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Breaking Up is Hard to Do When a franchise relationship isn't working, who has the right to call it quits?

By Devlin Smith

entrepreneur daily

Opinions expressed by Entrepreneur contributors are their own.

After a group of H&R Block franchisees filed suit alleging the tax-services company was hindering their business by selling tax preparation software to the public, the franchisees were notified that their franchise contracts would not be renewed. The franchisees claimed for the past 30 years franchise contracts had been automatically renewed, while H&R Block said both sides needed to consent for the agreement to continue.

Who's right in this situation? Should a franchisor, like an employer, be able to terminate contracts at will? If franchisees are happy or unhappy, what power do they have to extend or end their agreement? Franchise Zone got the inside story on franchise terminations from Bill Edwards, a former licensee and franchise executive with AlphaGraphics and current CEO of EDVEST Int'l Inc., a franchise consulting company.

Franchise Zone:How does the franchise renewal and termination process work?

Bill Edwards: That depends on the franchise agreement the franchisee signs. I've certainly seen franchise agreements that state the franchisor has the right to terminate the franchise agreement at any time for any reason. But that's not typical anymore. Now most franchise agreements say the franchisor has the right to terminate the franchise agreement under a certain set of circumstances, such as the franchisee declares bankruptcy, the franchisee is defrauding the company, the brand name is being damaged, the franchisee stops doing business for a period of time--those sort of things that are basically are focused on brand damage. The franchisor generally doesn't want to terminate an agreement unless there's a very good reason, because there's loss of revenue and loss of brand value. They have to list in their UFOC when they terminate franchises, and if they get to the point where they're terminating lots of franchises, it's harder to sell.

If, in fact, there is a problem where franchisees are out of compliance with the franchise agreement, there's usually a 45- or 60- or 90-day cure period where the franchisor formally notifies franchisees that they're in default on the agreement, gives them an opportunity to correct that default and works with them as closely as possible. It doesn't always work out. Sometimes the franchisee refuses to correct the default and then the franchisor has every right in the world to terminate the agreement, but the termination is really the last thing you really want to do.

Also, most franchise agreements have arbitration clauses that say if you can't agree, then you go to arbitration. Though more and more, we're beginning to see what's called a mediation clause, because arbitration is a time-consuming, expensive and pretty iffy way to resolve a problem.

Why did the franchise agreements change to where the franchisor has to have these different reasons to terminate rather than terminating at will?

I'm not going to say all franchise agreements have changed, but there has been a feeling, particularly since the early '90s, that although the franchisor has the right to the trademark and the business, the franchise agreement would be better off for both the franchisor and the franchisee if it were more balanced.

The reasons for termination are becoming much more defined than just, "We have the right to terminate at any time unilaterally." That's not a common clause anymore. Usually there's a clause saying here are the eight, 10, 12, 15 things that can cause termination. I don't think the franchisor has lost a lot of power by doing this; in fact, they've clarified why there would be a termination. Again, the whole idea is that, generally, franchisors do not want to terminate franchisees once they have them.

What if franchisees want to terminate before their contract is up? Do they have the right to do that as well?

In most contracts, they do not. Very few franchise agreements have what are called buyout clauses. The percentage of agreements focused on what the franchisor can do as opposed to what the franchisee can do is probably in the high 90 percent range. Some franchise agreements do have a buyout clause. We actually instituted that at AlphaGraphics in 1992--[the clause says] if franchisees have been in business for a certain amount of time and are in compliance with the requirements of their agreement, they can buy out of their agreement upon payment of some amount of money, which is a multiple of the previous years' royalties.

Interestingly enough, since that was put in place, less franchisees have bought out than you have fingers on your hands. It's almost as if franchisees like having the clause, but they just don't ever intend on having to use it.

If franchisees are in a system where they do not have a buyout clause and termination isn't an option, what can they do if they feel the franchisor isn't living up to their agreement?

They can sue. They can go to the franchise agreement and say, "Here's what you said you were going to do and you're not doing it," then it becomes a court case or it goes to mediation or arbitration. The first thing I hope they would do is go to mediation, because that's when people sit down and think about this with level heads. If that doesn't work, then arbitration, and if that doesn't work, then a suit.

In your experience, is there such a thing as an automatic renewal of a franchise?

No, there is not, and I'm going to clarify that. Generally agreements have a clause that says, "This agreement will be renewed if the franchisee is in full compliance with this agreement," and sometimes there's a renewal fee and sometimes there isn't. That clause is critical. That's not an automatic, but if they are doing a good job it is, and generally franchisors don't want to get rid of a franchisee who's doing a good job.

If franchisees aren't doing a good job, would they be notified by their franchisor?

All those things have to be documented. Certainly it would be unusual at the end of a 10- or 15-year agreement to suddenly get a letter from your franchisor saying, "You're not in compliance with the agreement. We're terminating you." Most franchises document the ongoing relationship with the franchisees very clearly and have a file on each franchisee, so they know the good and the bad. When it comes time for renewal or termination, they've got documentation. A franchisor normally, in my experience, would not want to terminate a good franchisee. They would want to renew, as it's a lot cheaper and easier. If the franchisee is doing the business right and paying them, it doesn't make a lot of sense unless there are other internal reasons specific to an individual franchise.

What kind of questions should prospective franchisees ask to make sure they completely understand termination and renewal?

They should get the UFOC, and the franchise agreement in particular, reviewed by their own lawyer. Unfortunately, a lot of franchisee candidates don't do that, but they need to do this to understand what their rights are. This is sort of a buyer beware situation. We always told our candidates, "Please have a lawyer review this," and I never felt comfortable that the majority of them didn't. This is not the time in the process to save money. It's really important to understand what the clauses mean.

Then, if you have any specific questions, ask the franchise development person for clarification. He or she should know the answer to that because it's his or her job to know those agreements backward and forward.

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