In life, and especially within the context of commercial arrangements, circumstances can arise where despite the best intentions and efforts of all stakeholders, things don't work out. It can be nobody's or everybody's fault.
Franchise relationships are no exception, as was highly publicised in the inquiry into the operation and effectiveness of the Franchising Code of Conduct, which concluded in 2019.
This guide sets out, in brief terms, the options available for those looking to exit a franchise.
The guide assumes that there has been no breach of the franchise agreement by either party, as this will involve different considerations and processes.
What do you do if your franchise agreement is not working out?
The franchise agreement will usually set out in detail the parties' options for bringing about the end of the franchise outside of a termination for breach.
Generally, those options include:
This is a protection under the Franchising Code of Conduct ('the Code'), which allows franchisees to terminate franchise agreements early into their operation.
The franchisee can exercise their cooling off rights within 14 days of entering into the franchise agreement; potentially longer if the franchisee will lease premises from the franchisor and the lease is not finalised, or if the franchisee is buying an existing business.
The franchisee does not have to give reasons; it just needs to provide notice to the franchisor.
The franchisor must return all money paid to it by the franchisee, but the franchisor can retain an amount in order to cover reasonable expenses (if those reasonable expenses have been disclosed).
While this right is an important one for franchisees, once the 14 day period ends, it can no longer be exercised.
A sale of the franchised business
This involves the franchisee selling their business to a third party. The franchisee will need the franchisor's consent, which cannot be unreasonably withheld.
Franchisors will typically withhold consent if the franchisee has debts outstanding, or the buyer does not fit the franchise system's criteria.
However, the franchisor has 42 days to communicate its decision to the franchisee (NB. this period can be restarted if the franchisor is not given relevant information), otherwise the franchisor will be deemed to have given consent.
This is a new right inserted into the Code in 2021, although it is not a magic wand for franchisees.
Essentially, a franchisee can give a written proposal to terminate the franchise agreement early, at any time.
The proposal can include any term the franchisee wants, and must give reasons for why it is being made.
The franchisor has 28 days to provide a substantive written response to the proposal. If the franchisor does not agree to an early termination, it must give reasons for its refusal.
While franchisees have always had the right to ask for early termination, this new process requires the parties to 'show their hand' and justify their positions.
Even if the franchisor rejects the proposal, both sides might be able to work out a satisfactory arrangement, as each party will have a greater understanding of where the other is coming from.
This will not be set out in a typical franchise agreement, although the franchisee can simply hand their franchise back if the franchisor is willing to take it on.
Depending on the circumstances, it might involve the franchisee receiving money in exchange for:
- giving up its physical assets;
- a waiver of moneys owing to the franchisor; or
- the franchisee being able to re-brand.
It all depends on the circumstances. The parties involved have control over the terms.
It is also important to remember that franchise agreements often specify what is to occur if the franchisee (or its key person) cannot work in the business anymore due to health issues. That might be a requirement to sell the business, or to allow the franchisor to step in and operate the business for a period of time.
Key points for franchisors and franchisees
Preparation is crucial
All franchisees should have a clear understanding of their early exit options before they enter into a franchise agreement. The disclosure document (item 17B) requires franchisors to disclose these options.
It is also important for franchisees to know who within the franchisor organisation they should approach with any day-to-day issues.
From a franchisor's perspective, the best way to avoid handling a requested exit is to have a robust recruitment policy.
The importance of communication
While 'the crucial nature of communication' has by now reached cliché status, it remains true in franchising.
Before signing up, franchisees should have a good understanding of the lines of communication with the franchisor, as well as their way of doing business. This can be done by speaking with former franchisees and reading the disclosure document carefully.
It is entirely possible that the franchisor will be able to resolve any niggling issues that a franchisee might experience. Similarly, the franchisor may have prospects to buy a franchised business waiting on an opportunity. Those possibilities will not be known without ongoing communication.
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.