It’s a situation that is not uncommon: a franchisee walks away from his franchise only a short time after signing the franchise agreement because he’s not happy with the way things are going. Good move or bad move?
Well it can be either, depending on how you look at it. Undoubtedly the advice to any franchisee has to be that they shouldn’t just walk away – at least not without having taken specialist legal advice first. But it’s not always the end of the world if they do.
More often than not it’s a bad move, at least from a strict legal perspective. Franchise agreements very seldom, if ever (I’ve never seen it), permit the franchisee to resign or walk away and, in law, he can only do so in very limited circumstances. Those circumstances tend to be either:
(1) that the franchisor seriously misrepresented the franchise opportunity to the franchisee prior to the parties signing the franchise agreement (commonly referred to as ‘mis-selling’ or ‘misrepresentation’); or
(2) that the franchisor has behaved in a manner that amounts to a serious breach of the terms of the franchise agreement.
But very rarely will it be clear that one of these ‘grounds’ exists.
What commonly happens in practice is that the franchisee assumes he is within his rights to walk away and does so. Now in one sense he could be forgiven for forming that view: he’s probably not a lawyer and so won’t appreciate the legal difficulties that come into play in these circumstances but, nevertheless, he will invariably promptly find himself on the receiving end of a firm letter of claim from the franchisor’s solicitors pointing out that he has acted unlawfully by walking away when he did, demanding that he compensates the franchisor and insisting that he complies with various restrictions (usually for up to a year) preventing him from competing with the franchisor.
It is typically only at this point that the franchisee seeks legal advice but by this time more often than not the horse has bolted. It is likely that the franchisee will struggle to argue successfully that he was legally within his rights to abandon the franchise because such claims are notoriously legally complex, not to mention expensive, and, in any event, the franchise agreement is usually heavily weighted in the franchisor’s favour and this will make it all the more difficult for the franchisee to succeed in this sort of argument. Even if the franchisee does have the makings of an argument that he was within his rights to walk away, unlike his deep-pocketed franchisor, the franchisee will often not have the financial resources to sustain a legal battle.
When he signed the franchise agreement, the franchisee will have committed to operating the franchise business for a fixed term – usually between 5 and 7 years. If he chooses to walk away early, the chances are that he is going to have to face the financial consequences.
The franchisor will demand compensation equivalent to the franchise fees it would have earned from the franchisee had the franchise continued for its full term – usually a significant amount of money – although the franchisor is under a legal obligation to take steps to limit those losses (called “mitigation”) by, for example, seeking to re-sell the franchisee’s former territory to a new franchisee as soon as possible. But, even after mitigation, the financial affect on the franchisee can be severe.
That said, experience tends to show that franchisors are usually less concerned about recovering money from the departed franchisee than they are about installing a new franchisee in the territory as soon as possible and also ensuring that the former franchisee does not compete with them. This means that it is sometimes possible to reach a settlement which includes the franchisee agreeing to adhere to the restrictions (such as maintaining confidentiality, not competing with the franchisor, etc.) in the franchise agreement which he will have accepted at the time of signing but only paying a nominal amount in damages (or at least significantly less than the franchisor initially demands). This is because the franchisee will invariably be in a financially weak position (no doubt because he put most of his life savings into the franchise in the first place) and so will usually throw this into the mix as part of the negotiation with the result that his franchisor will agree to accept a significantly lesser amount by way of damages.
Remember also that the franchisor will invariably not want a full-blown legal battle with the former franchisee, principally because of the negative publicity this can attract, particularly when it comes to trying to expand the franchise network by selling territories to new franchisees as would-be recruits will almost certainly enquire about so-called “bad-leavers” and the franchisor will be well advised to be candid when answering such questions.
So just walking away from a franchise without carefully considering one’s position first is, on the face of it, usually a bad move – certainly from a legal perspective. But clouds have silver linings and some good can come from the situation: simply walking away can lead to a settlement between the parties that amounts – financially at least – to a much better outcome for the franchisee than would have been the case if he’d stuck with a franchise business he was unhappy with – or just couldn’t make work – for several more years.
Equally, the franchisor can benefit too because by reaching settlement with the franchisee the franchisor no longer has the burden (and the associated risk) of having a disenchanted or failing franchisee in its network. The franchisor will be looking forward to moving on with finding someone who is better-suited to the role whilst at the same time receiving at least some compensation from the former franchisee in the process, or at least ensuring that the former franchisee does not set up in competition.
