionable for the Franchisor to do so. Relevant factors may include:
- the materiality of the fraud considered in the context of the breakdown in trust and confidence in the relationship which may result from the fraud;
- whether the Franchisor has an ulterior motive in bringing the relationship to an end;
- whether the Franchisor itself has engaged in questionable conduct of a fraudulent nature; and
- the manner in which the Franchisor has treated other Franchisees for similar conduct.
- Whether it would be in breach of the implied duty of good faith and fair dealing for the Franchisor to do so. Similar considerations as those which apply to unconscionable conduct will need to be considered.
- Whether the Franchisee is entitled to relief against forfeiture on the basis that a great and disproportionate loss will be suffered by the Franchisee as a result of a "minor" incident of underreporting.
In summary, where clear evidence of fraud is established, a Franchisor will typically be entitled to terminate a Franchise Agreement.
However, great care needs to be exercised in considering the evidence and determining that it is sufficiently compelling to persuade a Court that the conduct is fraudulent. Termination for fraud can be a high stakes strategy and Franchisors should always at least consider the merits of a negotiated exit from the network by the Franchisee. Additionally, caution always needs to be exercised where:
- The termination consequences are arguably very disproportionate to the fraudulent conduct. This issue is most likely to arise where the amount of the fraud is modest;
- The Franchisor's conduct in dealing with its franchisees may have been dishonest in some respects;
- The Franchisor has an ulterior motive in bringing the relationship to an end; or
- Termination for fraud would be inconsistent with the manner in which other franchisees have been treated.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.