Man and woman shaking hands with text Breaking up is hard to do… Ending a Franchise. Tips for Franchisees.

Breaking up is hard to do…

Ending a Franchise. Tips for Franchisees.

Take Control

So the franchisor is not holding up its end of the bargain and this is making life difficult for you as a franchisee. What do you do? Keep reading for some valuable tips on how to navigate the breakup.

Good news

The good news is that some recent Court decisions have upheld the rights of franchisees. Upcoming legislation will give you even greater rights.

Your rights to terminate

The first thing to work out is whether or not the franchisor’s actions give you the right to terminate. Ask yourself, has the franchisor…

  • abandoned the brand?
  • allowed someone else to operate in your exclusive territory?
  • not provided the promised systems, training and materials?
  • not used the marketing fund to promote the franchise?
  • seriously misrepresented what you were getting into?

If you have answered a resounding YES to one or all of these questions, then it may be time to consider exercising your rights to terminate the franchise or to seek damages.

Typically you start by sending the franchisee a carefully worded letter outlining what they have done wrong and a timeframe to fix it.

If they don’t fix it, you can send a termination notice, telling them that the franchise is terminated (of course you can only do this if you have proper grounds!!).

This is not a decision to take lightly and you need to do it properly – so talk to your lawyer first.

Not sure? Keep reading!

Something’s not right, but is it wrong enough?

Not all the franchisor’s actions will entitle you to terminate the franchise agreement. The franchisor must have breached an essential term. According to the courts, this is a term “which went so directly to the substance of the contract or was so essential to its very nature that its non-performance may fairly be considered by the other party as a substantial failure to perform the contract at all.”1

There is no ‘one size fits all’ when it comes to deciding what is and is not an essential term in a franchise agreement.

If it is not an essential term, you may still be able to terminate if it is a sufficiently serious breach of a non-essential term.

What’s an example?
Some examples of essential terms in a franchise agreement might include:
  • exclusive territory
  • providing systems, training and materials;
  • use of the marketing fund to benefit the franchise business; and
  • use of the franchisor’s brands and trade marks.
Case Study #1: Who’s that operating in my territory?
In Video Ezy International Pty Ltd v Sedema Pty Ltd [2014] NSWSC 143, Video Ezy granted Sedema several franchises to operate Video Ezy outlets in defined exclusive territories in Australia.
A related company of Video Ezy called EzyDVD, set up a website (ezydvd.com.au) that allowed customers to order movies online.
The exclusivity provision of the franchise agreement prohibited Video Ezy from carrying on a “trade or business involving the rental and/or sale of video products or any other business of a similar nature within the territory of the franchise”.
Sedema argued that allowing customers to order DVDs online breached the exclusivity provision of the franchise agreement. Video Ezy denied any breach, and argued that the words ‘within the territory’ did not prevent it from selling ‘into’ the territory.
The Judge found that Video Ezy had breached the franchise agreement and stated that: “The distinction suggested between the operation of a 'bricks and mortar' business and online trading is illusory.....It would be an affront to the reasonable person on the 'Bondi bus' to suggest that it was the common understanding of the parties that [Video Ezy] could sell or hire video products by mail order, at a market stall or out the back of a truck in the territories. So too would it be to suggest that the TiVo movie service and ezydvd.com.au on-line businesses were any different”. The Court also found that Video Ezy’s conduct amounted to:
  • a breach of its implied obligation of good faith under the franchise agreement; and
  • unconscionable conduct.
Video Ezy was ordered to pay damages to Sedema for their lost profits.
Moral of the story:
Franchisors cannot argue a distinction between physical stores and online sales. Franchisees should be wary of a franchisor’s online presence and its impact on their business, and exclusive territory.
Implied terms
It is also important to know that even if a term is not expressly written into a franchise agreement, it can still exist and be classified as essential. In some circumstances, a term can be implied into a contract. To date, courts have implied terms of reasonableness and good faith even where they have not been expressly written into the franchise agreement.
Case study #2: Acting in good faith - Whose interests are at heart?
In Bamco Villa Pty Ltd v Montedeen Pty Ltd; Delta Car Rentals Aust Pty Ltd v Bamco Villa Pty Ltd [2001] VSC 192, Montedeen granted Bamco Billa a ‘Delta Car Rental System’ franchise. The franchise agreement prevented other franchisees and the franchisor itself, from operating in Bamco Villa’s exclusive territory.
The franchisor opened a competing business within 200 metres of the franchisee’s territory and diverted phone calls from buildings within the territory to its own branch.
The franchisee ultimately closed its franchise.
The franchisor terminated the franchise agreement on the basis that the franchisee had repudiated the franchise agreement by closing its branch.
The franchisee argued that the franchisor’s conduct was in breach of an implied term that the franchisor would exercise its powers under the agreement “reasonably, in good faith and not capriciously.”
The court found that an implied term of good faith did exist and that the franchisor’s conduct had breached this term. Consequently, the termination of the franchise agreement by the franchisor was invalid. The court stated that:
The franchisor is not reasonably entitled to expect that the franchisee should raise finance to spend monies on upgrading its fleet and premises while the franchisor continues to fostercompetition against its franchisee in breach of the agreement and remains liable to the franchisee for substantial damages and costs. Moral of the story:
The parameters of a franchise agreement are not only determined by the words on the page. Courts are willing to imply terms into these agreements, particularly in relation to good faith.
Good news on the horizon
Legislators have recognised the courts’ attitudes to the implication of good faith obligations into franchise agreements and, accordingly, proposed amendments to the Franchising Code of Conduct2 include an obligation for the franchisor and franchisee to act in good faith during the franchising relationship and also when they are discussing and negotiating or disputing the franchise agreement.

This obligation requires the parties to act honestly and not arbitrarily and to co-operate to achieve the purposes of the franchise agreement.

It is expected that these changes will take effect on 1 January 2015, subject to the relevant bill passing through Parliament.

Refusing to be bound

If a franchisor acts with a clear intention that it no longer wishes to be bound by the terms of a franchise agreement, or that it will only act in a manner substantially inconsistent with its obligations under the agreement, it may be said that the franchisor has repudiated the contract.

If this occurs, the franchisee has a right to accept the franchisor’s  repudiation, thereby discharging itself from its obligations under the franchise agreement. The franchisee will also have an action for damages against the franchisor where repudiation has been established.

More than just a breach of the agreement is required in order to establish repudiation.

Whether or not there has been a repudiation is very much dependent on the particular circumstances of a case.

It is extremely important for a franchisee to obtain the appropriate advice before it tries to accept an alleged repudiation of the contract by a franchisor. If the franchisee was found to be incorrect in doing so, it would be open to the risk of a damages claim from the franchisor.

Case study #3: Changing the brand - can they or can’t they?
In the English case of Stone and Another (t/a Tyre 20) v Fleet Mobile Tyres Limited [2006] EWCA Civ 1209, the franchise business, a mobile tyrefitting service, was primarily operated under the brand name ‘Fleet Mobile Tyres’, with an internet-based service run under the trading name ‘eTyres’.
The franchisor wanted to restructure the business, so that the online business would become the focus. This meant all franchisees would be required to change the livery of their vans, the brand name on their stationery and their business cards to ‘eTyres’ and not ‘Fleet Mobile Tyres’.
The franchisees objected to the rebranding exercise (as well as deductions made by the franchisor on sales related to the eTyres business) and took action against the franchisor. They argued that:
  • the franchisor should not be allowed to substantially impair their ability to exercise the branding right; and
  • the franchisor was seeking to inhibit the promotion of the Fleet Mobile Tyres brand, amounting to a substantial impairment of the franchisees’ enjoyment of their rights under the franchise agreement.
The court held that the franchise agreement did not give the franchisor unfettered power to instruct the franchisees to change the branding as it saw fit and that the franchisor’s instructions would have prevented the franchisees from effectively promoting the Fleet Mobile Tyres part of the business.
Accordingly, the court found that the franchisor’s instructions would have substantially impeded the franchisees’ rights under the franchise agreement to such an extent that the franchisor’s actions were found to amount to a repudiation of the contract.
Moral of the story:
Franchisors cannot demand franchisees change the branding used in the franchised business without giving due consideration to the effects on the franchisees’ rights..

You just tell me what I want to hear

What happens when a franchisor seriously misrepresents the true state of affairs with regard to the franchise business?

The answer is that their actions can amount to misleading and deceptive conduct, in contravention of the Australian Consumer Law. This may entitle the Franchisee to commence legal proceedings for compensation from the franchisor.

A common example of misleading and deceptive conduct is unjustified predictions about future earning capabilities and financial prospects of the franchise business.3

As a general rule, proving that the franchisor’s statements were misleading and deceptive is not straight-forward. The court will consider the wider context in which the statements were made, and the conduct of the franchisor as a whole.

In addition, the franchisee must prove that they relied on the misleading statements to their detriment. Where misleading and deceptive conduct has been established, the key remedy will usually be rescission of the franchise agreement (i.e. torn up as if it was never signed). In some circumstances damages may also be available.

Case study #4: Trust me… Misleading profit projections
In Trans-It Freight Pty Ltd v Billy Baxters (Franchise) Pty Ltd [2012] VCA 71, Trans-IT told the franchisees that they could expect a $1.3 million turnover from the franchised business. No actual figures were available for the site in question, as it was a newly opened branch. Rather, the representations were based on the experience of the franchisor’s representative.
The court found that the representations made by the franchisor were misleading and deceptive (under the former Trade Practices Act 1974 (Cth)), as there were no reasonable grounds for the franchisor to make those representations and awarded the franchisees substantial damages to the tune of $1.22 million.
Moral of the story:
Don’t believe everything you hear. Where possible, conduct your own investigations and always obtain relevant legal and professional advice prior to entering into a franchise agreement

I’m in chains – Restraints

Franchise agreements will often include restraint of trade provisions, pursuant to which franchisees are restrained from operating competing businesses and/or soliciting customers from the franchised business for a specified period of time.

If you are going to take action to terminate your franchise agreement, you should be wary of any restraints contained in the contract.

While the validity of the restraint of trade clause will be judged on a case-by-case basis, in general they will be judged against the reasonableness of the following criteria:

  • the scope of trade restrained;
  • the geographical territory covered; and
  • the duration of the restraint.

Preservation and success of an exclusive franchise territory has previously has been found to be a circumstance that reasonably protected the legitimate interests of a franchisee.4

Now what?

You should now have a better understanding of your rights under the law when it comes to ending your franchise agreement and feel empowered to take action, where appropriate.

If, after considering your circumstances, you feel that you may have grounds to terminate or take other action, you should contact your lawyer to discuss the next steps, ensuring that you have collated all necessary evidence to support your view.

Importantly, in the meantime do not commit an intentional breach of the franchise agreement yourself or directly or indirectly accept what you think may be the franchisor’s breach prior to getting legal advice.

If you would like to discuss the points in this document – or would like further information – do not hesitate to contact the team at Norgate McLean Dolphin.

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