This is the fourth in our ongoing new series of short articles about the “basics” of franchising. In this series, we briefly offer practical information addressing some of the fundamental issues concerning franchising. This series is intended to answer and de-mystify some common questions frequently posed to us by prospective franchisees and franchisors.
If you purchased a franchise, that means you have obligations to a number of third parties, not the least of which are the franchisor and your lender. If you started operating the franchise, you probably have additional obligations to employees, suppliers, and a landlord. This means that “walking away” will require of you to deal with these obligations in order to avoid any claims by any unpaid parties
If you rescinded
In some cases, and provided you do so before two years have expired from the time you entered into the franchise agreement, you may be entitled to “walk away” from the franchise by exercising your right to “rescind”, or unwind, the franchise agreement. If you have a lawful basis to rescind, then you could take the position that you are not bound by the franchise agreement and that the franchisor must compensate you for things like your costs of setting up the franchise, the cost of your equipment and inventory, etc. It is important to recognize that delivering a notice of rescission to your franchisor does not automatically relieve you of your obligations to the franchisor, your lenders and others; the franchisor may disagree that you have a lawful basis to rescind, and the question would need to be decided by the courts. In the meantime, you would remain responsible for your obligations, and you may be sued by the franchisor, the lender, and others if you stop meeting your obligations to them..
If you just walked away without rescinding
Sometimes, rescission will not be available to you; for instance, you may be outside of the 2-year period to rescind from the time you entered into the franchise agreement. In such circumstances, you cannot simply simply “walk away” without addressing your obligations to third parties. A good way to understand all the obligations you, as a franchise owner, are under is to go through what could happen if you simply stopped running the franchise and stopped paying any amounts you owed. This list is not exhaustive; it is a snapshot of things that might cost you a lot of money.
- The franchisor: The franchisor is entitled to the payment of certain fees such as royalties from you, the franchisee, in exchange for the right to operate the franchise. If you stop paying those fees, the franchisor might be entitled to send in its own people to manage the franchise, and charge you a hefty, ongoing fee for this service. The franchisor is not buying the franchise by doing this, and none of your obligations would be transferred because of this. The franchisor might instead terminate your franchise agreement, take over your location (or sell it to another franchisee) and sue you for any unpaid fees to which the franchisor may be entitled.
- The landlord: The landlord, in response to not receiving rent, may threaten to kick you out or sell your assets located at the location. The landlord may sue you for past and future rents owing. This is also a commercial lease, which means that many protections you may have heard about for residential tenants likely do not apply.
- The lender: The lender is entitled to be repaid the funds it advanced you, plus interest. If you default on those payment, the lender would be entitled to enforce any security you may have given the lender in exchange for the loan, and/or sue you.
- Your employees: Your employees may sue both your corporation and you personally (if you are a director of your corporation) for unpaid wages.
Surrendering the franchise
Another way to “walk away” from the franchise is by seeking the franchisor’s permission to do so. It may be that the franchisor will agree if you were to ask it to surrender your franchise; for instance, the franchisor may have in mind another franchisee to replace you. Typically, the franchisor will ask for something in exchange for its agreement to let you surrender the franchisor, such as a lump sum payment. Note that a negotiated surrender will not relieve you of your obligations to other parties, like the landlord or lender – you will still need to attend to those obligations, perhaps by means of separate negotiations with those parties.
Selling the franchise
The more common way to walk away from a franchise is to sell it. Depending on how well your franchise is doing, you may be able to sell it for a significant amount of money. If it is not doing so well, you may just be able to get the value of the assets at the location (kitchen equipment, furniture, etc.).
In most cases, the franchisor will need to approve of the person buying your franchise. Getting this approval should be one of the first things you worry about, because without it, there is no sale. Before a deal gets serious, ask yourself if the buyer is likely to meet the requirements and pass the training that you had to go through when you applied for the franchise.
In rare cases, the franchisor itself may be willing to purchase your franchise and run it as a “corporate location” until a new franchisee is found.
Hoffer Adler LLP provides practical and cost-effective legal assistance to both franchisors and franchisees about all aspects of the franchising relationship. If you have any questions about a franchising matter, we would like to hear from you.