Franchising is a very popular form of running of a business. However, the reality is that circumstances can change and agreements come to an end. Getting out of a Franchise Agreement isn’t as simple as it may seem.
When you first entered a Franchise Agreement, you probably noticed the insane number of rules and regulations. These rules can be just as tricky at the end of the agreement. Whether your franchisor has breached the contract or you’re just ready to walk away, it’s a good idea to speak to a lawyer before taking any steps.
Holden ending their franchise in Australia and New Zealand is a good example of how it can get complicated if you don’t comply with franchising laws. As a result, some changes were made to the Franchising Code of Conduct. We’ll go through the details, and also how Franchise Agreements can end for a franchisee and franchisor in general.
What Happened With Holden?
You might’ve heard the news from General Motors that Holden decided to withdraw from the Australian and NZ market. The main reason was that they felt the brand was no longer competitive in Australia. However, the end of this Franchise Agreement meant that a lot of dealership owners (the franchisees) would be suffering financially.
In response to the sudden decision, a Senate Inquiry was launched and dealership owners maintained that they were entitled to compensation. We can expect the final report of the committee on March 18 2021.
A number of submissions were about dealers who had invested in Holden months before they decided to withdraw from the market. Investors who contacted Holden were not advised against making investments with them.
The ACCC commented that “The complaints raised concerns relating to the Franchising Code of Conduct and the unconscionable conduct and misleading and deceptive conduct provisions of the Australian Consumer Law.”
General Motors has proposed a compensation package, which provided that:
- Dealers can continue operations for a longer period of time (5 year term)
- Dealers would be compensated for the loss of new sales for the 2.5 years that remains in their agreement
However, General Motors failed to comply with the established rules when trying to exit the agreements. The ACCC got involved due to a breach of contract, commenting that “…GM did not conduct its negotiations with dealers in good faith, and did not give adequate disclosure of materially relevant facts, as is required under the Franchising Code.”
While the case was initially focused on Holden itself, the conversation shifted towards car dealerships, franchisors and franchisees in general. In particular, the case raised questions around the unequal bargaining power between the two parties, and how franchisees are often subject to sudden losses.
This is why it’s important that you know the details around termination in your Franchise Agreement. When the agreement ends, everything that happens afterwards will be governed largely by what is in that agreement.
Who Enforces The Rules Around Franchising?
When dealing with franchises, the two main sets of rules to follow are the Franchising Code of Conduct and the Australian Consumer Law, both of which are enforced by the ACCC (Australian Competition and Consumer Commission).
In other words, the ACCC can step in if the agreement isn’t ending smoothly.
The Franchising Code covers things such as:
- Disclosure requirements
- Good faith obligations
- Dispute resolution
- Cooling-off period
- Procedures for terminating a Franchise Agreement
Changes To The Franchising Code For Car Dealerships
On 1 June 2020, the Code was updated in relation to new car dealership agreements (however, they only apply to dealerships that deal primarily with new passenger vehicles or new light goods vehicles).
Both parties need to be aware of the following obligations.
End Of Term Obligations
Both the franchisor and franchisee need to notify the other party of what they intend to do when the Franchise Agreement is coming to an end. This means you need to communicate whether you will:
- Renew the agreement
- Enter a new agreement
- Terminate the existing agreement – in this case, the franchisor needs to provide a reason and a plan for winding up the business.
Written notice must be provided at least 12 months before the term ends (if the term has only been effective for less than 12 months, then it will be 6 months’ notice). If the franchisor doesn’t comply, there may be a penalty of up to $66,600.
Unless special circumstances apply, franchisors cannot ask franchisees to undertake ‘significant capital expenditure’. The updated Code now requires both parties to discuss the expenditure and only allow for such expenditure if the franchisee gives their consent.
This should also be included in the Disclosure Document. It should cover the:
- Nature of the expenditure
- Anticipated outcomes
- Expected risks and benefits
There are many cases where a franchisor will have multiple franchisees with similar issues. If there is more than one franchisee raising a dispute with the franchisor, the amended Code allows those franchisees to request that the franchisor deal with their disputes together (provided they are of the same nature).
As we mentioned earlier, franchisees are not given much bargaining power through their agreements. So, these changes aim to protect franchisees by imposing stronger obligations on the franchisor.
So, What Are The Ways Franchise Agreements Can End?
The following are some of the main ways this can happen:
- Expiration: the agreed franchising term has finished and the franchisee no longer operates the franchise business.
- Renewal: the franchisee exercises the option to renew (in the Agreement) after the initial term has ended.
- Extension: unlike a renewal, the franchisor chooses to extend the term of the Agreement – you can read more about this here.
- Termination: this is when the agreement is brought to an end early. It could happen mutually, prompted by the franchisor or by the franchisee. However, Franchise Agreements will generally make it harder for a franchisee to terminate the agreement.
Of course, there are other ways such as selling the franchise, transferring or assigning it to someone else.
When Can The Franchisor Terminate The Agreement?
If you’re in a Franchise Agreement, you probably know that it contains a lot of rules on what franchisees can and can’t do.
If the franchisee breaks any of these rules, the Franchising Code of Conduct allows the franchisor to issue a Breach Notice.
It should specify what the breach was and when the franchisee needs to remedy that breach.
To be valid under the Code, a Breach Notice must:
- be in writing;
- specify the exact breach of the Franchise Agreement;
- set out what the franchisee must do to remedy the breach; and
- provide a reasonable time for the franchisee to remedy the breach (it doesn’t have to be longer than 30 days).
If the franchisor wants to use the Breach Notice to terminate the Franchise Agreement, the notice must state that the franchisor will terminate the Franchise Agreement if the breach is not remedied accordingly.
I’ve Been Issued A Breach Notice – How Do I Respond?
While it’s not exactly ideal, there may be situations where you’ll receive a Breach Notice.
See what the alleged breach is exactly. If you think it can be rectified, then take steps to remedy the breach according to the requirements set out in the notice.
If you don’t agree with the breach, or you don’t think it’s reasonable, you can talk to the franchisor and try to reach an agreement. It’s always good to have all your negotiations in writing, in case something goes wrong.
If you can’t find a solution, you may be able to rely on the dispute resolution provisions in your agreement (otherwise they’re also in the Code).
There are also some circumstances where franchisors can end the agreement immediately without a Breach Notice. Some examples of when this may happen is when the franchisee:
- Walks away from the agreement with no explanation
- Becomes insolvent or bankrupt
- Endangers public health and safety
- Engages in fraudulent behaviour
- Agrees to terminate mutually
What If The Franchisee Was Not In Breach?
The franchisor may choose to terminate the agreement before it expires, very unexpectedly and when there has been no breach (like General Motors). When this happens, the franchisor needs to comply with the requirements in the Code, such as providing reasonable notice and giving a proper reason.
However, using this termination right should be considered carefully. The franchisor might be met with various allegations such as being unconscionable and not acting in good faith under the Code. As we saw, General Motors was under great scrutiny following their announcement and it also highlights the vulnerability of franchisees.
When Can The Franchisee Terminate The Agreement?
Generally speaking, a franchisee doesn’t have as much say in ending a Franchise Agreement. It’s uncommon to see a situation where a franchisee can end the agreement early without paying an exit fee or other money to the franchisor.
Sometimes, the agreement may include clauses that allow the franchisee to terminate the contract. However, before entering the agreement, it might be good to negotiate some terms around termination that is more suitable for the franchisee.
If the franchisor breaches the Franchise Agreement in any way, you might be able to terminate the agreement. You can follow the set dispute resolution procedure under the Code or the Franchise Agreement.
However, note that the dispute resolution procedure does not guarantee termination, and may largely depend on the strength of your case.
If the franchisor has breached an essential or fundamental term under the Franchise Agreement, a franchisee could terminate the agreement at general law.
In Franchise Agreements, there is a 7 day cooling-off period. This means you have 7 days to back out if you change your mind. However, this only applies to new agreements, and not renewals or extensions.
If the franchisee exercises their cooling-off right, the franchisor should repay the franchisee any funds paid, minus reasonable expenses incurred by the franchisor. Most Franchise Agreements should say the exact amount the franchisee would lose if they exercise this right, and what the “reasonable costs” are.
Selling Your Franchise
For whatever reason, it just doesn’t make sense to run the franchise anymore.
The Code allows you to sell or transfer your business to a third party. First, you’ll need to review your Franchise Agreement in case there are rules around whether you can sell your franchise.
In most cases, you’ll need the franchisor’s consent before doing so.
You can expect this process:
- You give the franchisor written notice about the sale, asking for consent.
- Tell the franchisor details about the potential buyer, e.g. whether they have experience in running a similar business, their financial capacity etc.
- Unless there’s some pressing issue, the franchisor should provide consent.
Once you have the franchisor’s consent, it’s recommended that you talk to a lawyer to have the required documents ready. For example, you’ll need a Contract for Sale of Business or a Deed of Termination with the franchisor. If you are leasing the premises on which you run the business, then you’ll also need to get permission from the landlord and transfer your lease as well.
What Happens After The Franchise Agreement Ends?
Usually, the Franchise Agreement will outline what you can and can’t do after it ends.
For example, the franchisee will likely be subject to a restraint of trade non-compete provision that prevents them from running a competing business with the franchisor.
Some obligations continue after the contract has ended, e.g. the duty to act in good faith (you can read more about this here).
Other end of term clauses you may need to be aware of:
- If there is a lease, who holds it when the franchise ends?
- Any buyback provisions of stock and equipment
If your agreement is ending soon, it’s a good idea to have a lawyer review your contract to fully understand the implications and what your options are.
It’s important that both parties understand their obligations to each other when exiting the agreement, as well as the consequences following termination.
If you have decided to end the franchise agreement or to sell your business, we’ve got a team of lawyers ready to help:
- What rights do I have to end my agreement early?
- Can I terminate the agreement if the other party has breached?
- What do I need to do if I want to sell the business?
- Can I operate a similar business after the agreement ends?
- Does any part of the agreement apply after it ends?
You can reach out to us at firstname.lastname@example.org or contact us on 1800 730 617 for an obligation-free chat.
Editor’s note: The information in this article is correct as of March 1, 2021. With the upcoming changes to the Franchising Code of Conduct from 1 July 2021, we recommend speaking with a lawyer to fully understand your options during this time.
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