Paul Kelly was right on song when he wrote his fabulous song… “From little things big things grow”. It’s the little things in a contract that can matter the most and this applies to franchise agreements.
The main terms are apparent for example, the franchisees’ obligations to pay a franchise fee, ongoing royalties and market levies, the restraints, compliance with the operating manual and system supplied by the franchisor.
An experienced franchise lawyer reviewing a franchise agreement will dig deeper and look at other issues such as the right of the franchisor to terminate an agreement, what occurs on expiry of the franchise term, the non-compete provisions on expiry and other important issues.
Clause 22 of the Code – Termination without cause
Clause 22 of the Code is a provision that has had little attention from the ACCC (Australian Competition and Consumer Commission) or the courts.
A clause may be tucked away in the franchise agreement which could be a time bomb for franchisees giving a franchisor the right to terminate the franchise where there is no breach by the franchisee. A franchisee may invest a substantial sum to establish their franchise. A retail franchise including fees and fitout could be between $250,000 and $500,000. The franchisee may need the first term or even their second term of the franchise to get a return on their investment.
TERMINATION – NO BREACH
So let’s look in more detail at Clause 22 “Termination – no breach by franchisee” to understand what is at stake. This clause applies if:
- A franchisor terminates a franchise agreement:
- in accordance with the agreement; and
- before it expires; and
- without the consent of the franchisee; and
- The franchisee has not breached the agreement; and
- Clause 23 does not apply (termination for special circumstances such as bankruptcy, fraud and abandonment).
It is worth noting that a condition of a franchise agreement that a franchisor can terminate the franchise agreement without the consent of the franchisee is not taken to be consent.
Before terminating the franchise agreement, the franchisor must give reasonable written notice of the proposed termination, and reasons for it, to the franchisee. The section on resolving disputes “applies in relation to a dispute arising from termination under this clause”.
But note that:
- “reasonable written notice” is not defined. So what may be considered reasonable by a franchisor may not be considered reasonable to a franchisee.
- “reasons for it” is not defined. There is no guidance as to whether the reason should be reasonable or legitimate. It could be just a bad, vindictive decision. It does not say the decision must be made in the franchisor’s legitimate commercial interests or that there has to be a genuine business case for the decision.
Franchisor and franchisee interests are generally aligned when they enter into a franchise, however as time goes by for a variety of reasons, their interests may diverge and in some cases the relationship sours. This could arise from a breakdown of their working relationship, a lack of trust or an inability to communicate. It may also arise if the franchisor considers the franchisee is not performing well or feels the franchisee is no longer a part of the team sharing the common vision.
The franchisee on their part may simply be asking legitimate questions of the franchisor and asking the franchisor to deliver on what it promised.
The franchisor may see an opportunity to offer the franchise to a better operator or even take over the franchise.
DANGER ZONE
The provision in the franchise agreement may be as simple as the following:
- “The franchisor may exercise its rights under Clause 22 of the Code”
Pretty innocuous really, unless you or your lawyer understand what this means. It means that even if the franchisee is performing extremely well, meeting all its obligations, following the system and doing all that is required of them, the franchisor can serve a notice on the franchisee to terminate the franchise without cause.
This is a devastating notice for a franchisee to receive and may crystallise a huge financial loss to them. The franchisee will have no opportunity to obtain a return on its investment and effort in building the business and any goodwill or ability to sell or transfer the franchise as a going concern will be lost.
Not fair you say? I would certainly agree!
THE FRANCHISOR PERSPECTIVE
Should a franchisor rely on this right to terminate on reasonable notice if such a clause exists in their franchise agreement?
Even if such a clause is in the agreement should a franchisor exercise that right?
As much as franchisors may like to reserve this right they need to consider the impact of having this type of provision in their agreement. It will no doubt be a disincentive to potential franchisees.
Why would a franchisee pay a franchise fee on an expectation of a five year term when in reality the franchisor can rely on this right to terminate the franchise on reasonable notice for no cause at any time within that term?
THE FRANCHISEE PERSPECTIVE
You need to know whether the franchise agreement gives the franchisor this contractual right to terminate on reasonable notice for no cause.
If the franchise agreement does not expressly grant this right, the franchisor cannot give notice without cause. If the agreement does have the right, consider whether to proceed and discuss this issue with the franchisor and your lawyer. It may be that they will agree to delete the clause or at least restrict the right.
CODE REVIEW
This issue was touched on in the review of the Franchise Code conducted recently by Alan Wein. In reference to the “termination without cause” provision relevant to the automotive industry, Wein indicated there were few complaints by franchisees of franchisors relying on clause 22 and if such action was taken by a franchisor issues of “reasonableness”, “conscionability” and “good faith” would be tested by a Court and depend on the facts in each case.
His view was that termination without cause where no reason or no reasonable reason was given would be unlikely to be upheld by a Court in favour of a franchisor.
It’s the little things from which big things may grow!
Robert Toth is a partner, corporate and commercial, at Wisewould Mahony lawyers.