When someone buys into a franchise, the last thing on their mind is what happens if things don’t work out. There are many reasons why things may not “work out” in the franchise context.
The possibilities are nearly endless. Franchisees are people, and franchisors are run by people, and people aren’t perfect. Even the largest franchisors have made mistakes that have affected their franchise systems. It’s important to begin this discussion with an analysis of the Franchise Agreement. Once we lay out that foundation, we’ll discuss what happens under different scenarios.
At the end of the day, the Franchise Agreement is a binding contract. Both the franchisee and franchisor are bound by the terms of the Franchise Agreement. Assuming each party has signed, and that valuable consideration has been given (money/franchise rights), the Franchise Agreement is valid and any fallout can be easily predicted under contract law.
Rarely, we have seen basic defects in Franchise Agreements. For instance, if the franchisee does not actually sign the Franchise Agreement, there may be remedies available depending on which state law is involved. On occasion, both parties lose their copies of the Franchise Agreement. Without an accurate record, it is hard to determine what happens. Even rarer, some franchisees never fully paid their initial franchise fee, which is part of the consideration required to make the Franchise Agreement a valid contract. YES, this stuff happens. It’s rare, but we’ve literally seen it all. Assuming that all parties have signed the Franchise Agreement and that it is supported by consideration, our analysis continues with discussing defaults.
Most Franchise Agreements contain curable and non-curable default provisions. A default occurs when either party to a contract breaches that contract by failing to perform their obligations. Franchise Agreements actually spell out specific default provisions, which are usually duties that are really important to the franchise system. For instance, a Franchise Agreement may state that a franchisee is in default if they offer products or services other than those authorized by the franchisor in the Operations Manual. It makes sense for that activity to constitute a breach of the Franchise Agreement. Picture this – you head into your local Chick-Fil-A, walk up to the counter, and you see they are now serving hamburgers on the menu. You would never see this because Chick-Fil-A’s franchisees know that if they sell an unauthorized product (anything other than chicken!), they will be in default and their franchisor will terminate the Franchise Agreement.
Curable defaults are “curable” in that the franchisee is given the opportunity to fix them. There is usually a timeframe of 5, 10, or even 30 or 60 days in which the franchisee can make things right. This usually includes things like being late on making royalty payments, failing to submit a report, or missing an additional training. None of these things are so egregious that the franchisor wants to terminate the Franchise Agreement. Remember – for the most part, franchisors want to keep their franchisees!
Non-curable defaults are scenarios in which the franchisee has no opportunity to make things right. This can include:
Franchisees will receive a “Notice of Default” from the franchisor or the franchisor’s attorneys. Usually, a Notice of Default for a curable default is a little more friendly. Think of it as a “get your act together” notice. A Notice of Default for a non-curable default is much more serious. This may be followed by a Termination. When we send a Notice of Default to a franchisee, whether curable or non-curable, we make sure that we explain the specific provisions of the Franchise Agreement that are involved. We also provide as much evidence as possible of the franchisee’s defaulting conduct. Then we will specifically state how much time, if any, the franchisee has to cure the default and what happens if they fail to make things right.
If you receive a Notice of Default, you should definitely consider having a franchise attorney look it over. If the Notice of Default isn’t specific, and you don’t think you’ve committed the actions your franchisor is alleging, the franchisor may be trying to pressure you to exit the system for whatever reason. You have rights, and you should seek counsel from a franchise attorney. Either way, a default that goes uncured is solid grounds for terminating a Franchise Agreement.
The franchisor almost never defaults under the Franchise Agreement. While there are tons of stated default reasons for franchisees, the franchisor is usually only obligated to perform the tasks listed under Item 11 of the Franchise Disclosure Document – “Franchisor’s Assistance.” Those terms should be incorporated into the Franchise Agreement. They are usually less than five or six individual items, and they will include things like “Franchisor will update the Operations Manual from time to time” or “Franchisor will protect the Trademark.” The franchisor will never be obligated to ensure the franchisee’s success. That would open them up to a world of liability because they will undoubtedly have franchisees who fail from time to time for various reasons outside of the franchisor’s control. Nevertheless, sometimes the franchisor is crazy and does stupid things. If they default, they usually have a time to cure (60 days or so), and they almost always “cure” to some extent. If you believe your franchisor has defaulted, you should contact a franchise attorney immediately. You likely have to provide a written notice and follow specific procedures to put your franchisor on notice of their default. Do not try this on your own!
We have counseled many, many franchisees who “want out” of their Franchise Agreements for various reasons. Usually, they don’t have any grounds for terminating their Franchise Agreement. The franchisor has done everything they’re supposed to do. Often, the franchisee isn’t making as much money as they thought they’d make. One very common problem is that the franchisee didn’t fully understand what they were getting into when they signed the Franchise Agreement. Franchise Agreements are heavily, insanely tilted in favor of the franchisor. That’s the nature of franchising. The franchisor has this great idea that works and usually makes money. The franchisee buys in to try to make money. The franchisor essentially controls 99.99% of the franchisee’s business. If the franchisee isn’t down with that, they should have come up with their own idea and created their own business instead of buying into a franchise. They also probably didn’t have a franchise attorney review their Franchise Disclosure Document and Franchise Agreement for them. Clearly they didn’t understand something in the 300+ page legal document they attempted to review on their own.
In an effort to part as amicably as possible, franchisors will usually encourage a franchisee to sell their business. This often involves hiring a broker to find a buyer, getting the franchisor’s approval of the buyer, amending a lot of legal documents, and paying the franchisor a hefty transfer fee in the four or five-figure range. However, the alternative to this may be the franchisor filing a lawsuit against the franchisee for all past-due amounts and future royalties due under the Franchise Agreement. We typically encourage upset franchisees to either work things out with the franchisor or to sell, get out, and recoup some of their investment.
If you believe you or your franchisor is in default of your Franchise Agreement, give us a call at (980) 202-5679 and we will contact you. We can review your Franchise Agreement, the facts, and some other relevant documents. Then, we’ll let you know what your rights and obligations are, and we can advise you on moving forward.