Clean Breaks Are Better Than Costly Conflicts: Best Practices To Avoid Litigation in Franchise Terminations and Non-Renewals
In personal relationships, a break-up can be acrimonious and painful or relatively clean and amicable. The same goes for the end of a franchisor-franchisee relationship. Franchise terminations and renewals are critical junctures in that relationship, often fraught with the potential for conflict and costly litigation. For franchisors, disputes arising from these transitions can drain money and time, disrupt operations, damage brand reputation, and establish unwelcome precedents that complicate future franchise operations. Litigation resulting from a bad breakup will also need to be reported in the franchisor’s Franchise Disclosure Document (FDD) and could jeopardize a potential new franchisee sale.
That is why, starting at the beginning of the franchise relationship, franchisors need to adopt forward-looking and thoughtful approaches for either ending a franchisee’s rights before the end of a set term or declining to renew those rights as the end of a term approaches. While “I hope we can still be friends” may be an unrealistic goal for a franchisor, the following tips and best practices can help minimize the chances that a franchisor-franchisee break-up descends into litigation.
The End Starts at the Beginning
The foundation of avoiding litigation involving terminations or renewals begins with the franchise agreement itself. Ambiguous language regarding termination grounds, renewal conditions, and notice requirements often invites disputes when a franchisor seeks to sever ties with a franchisee.
Franchise agreements should explicitly detail all circumstances that may constitute grounds for termination, including both material and non-material breaches. Renewal provisions should also set forth any prerequisites that the franchisee must satisfy, such as modernization requirements, financial benchmarks, or compliance with operational standards.
The agreement should also establish clear and transparent timelines for notice of termination or non-renewal, as well as any cure periods during which a franchisee can resolve stated deficiencies and thereby avoid termination. These provisions, once established, should be strictly adhered to by the franchisor, as failure to do so can form the basis for a wrongful termination claim or affirmative defense.
Meticulously Document Deficiencies, Breaches, and Other Franchisee Shortcomings
When a franchisee’s conduct or performance forms the basis of a termination or non-renewal decision, the franchisor needs to be armed with robust and thorough documentation to support that move. Franchisors should implement systematic processes for recording franchisee performance, compliance issues, and communications. When termination or non-renewal becomes necessary, this historical record demonstrates that the decision was based on legitimate business concerns rather than arbitrary or discriminatory factors.
Supporting documentation should include records such as regular performance evaluations, inspection reports, customer complaints, financial audits, and all communications regarding deficiencies. If a franchisee receives warnings about underperformance or non-compliance, these should be delivered in writing and retained permanently. Corrective actions required should also be clear and definitive where possible. This paper trail not only supports the franchisor’s position in potential litigation but often discourages franchisees from pursuing meritless claims when they recognize the strength of the documented evidence.
Maintain Consistency Across All Franchisees Regarding Termination and Non-Renewal
While the specific circumstances or deficiencies that lead to a franchisor ending a franchisee relationship can take many forms, consistently treating similar sets of facts can insulate the franchisor from claims of discriminatory treatment or breaches of the covenant of good faith and fair dealing. A franchisor terminating one franchisee for violations while overlooking the same or similar conduct by others can set the stage for such allegations. Although there is room for nuance in the treatment of similar violations based on factors such as severity or a history of non-compliance, consistency in applying operational standards, financial requirements, and quality controls across the entire franchise system is essential.
Frank and Open Communication
Miscommunication or a lack of communication is a significant source of conflict in business dealings of all kinds, including franchise relationships. Franchisors should maintain open channels of communication with franchisees who are facing performance issues or have questions about renewal. When problems arise, promptly notify the franchisee in writing, clearly explain the specific deficiencies, and provide reasonable opportunities and timeframes for correction. Avoid springing unexpected requirements on franchisees at the last moment, as courts may view such tactics as constructive non-renewal or evidence of bad faith.
Understand and Comply With State Franchise Termination and Non-Renewal Requirements
Franchise relationship laws vary significantly by jurisdiction, and many states have enacted protective legislation that imposes requirements beyond those stipulated in the franchise agreement. The New Jersey Franchise Practices Act, N.J.S.A. § 56:10-1 et seq. (Act), provides a representative illustration of such a statute.
For example, except in cases of franchisee abandonment or criminal conviction, the Act prohibits a franchisor from termination “without having first given written notice setting forth all the reasons for such termination, cancellation, or intent not to renew to the franchisee at least 60 days in advance…” Additionally, it is a violation of the Act to terminate, cancel, or fail to renew a franchise without good cause, defined as a “failure by the franchisee to substantially comply with those requirements imposed upon him by the franchise.”
For franchisors with franchisees in multiple jurisdictions, it is important to work with experienced counsel who can minimize potential violations and ensure compliance with applicable state-specific requirements. Similarly, counsel can conduct regular reviews of state law developments across markets where the franchise operates as part of the franchisor’s ongoing compliance program.
If you have questions or concerns about terminating or not renewing a franchise agreement, please contact Roy Hibberd.