Breaking a Franchise Agreement the Smart way
March 16, 2023
So you want to close your franchise? You’re not alone. A survey of more than 1,100 franchise owners across various industries in around late 2014/early 2015 showed that more than half of franchise owners do not think that they make a fair profit, 91 percent were in debt, and around 66 percent operated at a loss or were merely breaking even. When franchisees face financial difficulties, they may want to simply cut their losses, close the business, and move on to something new, but breaking a franchise agreement can be difficult. Find out the smartest way to get out of a franchise agreement with advice from the experts at Garner, Ginsburg & Johnsen, P.A.
Assessing the Risk of Breaking a Franchise Agreement
While every business with a brick and mortar location may have difficulty closing a failing business because of money owed to vendors, ongoing contracts with customers, and continuing lease obligations, franchisees face an additional hurdle – breaking a franchise agreement. A franchisee that closes without terminating the franchise agreement is at risk of being liable to the franchisor for “lost future profits,” or the money the franchisor would have earned if the franchisee had stayed open for the life of the franchise agreement. This is a scary prospect because it could result in a franchisee having to stay open, hemorrhage cash, and continue running a failing business with little chance of success. The alternative is to face a lawsuit from the franchisor for “abandoning” the business.
Leveraging Your Franchise’s Current State & Finding a Way Out
Once you know the risk of breaking a franchise agreement under the wrong circumstances, the question then is what you can do about it. There are at least a few options: (1) determine whether or not you have any leverage you can use against the franchisor so that it will allow you to exit the business; (2) sell the business to a third party or existing franchisee; (3) sell the business back to the franchisor; or (4) find out if the franchisor is willing to work with you on exiting the business.
Each of these possibilities for breaking a franchise agreement comes with its own risks. If you have leverage against the franchisor, for example, it may similarly have leverage against you, and it may try to use that to keep you in the business or to recover money from you. Selling the business, while perhaps the most ideal situation, is not always possible – you may not be able to find a buyer in a timely manner. And even if you do find a buyer, the purchase price may not result in a recoupment of any meaningful portion of your investment – although accepting pennies on the dollar may be better than the alternative.
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Getting Approval for a Franchise Sale
Any franchise sale must also be approved by the franchisor, so you will need to make sure your prospective buyer meets any criteria the franchisor may have for new or transferee franchisees. Selling the business back to the franchisor can be a good option, but only if the franchisor is willing to repurchase the business. Furthermore, the franchisor may not be willing to pay an amount that will be sufficient to make you whole. Finally, franchisors are sometimes willing to work with franchisees to allow them to exit the system quietly–what is sometimes referred to as a “walk away” solution. However, even if this option is available, you will still likely be stuck with ongoing lease and other obligations, and you will likely continue to be bound by the post-term non-competition provisions in your franchise agreement.
Finding the Right Representation
Unfortunately, there is no panacea for franchisees looking to extricate themselves from a failing business. It is a terrible position to be in – hemorrhaging cash without being able to close the business. This is why it is imperative for franchisees that find themselves unable to reach profitability to talk to a franchisee attorney as soon as possible to discuss exit strategies that limit risk and liability to the extent possible.
The bottom line is, breaking a franchise agreement involves risk no matter what, and that’s something you should consider before becoming a franchisee. Although it’s difficult to break your agreement, finding the right representation, leveraging effective negotiation and educating yourself with the right information can give you a reliable out.