Franchise agreements: how to navigate the great escape

Franchise agreements: how to navigate the great escape

Franchisor-franchisee disputes can be avoided or settled if you use your franchise lawyer effectively. Here’s how

It happens all too often: As a franchisor, you have spent time, effort and good money on getting your template franchise agreement drawn up by a proper franchise lawyer. When it came to filling in and sending out versions of the agreement to franchisees who are about to come on board, you entrust the task to someone in your admin team. Some months/years later, a franchisee is in default, action needs to be taken. You hand the relevant documents over to your lawyer, confident that you have a water-tight case. 

Then comes the unwelcome news: your franchisee’s lawyers have found a loophole. Your case is now looking not so water-tight, and your lawyers are now warning you about the substantial costs and risks of litigation. The quick, cost-effective route to justice that you thought you would have is nowhere in sight.

How can this have happened?

The truth is that it can happen frighteningly easily. There are a growing number of lawyers who regularly act for franchisees who are dissatisfied with their franchise, and no shortage of franchisees who visit those lawyers, saying that they wished they hadn’t signed up to the franchise in the first place, and who are seeking a way out. The smartest lawyers know all the escape routes. So if you want to know how to reduce your risks, read on.

Escape Route 1

Who has got the agreement? It is surprising just how often franchisors can’t actually find a properly signed copy of the relevant franchise agreement. After the agreement was originally signed, years can go by before a dispute arises, in which time you may well have had changes in staff and/or office moves. Documents go astray. If you don’t have signatures of all the parties on an agreement, you have given yourself an uphill battle.

Solution: Pay your franchise lawyer to take responsibility for issuing franchise agreements and keeping scanned copies of the signature copies.

Escape Route 2

You can find the signed agreement, but the details were not filled in properly. It is incredibly easy to slip-up here. You need a keen eye for detail to ensure that the right people signed in each of the right places, that all the details re territory and fees etc were correctly added.

Where a franchisee provides a personal guarantee, for example, this should be signed as a deed, which means that their signatures must be witnessed by someone independent. If witness signatures or details are missing, or if you witnessed the signature yourself, you could be in difficulty.

Solution: Same as for Escape Route 1. It should only cost a modest amount to pass the responsibility of this to your franchise lawyers.

Escape Route 3

The franchise agreement had expired. The franchisee continued operating beyond the expiry date of the agreement. You may have mentioned to them a few times the need for a new agreement, and you may even have sent them a renewal document. Nevertheless, it was not signed.

This does not make your legal case against the franchisee hopeless. But it does present difficulties, particularly if you want to enforce the non compete clauses that were to apply after termination.

There is an open position in the English courts whether the restrictive covenants - e.g. prohibiting the franchisee from being involved in a competing business for 12 months after the end of the term – should run from 12 months from the point that you terminate the agreement, or for 12 months from the original expiry date of the agreement.

The franchisee’s lawyers may well argue for the latter, and tell you that the 12 months has already expired.  Because the law is not clear-cut, your case will be more difficult.

Solution: Keep rigorous records so that you can flag well in advance that an agreement is up for renewal. Check that your standard agreement has a specific provision providing for a short notice period for termination if the agreement continues post its original expiry date.

Escape Route 4

The franchisee signed their franchise agreement without being advised to take independent legal advice. This, unfortunately, leaves a potential door open for the franchisee to argue that they did not understand what they were signing. In particular that they did not realise they were providing a personal guarantee.

As the franchise agreement was in all probability provided to the franchisee on a “non-negotiable” basis, and in the same form that you have provided to every other franchisee, there may well be a runnable argument that some provisions cannot be enforced. 

Solution: Certainly you need a specific warning in your franchise agreement, on the same page as the franchisees’ signatures, that they must not sign before taking independent advice.  Consider even making this mandatory before onboarding a new franchisee.

Escape Route 5

The restrictive covenants relating to not competing against the franchisor are too wide, or have left unintended loopholes. Restrictive covenants will not generally be enforceable if they are drafted wider than they strictly needed to be in order to protect the franchisor’s legitimate goodwill. A smart lawyer will pick at the wording, and will sometimes succeed in finding a hole which is sufficient to unravel the whole clause.

Solution: Get your franchise agreement reviewed regularly. Your restrictive covenants might have been appropriate for your business as it was at the time of drafting. But what was once exactly on point might not be so as your business evolves.

Escape Route 6

Misrepresentation. The most commonly-used escape route that lawyers acting for franchisees will use is a claim that the franchisor gave a prospective franchisee unrealistic forecasts of turnover, profits, or customer numbers. They then argue that because of this the franchisee should be able to “rescind” the agreement, which means treating the agreement as never having existed in the first place, making post-termination obligations completely null and void.

Solution: Never make forecasts of future earnings to prospective franchisees unless these are backed up with real-world evidence. Putting a disclaimer in your franchise brochure to the effect that the forecasts are illustrative only and that the franchisee’s performance is not guaranteed will not suffice. As to what counts as “real-world” evidence, seek advice from your franchise lawyer.

Escape Route 7

Your agreement falls foul of the Trading Schemes Act 1996. This Act was designed to stop pyramid selling. But the law of unintended consequences saw to it that it ended up putting a restriction on the enforceability of franchise agreements as well. You may be able to draft your agreement in such a way that you avoid the impact of this Act. But depending on your industry sector, this may not be achievable. 

Solution: If you don’t remember having taken careful advice from your franchise lawyer at the time, check this point with them again. Are you doing anything that might cause the Act to apply? If yes, you might need to make changes to your business methods.

Escape Route 8

Your franchisee has been involved in another competing business, and you want to sue for damages. But how do you calculate your actual losses? This is less of an “escape route”, but rather a hurdle that you will need to climb over if you want a payment by way of compensation.

Solution: Do not be deterred. You will need to think long and hard about what damage the (ex) franchisee is actually doing to you, and how they are damaging your income stream. Are they making it harder for you to recruit other franchisees? If yes, you are loosing out on Initial Fees and Management Service Fees. 

Escape Route 9

If you are taking action against your franchisee, you may well want to have “step-in rights”, which enable you to take over and run your franchisee’s business in order to protect your customers’ interests and the reputation of your brand. But these are notoriously tricky to draft. Particularly if you want the right to enter your franchisee’s premises and take over their lease.

Solution: Take advice from your franchise lawyer about whether you need a specific Deed of Option in relation to your franchisee’s lease.

Escape Route 10

If all else fails, a lawyer acting for a franchisee will have a look at whether the agreement or any part of it, is unenforceable because it is contrary to EU competition law. Most franchise lawyers will be very mindful of this when drafting franchise agreements. But problems can arise where business systems change over time, or when franchisors are tempted to make what seem like trivial changes to their franchise agreements.

Solution: Make sure that your franchise lawyers explain to you what “hardcore” restrictions and “grey list” restrictions are so that you can be sure that nothing in your business is falling foul, and do not fiddle with your agreement without legal advice, no matter how tempting it is.

In summary, whilst it is impossible to avoid all possible legal risks, there are some quite simple things you can do to ensure that you close off the most commonly-used escape routes. Almost all franchisors have to deal with legal disputes with franchisees at some point, and it is expensive and time-consuming. But having to drop action against an ex franchisee in flagrant breach is also highly damaging to reputation. Both you and your franchisee network deserve for that to be avoided.

ABOUT THE AUTHOR

Roz Goldstein is the managing director and founder of Goldstein Legal, a UK-based law firm specializing in national and international franchise law. Goldstein Legal’s strong industry reputation is built on years providing tailored legal advice to clients in the USA, UAE, and Europe. Roz founded the firm in 2006, after almost 20 years’ experience as an in-house lawyer for major publicly listed companies. She uses her commercial background and franchising expertise to deliver business-focused solutions for franchisors and franchisees. Roz sits on the British Franchise Association (bfa) board of directors as the bfa’s legal representative and is a bfa Qualified Franchise Professional (QFP).

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