A franchise can be a quick way to go into business. If you are the franchisee, meaning the one who is licensing a franchise and operating it, you have the advantage of instant brand recognition and an established market. As a franchisor, the owner of the franchise, you receive payment for the right to use the franchise name and, potentially, royalties on the profits.
However, not all franchise relationships work out. Sometimes owners or operators wish to terminate the franchise agreement early. There are several actions you need to take to make sure the termination is legal and does not create financial difficulties.
What Is a Franchise?
According to the International Franchise Association (IFA), a franchise is defined as when:
“[A] franchisor (a person or company that grants the license to a third party for the conducting of a business under their marks) not only specifies the products and services that will be offered by the franchisee (a person or company who is granted the license to do business under the trademark and trade name by the franchisor), but also provide an operating system, brand, and support.”
Examples of franchises include H&R Block Tax Preparation, Stanley Steemer’s carpet cleaning service, and the ubiquitous McDonald’s restaurant.
A franchise agreement is a contract between the franchisor and the franchisee. You should read it carefully and make a note of the termination clause, which specifies when, how, and by whom the agreement may be terminated. It should also contain language governing what each party can and cannot do after termination.
Some agreements are quite complex, and you would be well-advised to consult with a business attorney before signing it. State law may apply as well. Most prevent termination except for “good cause” which is defined by each state.
Without a material breach of contract or other problem, most franchises terminate at the expiration of the contract, or if the franchisee declines to renew the franchise option if either is specified.
Termination Clause in a Franchise Agreement
Typically a termination clause contains statements for either party to do the following:
- Suspend performance under the agreement when there is a “material breach” of contract by the other party.
- Terminate the agreement when a material breach has occurred and not been resolved within a reasonable time after a demand for resolution has been made.
A material breach occurs when a party does not comply with a provision of the contract which then dismantles the value of the contract or deprives one of the parties of the benefit of it.
A franchisor can terminate the agreement if a franchisee:
- Is convicted of a crime
- Loses a necessary license or lease
- Fails to pay royalties
- Fails to correct defaults after notice
- Goes bankrupt or becomes insolvent
- Fails to follow franchisor requirements regarding location and appearance
- Fails to comply with required business operations
A franchisee can terminate the agreement if a franchisor:
- Fails to provide training and support as stipulated in the contract
- Commits fraud or misrepresents the potential profits
- Fails to protect the franchisee’s business opportunity or territory
- Goes bankrupt or becomes insolvent
Certainly, other terms can exist within the contract, including what the consequences would be legally and financially if you simply closed up shop and abandoned the franchise.
After Terminating Franchise Agreement
The franchise agreement may also have contractual obligations (mainly for the franchisee) after termination is complete or the agreement has expired. The franchisee must:
- Stop using the franchisor’s trade name, trademarks, and service marks.
- Agree to a Covenant Not to Complete or a No-Compete clause
- Pay all outstanding amounts due
- Return franchisor manuals
- Agree not to use trade secrets
The franchisor may have a clause containing the right to repurchase branded inventory.
If You Wish to Terminate Your Franchise Agreement
If you have decided to terminate the franchise agreement before it expires, consult a business attorney familiar with franchising. Before you attempt termination, ask your lawyer:
- Is a material breach by the franchisor the only way out of the contract?
- Can my franchise be transferred to another person and do I need permission from the franchisor?
- (If you are the franchisor) How can I protect myself from liability for something the franchisee did before the contract ended?
Once you determine to terminate your franchise agreement, you and your attorney must draft a letter and request termination in writing. The letter should detail your intention to terminate the agreement and close the franchise and be sent to the franchisor.
Use certified or registered mail or another mailing service that provides tracking for your letter. Follow all the protocols in the original franchise agreement if your sell or transfer the operations and consult with your attorney to ensure you are legally and financially in the clear.
If you agreed to a franchise opportunity, whether as a franchisor or franchisee, your franchise agreement should contain a termination clause spelling out all the requirements of ending the agreement legally.
Consult a lawyer before acting on your desire to terminate the agreement and follow all the requirements in the contract for a legally and financially safe termination.