Termination of franchise agreements – how not to

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When acting for franchisors, I frequently find myself giving advice to tread carefully when terminating a franchise agreement. Where there is a significant amount of value in the franchisee’s business, no franchisee is going to stand back and allow the termination to proceed without a fight. If there is any element of dispute around the process for termination or the grounds of termination, including any element of lack of good faith, then there is a good starting point for the Court to step in to prevent termination by injuncting the franchisor from doing so.

A franchisor who is injuncted by Court order from terminating a franchisee in a very weak negotiating position. Unless there is a pathway to compulsory dispute resolution under the franchise agreement, they must wait for a substantive hearing for there to be any final decision on the case. That can take 1 to 2 years. In the meantime, they must continue to transact with the franchisee and allow them to remain in the system.

The High Court has recently heavily knocked back a franchisor who bullishly attempted to terminate a franchise agreement in this situation.

The case involved the Quest franchise system. Bear with me as I explain the facts; there are some complexities.

The parties had a franchise agreement dated 28 September 2012. There was a five year term, meaning that unless renewed it would expire on 27 September 2017. There was the usual renewal provision that required the franchisee to provide its notice of intention to renew three months before the end of the agreement. The renewal provision also required the franchisee to be substantially in compliance of the terms and conditions of the franchise agreement during the five year term.  

Six months prior to the end of the agreement the franchisor sent a list of issues to the franchisee that needed to be rectified before renewal could be considered. As an aside, I have seen this practice quite a bit in the work that I do and I think it is bad practice for franchisors to engage in. If there are problems with the franchisee’s performance then these need to be pointed out to the franchisee during the term. Sending a long list like that which might potentially include a number of new matters does not put a franchisor in a positive light when cases come before the High Court.

Nevertheless, the franchisee was required to sign a letter acknowledging that Quest’s approval of a renewal depended on the rectification of those items. The directors of the franchisee executed that acknowledgement and requested their renewal accordingly.

The expiry date of the agreement came and went and, as can often happen in franchising, there was no renewed franchise agreement in place at the expiry of the franchise agreement. According to the franchisor, there was agreement for the franchisee to continue trading on a monthly basis and an extension of the agreement to 1 April 2019 was given to allow the franchisee to supposedly meet the renewal requirements.

Fast forward to 26 June 2020, there was still no renewal agreement in place. Things were clearly drifting on. Quest had taken no action to bring the arrangement to an end. On 26 June 2020 however, Quest wrote to the franchisee stating it had no confidence the franchisee could lift its standards to meet the requirements. On 4 August 2020, it issued a one month notice of termination of the franchise agreement, in reliance on its view that the parties were in a month by month holding over situation, and in the meantime provided the franchisee with an offer to purchase the business. It seemed clear that the catalyst to the termination notice was the potential offer to purchase the business by another party.

The franchisee brought interim injunction proceedings against Quest in which it alleged that Quest breached the agreement by failing to provide renewal documentation for execution on or before 28 September 2017, by subsequently denying the franchisee’s right for a renewal for a five year term and by issuing the one months notice of termination. The franchisee’s argument hinged on whether or not it was able to point to sufficient evidence that it was in substantial compliance with the franchise agreement at the time renewal was requested.

It is commonly known by lawyers who appear in court on interim injunctions in that the courts do not resolve factual disputes at interim injunction hearings. This is a very commonly misunderstood aspect of the way in which the Court decides interim injunction hearings. All that an applicant needs to do is point to a serious question to be tried in relation to its allegations. The Court does not make any final determinations about relevant contested facts in interim injunction hearings.

In granting the injunction in favour of the franchisee, the Court found that there was sufficient evidence to establish that there was a serious question to be tried as to whether Quest was entitled to refuse the renewal. Having made that finding it then went on to consider the balance of convenience between the parties, holding that the injunction would not cause irrecoverable loss for Quest. Conversely, the franchisee was at risk of suffering greater loss than it may recover and damages.

Therefore, the message here for franchisors is to proceed with utmost caution:

  • when allowing franchisees to continue to trade past a renewal date (getting a renewal bolted down in September 2017 would have been a better course for the franchisor, allowing the situation to drift on only leads to the franchisee’s expectation that the arrangement will not come to any end)
  • when issuing one month termination notices in circumstances where it is likely there are going to be challenges to the grounds of termination. A franchisee in a substantial business of this type is only ever going to react by lawyering up and seeking an interim injunction. It is unclear whether dispute resolution had been previously entered into between the parties and this would have been the better course. That would have avoided the negative publicity that now permanently attaches to the franchisor’s brand and would have further avoided the franchisor now being in a situation where the franchisee is in a very strong negotiating position. Too often I see franchisors in similar situations taking overly aggressive positions with franchisees, usually compounded by legal input, when there is an easier pathway through dispute resolution to moving franchisees along who have become unpalatable in the system.
This article is not a substitute for legal advice about your own individual situation. Every case can be different so please seek legal advice or contact me direct for advice that applies to you.