Exiting a Troubled Franchise

Business Law Notes

Fall 2004 Edition

 

EXITING A TROUBLED FRANCHISE

By M. Blen Gee, Jr.

A franchisee may find that the franchise business he has poured so much effort into is not the success that he had hoped. Many franchisors poorly manage their systems and some abuse their franchisees. For many reasons, the franchisee may make the decision to exit the franchise system.

If the franchisor is strong and your franchise business is profitable, selling your franchise within the system should not be too difficult. If the franchisor is poorly run and in decline, selling your franchise business within the franchise system may be difficult. The franchise agreement may be structured so that you cannot sell the franchised business outside of the system. Worse still, you may be behind in royalties and advertising payments, have personally guaranteed the franchise agreement. Here are some key suggestions as to how do you exit the system and salvage some of the value of your business:

  • Find a good franchise lawyer to assist you.
  • Review your franchise agreement carefully with your attorney. The typical franchise agreement is heavily slanted toward the franchisor. However, there may be favorable provisions in the agreement or a loophole that you can squeeze through.
  • Develop a joint business and legal strategy. While it may be difficult to sell the franchise within the system, an established location with a regular clientele may have value. Your customer list may have value. Know what your business options are and what limitations the franchisor imposes on you.
  • If you are substantially behind on the payment of royalties, you may be able to use this to your advantage if you can leverage an affordable pay-out upon your exit.
  • The franchisor may have breached the agreement. There may be other abuses by the franchisor such as anti-trust violations, breach of the implied covenant of good faith and fair dealing, outright fraud or constructive fraud. Review all of the franchisor’ “bad acts” with your attorney. If there is a valid factual basis for one or more claims against the franchisor, this can give you substantial leverage. Even though many franchisors litigate aggressively, generally speaking, franchisors prefer to avoid litigation. Litigation must be reported in the Uniform Franchise Offering Circular (UFOC).
  • Contact other franchisees who have left the system or are contemplating leaving to find out what position the franchisor is taking on various issues. Do not be surprised if franchisees have been required to sign a confidentiality agreement as part of their termination package.
  • Confer with your attorney as to when and how to notify the franchisor that you intend to leave the system. Strictly comply with all notice requirements of your franchise agreement.
  • Litigate as a last resort. Litigation is expensive and inherently unpredictable. The franchise agreement will be heavily favorable to the franchisor in the event of litigation (or arbitration). If litigation is likely, discuss the costs with your attorney and manage your cash flow so that you have an adequate litigation fund. All too frequently, a franchisee is forced to take an unfavorable settlement because he simply does not have the money to continue to litigate.

IF THE DEAL SEEMS TO GOOD TO BE TRUE, IT PROBABLY IS!

By Jean Winborne Boyles

We are all eager to make more money, but when the deal seems to be too good to be true, it usually is. You may be approached in a social rather than a business manner. The motto is “Do Your Due Diligence.” Do not be afraid to ask what may seem to be an invasive question. “I should have known better” or “I wish I had looked at this as a business deal rather than just an opportunity with a friend” are sad laments.

There are many legal ramifications to business deals. One is to approach it as a business deal and not as a social engagement. Ask questions. Do not write checks without a thorough knowledge about the investment. Two sources of information are the Secretary of State and the Better Business Bureau. Ask for references, talk to other people who have invested. If you are the first one, beware. In short, be careful with business investment opportunities. The opportunity may be for the one you are giving the money to, not for you.

 

About our Authors:

M. Blen Gee, Jr. is an honors graduate of the University of North Carolina School of Law. His areas of concentration include business and corporate law, including sales of businesses; business litigation, including arbitration and mediation; franchise law; automobile dealer law; and insurance company insolvency. Mr. Gee has earned the highest peer-review rating for professional excellence and ethical standards by the national publication Martindale Hubbell.

 


Jean Winborne Boyles concentrates her practice in health law, corporate law, bankruptcy and creditors’ rights, commercial leasing, antitrust and state administrative law.

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