Terminating a franchise agreement is sadly, what some franchisees are considering at this present time as well as looking at other options under their franchise agreement.
Last week I hosted a franchisee legal surgery with the British Franchise Association (bfa). Unfortunately, the common thread was franchisees finding themselves in a very difficult financial position due to the pandemic and the forced closures of many of their businesses due to the lockdown. Now they are having a problematic time in re-opening many of these small businesses, in compliance with the Government’s COVID-secure regulations whilst at the same time ensuring their businesses remain financially viable. For example, small gym franchise owners who can now only have a very limited number of members in at any one time and baby class franchise owners who have the task of navigating how they re-open in community halls with social distancing and enhanced cleaning in place, whilst not operating at a loss. Such franchisees fear customer numbers will be down whilst consumer confidence recovers slowly.
Below we set out a number of possible options for terminating a franchise agreement.
The starting point are the specific terms of your franchise agreement as each agreement will be different. Generally, the position is that if you sign up to a 5 year agreement as is common in the UK, you cannot easily leave before the expiry of that fixed term, unless you sell your business to an approved purchaser and there will be a clause in your agreement dealing with the sale process.
In two recent (albeit pre-Covid) blogs I have already set out how a franchisee could potentially terminate due to the franchisor’s fundamental breach of contract or because they believe they have been mis-sold their franchise (i.e. that they have a claim for misrepresentation) if either of these circumstances are applicable.
A few other options have come to the forefront due to the pandemic. I have received many queries relating to the operation of the force majeure clause in the franchise contract and the common law principle of frustration.
Force majeure is a contractual clause that is invoked when an event outside the reasonable control of either party prevents the performance of contractual obligations. Most franchise agreements contain one. Such a clause permits the termination or suspension of obligations that would otherwise constitute a breach, if such a force majeure event occurs.
It is important to look carefully at the exact rights granted in the force majeure clause and see if it can assist your position. It may be that it is one sided, permitting only one of the parties to invoke it, or grants reciprocal use by either party. Some clauses may only permit a suspension of certain obligations whilst the force majeure event is ongoing and others will allow eventual termination if the event carries on for a specified period of time. Some require the affected party to give written notice to the other party that they are so affected by the force majeure event.
Whilst a force majeure clause may have covered the situation when the UK first went into lockdown back in March and many businesses were mandated to close, its ongoing application is more questionable now that the UK is easing out of lockdown and many businesses can now re-open, albeit with safety measures in place. Whilst Covid-19 is far from over, the legal question is whether the pandemic – i.e. the force majeure event preventing you from operating your business, is still an ongoing event preventing you from fulfilling your contractual obligations? The answer is not straightforward. At the time of writing, the Government has just announced further local lockdowns for the North of England, so the answer to this question is going to be a moving target and for some time to come.
Similar to force majeure a ‘frustrating event’ is one that unexpectedly occurs at a time after the contract has been formed. It must be fundamental, going to the heart of the contract and in a way that is entirely beyond what the parties could reasonably have contemplated. It must not be due to the fault of either party and it must make further performance illegal, impossible or at least radically different from that which was contemplated by the parties at the time the contract was made. The way some franchised businesses are going to have operate going forward will be very different indeed but whether or not this meets the ‘radically different’ high bar, remains to be seen and we don’t yet know what stance the courts will take on this.
If frustration is proved, then the party is relieved from further performance of its contractual obligations. However, I must stress the burden of proving frustration is a heavy one. Both force majeure and frustration are only really concerned with an obligation being ‘impossible’ to fulfil, rather than no longer being practical or financial attractive. If fulfilling contractual obligations just becomes more expensive for one party, that is unlikely in itself to frustrate the franchise agreement.
Similar to frustration, if the franchisor has to change the franchise system so significantly in order to be able to operate in the new normal, could this be considered a ‘derogation from grant’? This has the potential to be the case if such changes diverge so materially from the proposition that the franchisee invested in originally and would substantially deprive the franchisee of the chance to trade profitably.
Practically, most franchisees in the position described above would be advised to discuss matters with their franchisor in the first instance and see if a mutually satisfactory position or settlement can be reached. There may be a dispute resolution procedure set out in the franchise agreement perhaps involving mediation, which would be preferable to litigation due to the time and costs involved for both parties, even if you feel you have a strong claim against the franchisor. The bfa can also offer a mediation service.
When entering negotiations or a mediation, disgruntled franchisees should think carefully whether termination of their agreement is in fact their ideal outcome or would in fact some breathing space in fact be desirable, with a further temporary pause on some or all of their obligations for a period of time, particularly if their industry is one still to re-open or where it is particularly difficult to comply with the new safety measures. Alternatively, you may be able to negotiate a reduction in the management fee payable, whilst the business is unable to operate at full capacity. These ideas may or may not be acceptable to your franchisor but we are in uncharted territory so hopefully franchisors are willing to listen to the concerns of their franchisees, to support them and take a pragmatic approach where possible.
Any agreed changes to the franchise agreement should be documented in writing in accordance with the variation provisions set out in the agreement. This also applies to any contractual changes that the franchisor wishes to impose on a franchisee in light of Covid-19, although a franchisor generally has some flexibility to amend and update its operations manual.
Terminating your franchise agreement is never an easy option and not something to undertake lightly without taking proper advice. Terminating incorrectly or simply ceasing to operate the business, could put you in breach of contract yourself and your franchisor is likely to pursue a claim against you for the amount of fees they will have ‘lost’ under the contract for the rest of the term. Your agreement may even stipulate a fee in ‘liquidated damages’ which you would be expected to pay if you terminate early.
Remember that you will no doubt have signed up to post-termination restrictions in the franchise agreement preventing you from being involved with a similar business for a period of time and you may also have signed a personal guarantee, making yourself personally liable to the franchisor for the obligations of your franchisee company (if you trade as a limited company).
I am always happy to have an initial free of charge phone call with a franchisee and to review your franchise agreement and provide an explanation of your legal options on a fixed fee basis. For more information please contact Emily Sadler.