Franchise Tutorial 22: Intro to Termination, Transfers and Assignments
All franchise agreements make reference to defaults. This is where you are in breach of the franchise agreement. The franchise agreement has obligations that you must meet and to fail to meet these obligations will cause financial loss to the franchisor or cause damage to the franchise brand. Some defaults can be corrected or "cured." Examples would be non-payment of royalties or fees, non-compliance with standards or failing to submit reports and financial statements. In these cases, the franchisor will give you a reasonable amount of time to cure these defaults, usually 14 days. If you need more time due to unusual circumstances, let the franchisor know and they will often grant extensions. If you still fail to cure the default, then the franchisor has the right to terminate the agreement. Through your actions, you will decide whether or not the agreement comes to an end.
There will be some instances where the franchisor has the right to terminate the franchise agreement without notice due to your actions. It may be that you have charged a security interest or sold the business without the franchisor's permission, intentionally provided false or misrepresented financial statements or you have given away confidential information. It may be that your company has gone bankrupt, into receivership or simply been abandoned. These circumstances all reflect a failing business. It is important to remember that a good franchise system will usually minimize your risk, but does not make you immune. The nature of business is that there will always be a chance that the business will fail for a variety of reasons. Ideally, you and the franchisor have been communicating and dealing with the shortfalls of the business long before it gets to this stage.
Know that, in the event that the business is failing you have choices. One is to sell the business and transfer or assign the franchise licence agreement to a new franchisee. This is a far better choice than letting the business fail, as it allows you to recoup some, if not all, of your investment. You may also choose to transfer the franchise agreement because the business is doing well and you wish to recoup a return on your investment. You may want to retire, there may be a partnership breakup, or you have simply decided you want to do something else. Understand that a franchise is not a life sentence. Although the term of the franchise agreement may say 10 years, you may choose to sell your business and get out sooner.
When selling your business and assigning the franchise licence, be sure to check with the franchisor to see if they have a resale program. They may be working with qualified buyers who have an interest in your location. A transfer involves several requirements. The franchisor will want to approve any advertising that you do for the business sale. The franchisor must approve the new franchisee, all royalties and fees must be paid and the franchise must be in good standing. There will typically be a transfer fee to pay to the franchisor, often a percentage of the current franchise agreement and, in some cases, a percentage of the total business sale price. The transfer fee will typically be used to cover the franchisor's administration and training costs to facilitate the transfer to the new franchisee. Note, in many franchise agreements there will be a clause where the franchisor has the right of first refusal and may choose to match the purchase price and buy the business themselves.
There are several unique circumstances where a change in ownership takes place. In some cases, you may decide to assign shares to potential investors or even key employees. The franchisor will typically want to approve the new shareholders if it is a substantial share transfer and will definitely need to approve the assignment of shares if it changes controlling interest in the company. There may be circumstances where you transfer shares to family members. Often franchisors will allow this to take place without a transfer fee. There may be the harsh reality of death or permanent disability. The franchise agreement will often contemplate these situations with terms allowing the estate a reasonable amount of time to transfer the franchise to a new franchisee and recoup the investment. During this time the business must continue to operate and the franchisor will often step in and manage or arrange the management of the business for a fee.
When the franchise is terminated, you will be required to immediately cease doing business under the brand. You will be required to return the confidential operation manuals and pay all outstanding fees and payments to the franchisor. In some cases, this may include future royalties that the franchisor would have earned if the franchised location had continued. Typically, you will not be able to operate a competing business within a defined geographical area for a specified period of time.
Franchise relationships will come to an end for a variety of reasons. In many cases, it is you and your actions that will dictate if it will happen and how. In other circumstances, it will be events outside of your control. When it is time to bring the franchise relationship to an end, review your franchise agreement to have a full understanding of what the terms and conditions are for your agreement in these various scenarios. This will allow you to maximize your return on investment, or alternatively minimize your loss.
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Posted Date: January 2011