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16 March 2021
The franchisor-franchisee relationship is, in many respects, just like any other long-term relationship – each party will change over the years and there will be challenges and tensions along the way.
Successful relationships which stand the test of time share the common traits of mutual respect, good communication, a convergence of interests, an appreciation of what drew the parties together in the first place and, perhaps most importantly, a willingness to make up.
This article considers common issues faced by well-established and successful franchisors and how to best handle or avoid them.
Once a franchisee has established its business and is turning over a solid profit, it is almost human nature for it to question why it is still paying royalties to a franchisor. Some take that thought a step further and attempt to terminate their franchise arrangement with a view to running the same or similar business under their own brand, without the pesky royalties.
The obvious franchisor answer is post-termination restrictive covenants. These are essentially contractual terms which prevent a franchisee from performing certain acts (eg, running the same business under another brand) after the franchise agreement has been terminated.
Such clauses will usually focus on, among other things, preventing a franchisee from:
However, franchisors must tread carefully when it comes to these types of clause.
If a restrictive covenant acts as a restraint on trade, on the face of it at least, it is unenforceable. The exception to that rule is if the franchisor can show that the relevant clauses were designed to protect its legitimate business interests and that they go no further than necessary to achieve that purpose.
From a franchisor's perspective, it is imperative that its franchise agreements contain such restrictive covenants and, perhaps more importantly, that the relevant clauses are pitched correctly so as not to be found unenforceable when needed most.
Well-established franchisors will always be mindful of possible new markets further afield.
International expansion can bring great rewards; however, there are various pitfalls. These pitfalls largely fall into two categories: commercial and legal.
Commercial considerations include:
With respect to legal considerations, one obvious but important example is differing local laws. Laws on competition, brand protection, pre-disclosure requirements and guarantees can vary greatly. Local advice is critical. Often, the franchisor's standard franchise agreement will have to be tailored.
Enforcement is another common problem. As an example, a franchisee abroad starts to fail due to one of the abovementioned pitfalls. The franchisor terminates the franchise agreement. However, the franchisee ignores this and continues to trade (which is common in certain countries).
The franchise agreement will likely enable the franchisor to enforce its post-termination restrictive covenants to stop the now-terminated franchisee trading. This is done by way of an injunction through a local court. However, depending on the jurisdiction, local courts have been known to refuse to grant the required order until a UK court has granted an injunction (on the basis that the franchise agreement is under UK law, for example).
This means that the franchisor is faced with:
The expense, practicalities and time burden in doing so can be hefty, all to stop one miscreant former franchisee.
In some cases, there are ways around such drawn-out enforcement procedures. For example, depending on the jurisdiction, the franchisor may be able to freeze the franchisee's assets via an injunction through the local courts for debts owed (rather than the broader injunction to enforce post-termination restrictive covenants). This can achieve the result that the franchisor is after (ie, stopping the rogue franchisee) without the added cost of UK proceedings.
However, ultimately, the best solution to most international expansion issues is painfully simple: franchisors should get organised before expanding and entering into any agreements. They should obtain clear advice (both legal and commercial) from seasoned advisers and undertake thorough due diligence on any potential international franchisee.
A group of franchisees can, if it is properly organised and has a common purpose, create significant commercial leverage.
Well-established franchisors by their nature tend to have numerous franchisees. Unrest or concerns from within the franchisee network can quickly escalate into a group of franchisees forming, potentially to work against the franchisor.
Many franchisors worry about such groups – and for good reason. A well-organised, committed group of disgruntled franchisees is possibly the greatest threat to a franchisor as it can unpick the very fabric on which the franchisor's business rests.
There are various strategies that can be deployed when faced with an unhappy group of franchisees working against a franchisor.
Ideally, the franchisor will be able to work with the group to iron out problems and avoid the dispute escalating further. However, it may be forced to take a more aggressive approach – for example, litigating against individual franchisees to send a message and deter the other franchisees or reaching an agreement with key franchisees in a bid to dismantle the group.
Of course, the best approach is to avoid confrontation in the first place. Perhaps ironically, the best way to do that is for franchisors and franchisees to open a strong line of communication (potentially even by starting a committee that represents and speaks for the broader franchisee network) before issues arise. This allows franchisors and franchisees to identify problems and resolve them before they snowball.
Silence at renewal happens all too often. After a successful initial term, both the franchisor and the franchisee forget (or ignore) the underlying contractual arrangement. The parties continue to operate as they have always done and the original franchise agreement is left to one side.
From a legal viewpoint, generally speaking, it is likely in such a circumstance that the parties will have been deemed to have extended the original franchise agreement by conduct (also referred to as a 'franchise at will').
However, this results in ambiguity and uncertainty. If the formal renewal process is not followed, the term of the extension and the trigger point for the non-compete provisions (eg, a likely restriction on the franchisee operating a competing business) will be up in the air. The franchisee will want to exit as quickly as possible, minimising or avoiding any non-compete obligations. Conversely, the franchisor will want the term to be as long as possible and to enforce the non-competes.
How these issues are decided will depend on the facts of each case. Even then, there is competing case law as to how the law is applied.
Take for example the trigger point for non-compete clauses for a franchise at will.
Previously, the High Court held in Flat Roof Co Ltd v Bowden ( EWHC 2894 (Ch)) that post-termination restrictive covenants (including non-compete clauses) do not extend beyond their contractual expiry dates, even if the parties continue the franchise informally.
However, in PSG Franchising Ltd v Lydia Darby Ltd ( EWHC 3707 (QB)), the High Court disagreed. It found that Flat Roof did not represent a widely shared understanding of the legal position and that restrictive covenants applied with effect from the point where the parties' relationship had terminated (in that case, 17 months after the written franchise agreement had expired).
Until a higher court sheds some light on this issue, there will be uncertainty when it comes to non-compete clauses for a franchise at will. Therefore, the best approach is to use the renewal process to recalibrate the underlying contractual arrangements to align them with the business relationship and to document those in an updated franchise agreement.
Taking such steps is more than simply avoiding a future, potentially expensive dispute. It is an opportunity for the parties to strengthen their relationship and ensure that their intentions for the future are aligned.
These are just some of the typical issues that lead to disputes among franchise networks.
Arguably, some are good problems to have (if there is such a thing) – they are certainly better than a failing franchise network and the associated issues which that brings.
However, a good portion of the above issues can be avoided, primarily through a well-drafted franchise agreement and a genuinely open and frank line of communication with the franchisee network.
It is ultimately a matter of balancing the interests of both the franchisor and the franchisee (which are sometimes aligned, other times divergent). Often, the more the franchisor pushes to increase its profits (eg, by opening more stores), the more a franchisee's revenues will suffer. Finding a middle ground that means both are happy and profitable is really what it is all about.
For further information on this topic please contact Andrew Dodd at Fieldfisher LLP by telephone (+44 20 7861 4000) or email (firstname.lastname@example.org). The Fieldfisher LLP website can be accessed at www.fieldfisher.com.
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