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Suing Your Franchisor

If this is a question that you are evaluating, then you have signed a franchise agreement, have established or are about to establish your franchise outlet and you are now faced with a situation where the relationship with the franchisor is not what you expected. You want out of the franchise agreement. Below we discuss legal and business factors to consider when evaluating your termination options and your rights as a franchisee.

What Stage is Your Dispute At?

Understanding where you are at is critical. If you have just signed a franchise agreement and have not yet invested in establishing your franchised business then you will have more flexibility and more options than if you have already heavily invested in the franchised business. The longer a franchise relationship exists and the more you invest in your franchised business, the higher the stakes.

Summary

For newly signed franchise agreements you and your lawyer may have leverage to terminate the franchise agreement. If the reason for your exist is due to a misrepresentation, then part of this negotiation may be a refund of your franchise fee. If you just changed your mind, then the negotiation may be about obtaining a release from your franchise agreement. If you are further along and have established your franchised outlet or location then more is involved and you need to evaluate additional factors discussed below.

What Are Your Goals?

Is your goal:

(a) to terminate the franchise agreement, discontinue the operations of the franchised business and get out of the business entirely; or
(b) to terminate the franchise agreement but to continue the business under a different name?

Achieving goal (a) is much simpler than goal (b). While both goals are achievable, the path is very different. If the franchised business has not turned out the way that you would like and you want to exit the business and industry then the goal should be to negotiate an exit strategy where you pay all past due royalties, obtain a release as to all future payment and royalty obligations and you abide by post termination non-compete covenants. If a franchised business is unsuccessful, more often than not, it is in the best interests of the franchisor to negotiate a release. In the second scenario, option (b), the difficulty becomes the post-termination covenants and a franchisors reluctance to not lose a franchised outlet or location that is profitable. Option (b) requires an additional analysis and negotiating leverage must be focused on potential violations committed by the franchisor.

Summary

If your franchise has proven unsuccessful and you want to exit the industry then obtaining a mutual release from the franchisor is an achievable and worthwhile goal. If you are seeking an exist strategy where you rebrand the business or stay within the industry then a more detailed review will be required and your focus must be on obtaining leverage through potential franchise violations that may have been committed by the franchisor.

Are There Franchise Violations?

The answer to this question requires an evaluation and review of your FDD, franchise agreement and the FDD disclosure process that occurred prior to your franchise purchase. When it comes to franchise violations they either exist or they don't but, when franchise violations exist, they have the potential to decidedly tip negotiating leverage in your favor. If you are looking for an exit strategy that involves the rebranding of your business and your continued operation in the franchise industry, then the potential existence franchise violations will be critical to your evaluation.

Examples of franchise violations include a franchisor's:

  • Failure to timely disclose its FDD;
  • Failure to disclose a current and updated FDD;
  • Failure to have registered its FDD;
  • Failure to abide by registration conditions such as escrow and deferral requirements;
  • Failure to properly disclose its financial statements within its FDD;
  • Failure to properly disclose items within the FDD; and
  • Violation of disclosure requirements regarding financial performance representations and earnings claims.

Summary

Franchise violations can be game changers and if they exist can decidedly tip negotiating leverage in your favor. Determining whether or not a franchise violation has occurred requires an evaluation of your franchise transaction, franchise agreements, FDD and the franchisor's registration status.

Don't Forget About the State Franchise Laws

Various states have enacted laws that are designed to provide supplemental protection to franchisees. These laws are typically referred to as franchise relationship laws and they are typically focused on granting extra rights to franchisees. In certain cases state franchise relationship laws may override provisions of your franchise agreement and provide you with supplemental rights in situations involving the termination and renewal of your franchise rights.

Summary

Don't overlook state franchise relationship laws. If you are located within a state that has enacted franchise relationship laws then your analysis must include supplemental rights that may or may not be afforded to you under state law.

What's the Next Step?

Determining the next step and the right course of action for you requires a thorough and realistic evaluation of the factors discussed above. There are options and setting a clear plan will make a significant difference in resolving your dispute, maximizing your opportunity for a negotiated settlement and, if required, increasing your leverage in potential litigation.

Charles Internicola

by Charles Internicola
National Business and Franchise Lawyer

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