How To Get Out of a Franchise Agreement
- June 16, 2022
Figuring out how to get out of a franchise agreement with minimal personal loss can be a challenge, even for seasoned professionals.
There are plenty of valid reasons for a franchisee wishing to terminate a franchise agreement, including:
- The franchisor has failed to protect the franchisee’s territory
- The franchisor has failed to provide contractually stipulated training and/or support
- The franchisor has misrepresented aspects of the business, including financial projections
However, even if none of these apply, franchisees still have options for exiting the franchise relationship. Here’s what you need to know about how to get out of a franchise agreement.
What to Know About Franchise Agreements
Franchise agreements are signed contracts that create a legal relationship between a franchisee and a franchisor. Because franchise agreements tend to be long-term contracts covering a period of multiple years, it’s not unusual for the life circumstances of the franchisee to change, requiring the contract to be renegotiated or terminated.
The Termination Clause
There is a termination clause in most franchise agreements that outlines the circumstances in which either party would be released from the franchise relationship.
Because both parties are required to abide by the terms of the franchise agreement, good cause for termination generally involves violation of the terms of the agreement in some way. An experienced California franchise lawyer can determine whether you have good cause to terminate the agreement.
The California Franchise Relations Act
The 2016 updates to the California Franchise Relations Act, are a game changer for those who entered into franchise agreements in 2016 and beyond (of for any franchise agreements of indefinite duration).
Under the new version of the law, a franchisor no longer has the right to simply refuse a sale or transfer initiated by the franchisee to a third party, provided the existing terms outlined in the franchise agreement regarding the sale or transfer of the franchise are met. So this gives the option to the franchisee of exiting the franchise system through a sale of his existing franchise, without incurring any penalties with the franchisor. Disputes do still arise from time to time as to whether the potential buyer fits the criteria of an “approved franchisee” or not, but under the new updates to the CFRA the franchisor must follow an objective standard.
Furthermore, upon termination of the franchise agreement, the franchisor now has an obligation to either pay the fair market price of the franchise (for a termination without good cause) or to purchase all inventory, supplies, equipment, fixtures and furnishings that the franchisee used to run the franchise (for a termination for good cause).
The “good cause” standard has also been overhauled: it is now interpreted as a franchisee’s substantial failure to comply with the lawful requirements of the franchise agreement.
Under the new updates, before a franchisor can initiate an involuntary termination based on good cause, the franchisor now has to send a notice and give the franchisee an opportunity to cure for 60 days, in most instances.
Options for Leaving a Franchise Agreement
Franchisees looking to get out of a franchise agreement have several options, depending on their needs and the specific language of their franchise agreement.
Selling the Franchise
The best-case scenario for getting out of a franchise agreement is to sell the franchise to another party. Under the CFRA, the franchisor may not refuse a legitimate transfer without good cause, and they aren’t allowed to set unreasonable conditions: they must follow an objective standard.
Franchise agreements typically stipulate that anyone you sell the franchise to must meet the same criteria that were in place when you entered into the franchise agreement. For instance, it’s common for franchisees to be required to:
- Have a certain amount of liquid capital on hand
- Be able to pass a criminal background check
- Have a minimum credit score
Most franchise agreements contain a clause that the franchisor be given first right of refusal should the franchisee decide to sell, so it may also be possible to sell the franchise back to the franchisor provided they’re in agreement. However, no obligation exists on their part to buy it back. This option is usually simplest for all parties, but keep in mind that you won’t always be able to recoup all of your losses this way.
Terminating the Franchise Agreement
Even when it’s not possible to find a buyer for the franchise, there may be ways to legally exit a franchise relationship.
It’s important to note that terminating a franchise agreement doesn’t mean abandoning it. When the franchisee walks away with no notice and no attempt at negotiations, the franchisor may be able to sue for loss of future profits, for example future royalties for the remainder of your franchise term. Furthermore, franchise agreements typically contain clauses requiring disputes to go to arbitration, and failure to follow this procedure may result in the filing of further counter-claims by the franchisor against you.
Nearly all franchise agreements include termination clauses that outline the terms under which either party can legally terminate the association. If either party violates these terms, the franchise agreement can be legally terminated.
Finally, there is also the possibility of negotiating a walk-away with the franchisor, even if the franchisor does not buy-back the franchise or otherwise continue to operate it. This option may be attractive if there are performance issues on both sides, and it is often requested when franchisees are not hitting the financial numbers disclosed to them in the FDD.
One of the experienced franchise lawyers at Global Legal can advise you on relevant options and start negotiations with the franchisor on your behalf.
Obligations of the Franchisee Upon Termination
Even if you’re able to negotiate walk away terms with the franchise holder that allow you to exit the business quietly, chances are that you’ll still have some obligations upon termination. These obligations could include:
- A non-compete agreement
- The return of any operations material or other IP provided at the beginning
- Full payment of any remaining obligations
A typical non-compete agreement will state that you cannot own or operate a competing business within a certain range of the franchise for a specified period of time after terminating your contract with the franchise holder. The key to determining whether non-compete agreements are enforceable or not is how reasonable those restrictions are.
You will also be required to return any signs and other materials in your possession that portray brand names and logos. Franchisees may also have a contractual obligation to ensure that the premises are in good repair, at their own expense, at the termination of the contract.
One main obstacle involved with these types of negotiations is resolving all outstanding disputes, including any remaining royalty payments. Ceasing to make these payments without legal representation isn’t recommended because that could open you up to a lawsuit by the franchise owner.
How Our Franchise Attorneys Can Help
An experienced franchise litigation lawyer can help you assess the risks of breaking the agreement, find and identify any clauses in the franchise agreement that may work in your favor, approach the franchisor on your behalf, and help you get approval for a sale or transfer.
Even if you’re able to get the franchisor to agree to negotiate so that you can get out of the franchise agreement, it’s still a good idea to schedule an appointment to see an attorney with a significant amount of knowledge about California franchise law. The team at Global Legal has over a decade and a half of combined experience helping franchisors and franchisees achieve the results they want.
Contact Global Legal Law Firm to set up a consultation or to learn more about how to get out of a franchise agreement.
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