It’s a situation I come across a lot: a franchisee has walked 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 materially misrepresented the franchise opportunity to the franchisee prior to the parties signing the franchise agreement; or (2) that the franchisor has otherwise 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. The franchisee is likely going to struggle to argue that he was legally within his rights to abandon the franchise because such claims are notoriously legally complex and, in any event, the franchise agreement is usually heavily weighted in the franchisor’s favour and so will make it all the more difficult for the franchisee to succeed in these sorts of arguments. And even if the franchisee does have the makings of an argument that he was within his rights to walk away, he will often not have the financial resources to sustain a legal battle with the deep-pocketed franchisor.
When he signed the franchise agreement, the franchisee will have committed to the franchise business for a fixed term – usually between 5 and 7 years. If he chooses to walk away early, the chances are 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, or example, seeking to re-sell the franchisee’s former territory to a new franchisee as soon as possible. But, even after mitigation, the financial impact on the franchisee can be severe.
That said, it is my experience that franchisors are usually more concerned about ensuring the former franchisee does not compete with them than they are about recovering money. This means that it is sometimes possible to reach a settlement that includes the franchisee agreeing to adhere to restrictive covenants but only paying a nominal amount in damages (or at least significantly less than the franchisor initially demands). Add to this that the franchisee is invariably in a financially weak position (no doubt because he put most of his life savings into the franchise in the first place) so this is usually thrown into the mix as part of the negotiation and can bear significantly on how much money the franchisor agrees to accept. Remember also that the franchisor will not want a full-blown legal battle with the former franchisee, principally because it is bad PR, 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 would be ill-advised not to be candid when answering such questions.
So just walking away from a franchise without carefully considering your 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 for several more years. Equally, the franchisor can benefit too because by reaching settlement with the franchisee the franchisor no longer has the burden of (and risk associated with) having a disenchanted franchisee in its network and can move on with finding someone who is better-suited to the role whilst at the same time pocketing at least some compensation from the former franchisee in the process.