Learn the types of conditions that allow you to terminate a franchise agreement.
You Can’t Simply Decide to Terminate Your Franchise
Each franchise is based upon a contract agreed upon by the franchise operator, the franchisee, and the franchise owner, the franchisor. Short of not renewing the contract upon its expiration or transferring the contract to someone else, both parties are bound to that contract until it expires. If either the franchisor or the franchisee is unhappy with the way the franchise is working out and wants out before the contract expiration, they'll have to show that the other has failed to live up to their side of the agreement in a significant way.
What Is a Termination Clause?
A termination clause is the portion of the franchise agreement that describes whether, when, and how a franchisor or franchisee can terminate the agreement. Each franchise agreement is different. But most include a provision that says a franchise can be terminated if either the franchisor or the franchisee fails to live up to the contract in a way that prevents the other from getting the benefits intended by the contract.
A franchisee who is disappointed by the profits the business generates, for example, would probably not have sufficient reason to terminate a franchise. But the franchisee might be able to terminate the agreement if it turned out the franchisor misrepresented the profit potential of the business.
Many states also have laws that govern franchise relationships, and they usually require a franchisor to have good cause to terminate a franchise agreement. The definition of good cause varies from state to state but usually requires a franchisor to give the franchisee written notice of a failure to perform as specified in the contract and to allow the franchisee time to correct the issue.
Before you decide to terminate your franchise agreement, be certain to read your contract carefully and check the laws in your area or get some help from an experienced business law attorney.
When Can a Franchise Be Terminated?
In most cases, franchise agreements can be terminated when a material breach has occurred. A material breach is when one of the parties in the agreement has done something that deprives the other party of the benefit of the contract or destroys the value of the contract.
Actions that might amount to a material breach by a franchisee include:
- not paying royalties or not reporting revenue to the franchisor
- filing bankruptcy or being unable to pay bills
- being convicted of a crime
- losing a license needed to operate the business, or
- failing to follow the operating requirements in the franchise agreement.
If a restaurant franchise agreement requires the franchisee to erect a sign with a large, bright yellow "M" of a specific design, for example, and the franchisee instead uses a blue "M," it might be considered a material breach because the change might result in reduced contract benefits such as less public exposure and profits for the franchisor.
Other examples of a material breach might be operating in a location that’s not permitted by the agreement or not adhering to the hours of operation specified in the agreement.
Examples of a Material Breach by a Franchisor
Actions of a franchisor that might amount to a material breach include:
- failing to provide training and support as agreed
- misrepresenting or falsely stating the profits the franchise would potentially generate
- failing to protect the franchisee's business opportunity or territory by, for example, allowing another franchise to open in the franchisee's territory, or
- filing bankruptcy or failing to pay bills.
What Happens If a Material Breach Occurs?
When one of the parties believes the contract has been breached, the first step is usually to send a breach notice describing the breach and the steps required to correct it.
A franchisee who has breached the contract by not adhering to rules such as hours of operation or design specifications, or who has failed to keep up royalty payments, for example, would be given a period of time (usually outlined in the contract) to make repairs, corrections, or payments.
The notice might initiate negotiations between the franchisor and franchisee and problems might be resolved at this stage. But if a contract is terminated, the party who breached the contract can be sued for damages resulting from the breach.
Franchisors typically have more clout in these situations than do franchisees. They usually have greater financial and legal resources than the franchisee, they can argue the claim, and they might even counter it with charges against the franchisee. In these cases, it’s a good idea to consult an experienced business law attorney before taking any action to terminate your franchise.
Do’s and Don’ts After Terminating a Franchise
Franchise agreements should (and usually do) specify what the parties can and can't do after the franchise agreement terminates. These rules usually also apply if your contract has expired and you have chosen not to renew it.
Don’ts for Franchisees
Don’t use the franchisor’s trade name or other branding. Once the agreement ends the franchisee is required to stop using trademarks, logos, and any other branding that belongs to the franchisor or is similar to that of the franchisor. Franchisors also have the right to buy back branded items, such as aprons, take-out menus, brochures, or demonstration kits with the franchisor name, logo, or service marks if the business paid for these supplies.
Don’t open another business that competes with the franchisor. These requirements, called a covenant not to compete or a non-compete clause, typically prohibit franchisees from opening another business or working at a company that competes with the franchisor for a specified period of time.
Don’t use the franchisor’s trade secrets. As a franchisee, you might have received recipes, customer lists, or details about proprietary systems in order to operate the franchise. These types of items continue to belong to the franchisor once the agreement terminates and you cannot use them in another business.
Do’s for Franchisees
Do pay any outstanding monies due the franchisor. Terminating a franchise doesn’t remove the obligation to pay outstanding debts, such as royalty payments, incurred while you operated the franchise.
Do return manuals and training materials. Any training or operational manuals furnished by the franchisor must be returned.