How to Effectively End a Franchise Agreement: An In-Depth Review

Termination of the Franchise Agreement

The terms under which a franchise relationship can be terminated are typically contained in both a franchise agreement and franchise disclosures. However, termination of a franchisee’s rights and obligations under a franchise agreement is also governed by state law.
The basic legal foundation for the ability of a franchisor to terminate a franchise relationship is governed by the Unfair Competition Law as embodied in California Business and Professions Code. "Franchisor" includes a franchisor and its affiliate, and "franchisee" includes a franchisee and its affiliate. The California Franchise Investment Law is an important consumer protection law that regulates all sellers of franchises in California.
California law requires a franchise agreement between a franchisor and franchisee to grant the franchisee the right to conduct business under a marketing plan or system prescribed in substantial part by the franchisor. In addition to this right to conduct business, a franchise agreement must require the franchisee to pay, directly or indirectly, a franchise fee (other than a bona fide payment for goods) of at least five hundred dollars at the time of or before the franchisee commences the franchise business. A violation of these provisions by a franchisor or franchisee renders the franchise agreement void, except that the franchisee may affirm the franchise agreement and enforce it in a court of law .
According to the California Code of Regulations, "Termination" means the cancellation, involuntary or voluntary, by a franchisor of a franchisee’s right to conduct business pursuant to a franchise agreement prior to the expiration of the term of the franchise. "Non-renewal" means the refusal of a franchisor to extend or renew the franchise agreement upon its expiration. A "franchise relationship" is the relationship between a franchisee and a franchisor wherein the franchisee is granted the right to engage in business under a marketing plan or system prescribed in substantial part by the franchisor and to offer and sell goods or services associated with the franchisor’s trademark, service mark, trade name, logo, symbol, or other indicia of origin.
The California Code of Regulations prohibits a franchisor from terminating a franchise relationship without cause and requires that the franchisor:
Before terminating a franchise agreement, a franchisor should consider the following:
If a franchisor fails to comply with any of the above requirements prior to terminating a franchise relationship, it is likely that the franchisee will be entitled to an injunction or restraining order against the franchisor. If the franchisor also fails to comply with the legal requirements, the franchisee may be able to recover its attorneys’ fees incurred in seeking and obtaining such an injunction or restraining order against the franchisor.

Basis for Terminating a Franchise Agreement

The most common legal grounds for terminating a franchise agreement by a franchisor are breach of contract, non-compliance with the franchise agreement or the franchise system requirements, and failure to meet performance standards or an agreed upon sales floor, usually over a specified period of time. A well-prepared franchise disclosure document (FDD) or franchise agreement should list the events of default that would give a franchisor the right to terminate a franchise agreement and the franchisee’s right to seek to cure the default. The Franchise Rule also requires that the FDD include with specificity pre-termination and post-termination obligations of the franchisee including return or disposal of the franchise business’s signs, uniforms, products, and identifying material.
The franchise agreement or FDD will generally include a list of the specific events of default. Generally, an event of default will constitute "material" when it is of sufficient importance to justify termination of the franchise agreement.
Default events that will usually constitute "material" a default include: Additionally, the FDD must disclose if the franchisor has no obligation to give the franchisee notice and time to cure defaults (examples include repeated defaults after notice and opportunity to cure). The Franchise Rule prohibits a franchisor from terminating, canceling or failing to renew a franchise agreement except as provided in the franchise agreement or FDD. The Franchise Rule provides that if the franchisor can terminate, cancel or not renew the franchise agreement for only a portion of its violations of the system, then the violation must be of sufficient magnitude to materially affect the operation of the franchise. The Franchise Rule requires that prior to terminating, canceling, or refusing to renew the franchise agreement, a franchisor must provide the franchisee written notice of such termination, cancellation or non-renewal, the reasons therefore (which must be in good faith) and a period of at least 30 days during which the franchisee has the opportunity to cure or remedy the default.
A default may be cured, or agreed to be waived or not enforced, in the franchisor’s sole discretion if there has been a de minimis violation by the franchisee. The Franchise Rule permits but does not require a franchisor to provide a franchisee with a right to cure the default within a reasonable period of time. Franchisors frequently grant a discretion to the franchisee to cure the default as a matter of good will or under a franchisee relations handbook. Although a failure to provide notice and the opportunity to remedy a default is not necessarily a "material" breach of a franchise agreement, a franchisee that believes the default is not "material" will frequently file a petition of temporary injunction to protect its goodwill.

Must-Have Components of a Termination Letter

Once you make the decision to terminate a franchise agreement, your next challenge is determining the essential elements of the termination letter. If you read my blog where I discuss the essentials of an effective termination, you will note that I emphasize the importance of being respectful, fair and compassionate in your approach. In keeping with that theme, I have provided a list of elements that should be included in the termination letter in a respectful, fair and compassionate manner. Notice: You must provide the franchisee with the notice required by the franchise agreement. In some cases, you may want to consider providing a longer notice period. Even if you are not obligated to provide the franchisee with a lengthy notice period, this gives the franchisee an opportunity to comply with the franchise agreement and cure any alleged defaults. Essential Elements
A provision explaining the reason for termination:
An explanation of the geographic area where the franchisee no longer has the right to operate the franchise;
A provision explaining whether or not the franchisee must cease using the franchisor’s marks (so long as it is not a surprise, you can explain you have a responsibility to protect your marks and the franchisee must comply);
A provision explaining whether the franchisee will be provided a post-termination audit and if so, what the franchisee is responsible for covering;
In cases of termination due to nonpayment of fees, a provision requiring the payment of all amounts owed;
A provision requiring the return of proprietary information and manuals;
A provision prohibiting the use of the system and your marks;
A provision specifying when the obligations of the franchisee continue; and
These essential elements are, of course, in addition to more standard notice and other legal requirements.

Sample Termination Letter

When it comes to actually drafting the termination, your attorney will look to include some or all of the following things into the termination letter:
• Current name and address of franchisor
• Date
• Franchisor contact person and contact information
• Franchisee’s name
• Franchisee’s address
• Franchise number
• Location of franchise
• Owner’s name
• Owner’s social security number
• List of agreements/franchisee documents being terminated
• Specific reasons for termination in accordance with the Franchise Agreement terms
• Offer to return any and all fees paid by franchisee upon surrender of the franchise license
• Franchise/Distribution may demand from franchisee in accordance with the terms of the Franchise Agreement are: restitution for amounts owed to the franchisor, return of the franchise license, return of confidential and proprietary information, etc.
• Signature line for franchisor’s representative.
A sample termination letter is as follows, complete with generic and placeholder sections ("Franchisee agrees that this Agreement and all rights hereunder are conferred, and the rights hereunder are granted solely in consideration of…"), so you as a franchisor may specifically tailor this template to your business situation, your system’s needs, and your future plans.
JANE FRANCHISEE
2727 Sample Lane
Elmorton, Massachusetts 02222
September 29, 2015
The Franchise Company
1234 Main Street Unit 12
New York, New York 24422
Attn: Tim Mershine
RE: Termination of Franchise Agreement
Dear The Franchise Company:
As you know, in accordance with Section 15.3 of the Franchise Agreement entered between us on September 29, 2012, I hereby give you notice that I shall be surrendering my Franchise Agreement effective 60 days from the date hereof (which is November 28, 2015) which is the minimum time period for surrendering said Franchise Agreement and franchisor is also entitled to take such steps as are necessary to preserve its interests in the areas of the alleged defaults. Franchisee understands and agrees that Franchisee is not entitled to any refund, return or balance of any franchise fees, royalties, charges or payments made to Franchiseeco or any other payments made hereunder. As of the date hereof and as a condition to the effectiveness of this notice, Franchisee is returning the original Franchise Agreement and all related manuals, confidential information, supplier lists, marketing materials and other items concerning Franchiseeco and the brand.
Please contact me before November 28, 2015 to make arrangements to pick up these items and reclaim your property as set out above. Dated this the 29th day of September, 2015.

Navigating Legal and Practical Concerns

In addition to requiring strong cause for early termination, state law may impose another limitation on the Franchisor’s right to terminate. Almost all states have adopted the International Franchise Association’s "FTC Waiver" model. That model requires that the franchise agreement be "terminable at will" at the end of the term – even if "cause" is not established prior to the expiration of the term. The idea is to allow both parties to escape an unwanted relationship at the end of the term. The "FTC Waiver" does not, however, allow a franchisor to terminate prior to the expiration of the term if the Franchise Agreement does not contain a "strong cause" provision.
The best defense to a franchisee’s claims for breach of contract is to develop tools to avoid having to defend such a claim in the first place. Franchisors should invest in training and support tools that help franchisees avoid defective performance. Item 17 of the FDD requires that the franchisor describe in detail everything that is done to train new franchisees (including, but not limited to, new franchisee training meetings, the number of hours of training, plans for franchisee training centers, etc.). Franchisees should be required to participate in initial and ongoing training. If poorly trained franchisees provide defective performance, it is difficult to demonstrate cause to terminate or not renew.
Franchisees will often disagree with the franchisee terminating decisions. Sometimes, this disagreement morphs into litigation in which the franchisee claims that the franchisor breached the when it declined to grant a renewal, or it terminated the franchise agreement prior to the end of the term. An award of money damages may be obtained in some cases, but in many cases damages will not be an adequate remedy . In those cases, the nonrenewing franchisee may seek equitable relief, injunctive relief, and/or specific performance of the franchise agreement. In many states, such remedies are available only if:
Franchisors should expect that they will be sued if they terminate a franchise agreement without a strong cause – especially in states that require a "strong cause" for termination. A franchisor can manage its downside risk by requiring that franchise agreements be governed by law in the state where the franchisor is headquartered, or where the principal offices of the franchisor are located. And those differences are enormous.
Out-of-state franchisors should require that all lawsuits be filed in the federal district court located in the state where its principal offices are located. In the northern division of the Central District of California, for example, there is extensive authority granting franchisors broad discretion to terminate, raise strong defenses to termination claims, and even obtain attorneys’ fees from franchisees who sue. Texas courts are also very friendly to the franchise industry generally, and often grant franchisors attorneys’ fees. Franchisors operating in Illinois should be aware that while that state does not have a strong cause requirement, courts there do require a good faith effort to resolve disputes prior to terminating.
During the transition between existing and new franchise owners, franchisees and their lenders may try to thwart the transition by withholding payments, refusing to cooperate, and refusing to execute documents necessary to effect the transition. A strong renewal and transfer provision that grants the franchisor the right to terminate if the franchisee and/or the new franchisee fails to execute documents, or refuses to cooperate, will minimize this exposure to the extent allowed by law.

Reducing Risk and Avoiding Litigation

Experience teaches that there are many actions a franchisor can take or should have taken to mitigate the risks of getting litigated with its franchisee. Not every franchisee is a bad actor. Even a good franchisee may not be complying with its obligations due to ignorance, and a good franchisor should want to work with a good franchisee to bring its performance back into line with the system. Make sure you clearly communicate with your franchisee before terminating the relationship. This means in all instances documenting in writing all communications and actions you take that are related to a sale, and following your own internal policies and procedures for making such decisions. Before terminating a franchise agreement for a default, have your marketing and/or operations departments take some responsibility for the franchise or licensee’s location’s performance. Sometimes a local marketing blitz can make a bad month good or a small problem go away. Give your franchisee some direction and support in order to assess any operational performance issues. With a proactive approach on both sides, the relationship can be repaired. Be careful that whatever you do is done even handedly. Termination decisions can be predicated on a number of factors related to the business itself (local development, economy or market); however, each of these factors should be documented so that it is clear what the relevant circumstances were in deciding whether to terminate or not. In doing this, you will be able to demonstrate even handedness and minimize your liability for wrongful termination. Now about those bad actors… A deal is a deal, or so the franchisee thinks when the agreement was executed. Bad actors will pull the "deal" card out of their pockets and play it even when it is clear they are not in compliance with the terms of the agreement and have no basis for rights to renew or to continue doing business as a "franchisee." When it comes to dealing with them, clear and detailed record keeping is your best defense. Before terminating a franchisee that does not follow your rules, first give the franchisee a chance to comply with the system or otherwise cure the breach. Approaching the fringe player with the opportunity to comply with the terms of the agreement will help you to avoid claims of wrongful termination. With good documentation, you can clearly show the missed opportunities to comply with the franchise agreement. The immunities offered by applicable state law and the enforcement of the terms of your franchise agreement help to protect you from a frivolous lawsuit or a hostile brand dissociation campaign. However, if you have made a good faith effort to comply with applicable state law (for example, providing 30-60 days’ written notice to the franchisee of the basis for nonrenewal), franchise agreement enforcement, local consumer protection laws, and federal laws, there is little risk in terminating a franchise agreement that is in fact in default.

Franchisor Best Practices

To maintain a positive reputation for the brand it is important to maintain records related to the terminated relationship, including the termination letter, complaint resolution records, records related to follow up communications with the former franchisee, and the records of any communications with the public regarding the separation. This offers many benefits: While the separation should be civil , some friction may remain. While there is little that can be done once a franchisee leaves, for the sake of your reputation and future relationships, it is best practice to communicate well after the termination to ensure a peaceful separation. Communicating with the public, such as customers, through social media is also advisable.