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:
Cooling off
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.
Early termination
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.
Mutual surrender
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.
