A lot of attention is paid to what happens before and at the beginning of a franchisee-franchisor relationship, but what happens when it ends?
There are two main ways a franchise relationship can come to an end: by the natural expiration of the franchise agreement after the agreed upon term length, or by termination initiated by either the franchisee or the franchisor.
To explore what happens when the franchise relationship is over, we turned to Charles Internicola, the managing partner and founder of The Internicola Law Firm, for some details. The Internicola Law Firm works with and guides clients at every stage of the business development cycle, including franchise expansion. Charles serves as outside and general counsel to a number of franchise, manufacturing and service based businesses throughout the nation.
What happens to a franchise when the franchisee has fulfilled his or her obligations of the contract and wants to walk away at the end of an agreement?
When a franchise agreement expires, franchisees possess the option to walk away from the franchised business. What happens after the franchisee walks away depends on the type of business. For example, is the franchised business one that operates out of a fixed business location such as a restaurant or retail store or is the franchise a home based business?
If the franchise was a home based or home operated business that at the time of termination, rights related to the franchised territory revert back to the franchisor who is then free to resell that territory to another franchisee. If the franchised business operated out of a fixed retail location, there may be remaining good will associated with the location and considerations may exist as to whether or not the franchisor wishes to take over the retail location and possibly resell the location to a new franchisee.
No matter the type of franchise, once the franchise agreement is terminated and the franchisee walks away, the franchisee will be subject to post-termination non-competition covenants which will preclude the franchisee from then establishing a competing business.
How prevalent are non-compete clauses in franchise terminations?
Non-competition clauses are extremely common and for good reason. To establish a franchise relationship and to entrust franchisees with access to the franchise system, franchisors absolutely need the protection of non-competition clauses.
On the other hand, sometimes franchisees do want to renew their contract. How is a franchisee evaluated if he/she does want to continue?Franchisees typically possess contractual franchise agreement renewal options. Also, many states have enacted franchise relationship laws which create a statutory right in favor of a franchisee that wishes to renew his or her franchise. Factors that franchisors will consider as to a franchisees renewal relate, largely, to the franchisees prior performance, the franchisees satisfaction and payment of all fees and obligations that were due to the franchisor and whether or not the franchisee will upgrade the franchised business to conform to the franchisors then current standards, specifications and trade dress requirements.
Unfortunately, not all franchisor-franchisee relationships end amicably. What are the top reasons for franchise termination?
From a franchisee perspective, the top reason for terminating a franchise agreement or not renewing relates to profits. That is, the franchised business does not generate sufficient profits and so the franchisee discontinues the businesses operation. Another contributor to a franchise agreement termination relates to the underlying lease where the franchisee loses the lease or rent increases render the franchised business unprofitable.
From a franchisor perspective, the top reason for terminating or not renewing a franchise relates to nonperformance by the franchisee. That is the franchisee does not pay the required royalties and does not operate the franchised business in accordance with the franchisors standards and specifications.
In the event the franchisee wants to continue business, but not with the franchisor, how long does a former franchisee typically have to de-brand?
Post termination non-competition clauses typically last for 24 months following termination of the franchise agreement.
De-branding a franchise means removing everything that identifies and associates the now-former franchisee’s store from the franchisor, from signage down to the paint colors on the walls.
Furthermore, as franchise and trademark lawyer Jeff Fabian shares, “in this day and age, de-branding requirements typically extend much further into online ‘property,’ and include things like stopping the use of company email addresses and social media activity as a franchisee... tweets and status updates referencing the franchise are likely required to stop, and old posts probably need to be deleted.”
A special issue that has come up in recent years is the ownership of phone numbers. With people using cell phones more and more, if the franchisor hasn’t made provisions for new numbers to be used in conjunction with the business, former franchisees might receive residual business from the franchise’s former presence.