Opening a franchise is an incredibly exciting experience, because you get the opportunity to run an established business without putting in the legwork of building it from the ground up. Yet franchises sometimes fail. Whatever the reason, excitement can quickly turn to dread for franchisees stuck with a failing business. If you find yourself in this situation, keep reading to learn more about terminating a franchise agreement early.
What Is a Franchise?
The International Franchise Association (IFA) defines a franchise as a “method of distributing products or services involving a franchisor, who establishes the brand’s trademark or trade name and a business system, and a franchisee, who pays a royalty and often an initial fee for the right to do business under the franchisor’s name and system.”
While there are countless examples of massive global franchises like McDonald’s and Subway, a franchise can consist of just a handful of franchisees. There are two different types of franchising relationships:
- Business Format Franchising. In this franchising relationship, the franchisor provides an entire system for operating a business. This includes the franchisor’s trade name, products and services, site development support, operating manuals, training, quality control, marketing, and business advisory support.
- Traditional or Product Distribution Franchising. This form of franchising is more common than business format franchising. The franchisor permits the sale of its products while granting the franchisee freedom to oversee other aspects of their business.
What Is a Franchise Agreement?
A franchise agreement is a legal contract between a franchisor and franchisee. The agreement grants the franchisee the legal right to establish a franchise outlet and use the franchisor’s trademark, products, processes, and other aspects of the business designated by the franchisor.
The franchise agreement also specifies the grounds and processes for terminating a franchise agreement. Franchise agreements can be incredibly complex and are enforced at the state level. Thus, if you are interested in terminating a franchise agreement in Texas, you should consult an experienced Texas franchise lawyer.
Grounds for Terminating a Franchise Agreement
Franchise agreements typically include termination clauses that list the grounds for termination. A standard franchise agreement will allow a party to terminate the agreement if the other party has committed a material breach.
A material breach occurs when one of the parties fails to comply with the terms of the franchise agreement, and the breach serves to materially devalue the contract, deprive the other party of the bargained-for benefits under the contract, or prevent the other party from performing its duties under the agreement. The franchise agreement will usually expressly state what constitutes a material breach.
For example, the agreement may state that the franchisee materially breaches the agreement if it:
- Fails to pay the franchisor royalties
- Files for bankruptcy protection
- Commits a crime
- Fails to comply with the franchisor’s business operations
- Fails to obtain a business license, permit(s), or lease required to run the business
- Goes outside of the franchisee’s territorial limits
A franchise agreement will typically provide that a franchisor materially breaches the agreement if it:
- Files for bankruptcy protection
- Fails to provide training, support, marketing, or product/services as required under the agreement
- Fails to protect the franchisee’s territory
- Commits fraud or makes other financial misrepresentations
Note that a franchise agreement may include other grounds for termination or may not include any termination clause at all. But under Texas state contract law, a party may still be able to terminate the franchise agreement if the other party has committed a material breach.
Risks of Terminating a Franchise Agreement
Terminating a franchise agreement poses some significant risks. For the franchisee, wrongfully terminating the agreement can result in it being held liable to the franchisor for “lost future profits.” The franchisor could also sue you for breach of contract, charge you a penalty for terminating the agreement early, and require you to pay the remaining franchise balance. Moreover, if a franchisee abandons the business, they lose their initial capital investment.
Steps for Terminating a Franchise Agreement
Most people enter business arrangements like franchises because it seems like a good opportunity to make money. But even the most established franchises experience failures. Unfortunately, franchise agreements typically do not allow the franchisee to terminate the agreement unless the franchisor has materially breached the agreement. In other words, a franchisee cannot simply walk away from a failing franchise without being held potentially liable to the franchisor.
If you find yourself in this situation, it is important to follow these steps for terminating a franchise agreement:
Pursue Your Termination Rights
Start by reviewing your franchise agreement. It is possible that the franchisor materially breached the agreement, or your agreement may be one of the rare ones that grants a franchisee broader termination rights. Consult with an experienced Texas franchise lawyer to review the agreement and advise you of your rights and options.
Assert a Breach of Contract Claim
Even if the franchise agreement does not include grounds for termination, you may be able to pursue a breach of contract claim against the franchisor. Again, consult with an experienced Texas franchise lawyer to explore potential causes of action.
Find a Buyer
If you don’t have grounds for terminating a franchise agreement early, another option is to find a buyer for your business. Most franchise agreements allow a franchisee to sell their franchise to a third party, with some conditions. For example, the franchisor will have to approve the buyer and the terms of the sale. You may also have to pay a franchise transfer fee to the franchisor. But once the sale is complete, you will likely have no further legal obligations to the franchisor.
Complete the Term
Franchise agreements vary greatly in length. But if you have owned your franchise for a while, you may be near the end of the franchise term. If you are unable to find a buyer, consider running the business until the term expires. While not ideal, once the franchise agreement expires, you can walk away from the business without facing potential civil liability.
Finding the Right Representation
Feeling as if you are stuck with a failing franchise is an incredibly stressful position to be in. The experienced legal team at Padua Law has helped countless franchisees throughout Texas terminate their agreements and find feasible exit strategies to limit risk and liability. Contact us today for a free consultation to discuss your rights and options.