Business Succession Planning: Got an Exit Strategy?

Business Law Notes

Summer 2008 Edition

 

Slavery in the 21st Century
FRANCHISEE LIABILITY FOR FUTURE ROYALTIES

By M. Blen Gee, Jr.

A few years ago, you purchased an up-and-coming franchise and signed a 20-year franchise agreement. But now things are not going well. It seems like every time you turn around, the franchisor is changing the rules and the franchise has become less and less profitable. You start looking for a buyer, but because the franchise system has deteriorated so much, no one is interested. Finally, in desperation, you decide to cut your losses and just quit. You tell your landlord you are leaving. He says “No problem,” he can lease the space easily and he will let you out of your lease at minimal cost.

Then you write your franchisor that you are just not making any money, you are about to lose everything you have and you are going to terminate your franchise. You get a hot letter back from the franchisor’s Washington D.C. legal counsel telling you that, if you terminate prematurely, you will be liable for all the future royalties on the 15 years remaining in your franchise agreement. That amounts to several hundred thousand dollars!

In a panic, you run to your lawyer. He flips to Item 17 of your UFOC (Uniform Franchise Offering Circular) and under the heading “Termination by You” in big, bold, black, ugly letters is the word “NONE”! The lawyer heaves a sigh and tells you “Yes, you probably will owe all that money if you try to terminate your franchise agreement.”

Typically, a franchisor does not give its franchisees a “no-fault” right for them to terminate. On the contrary, there appears to be an increasing trend by franchisors to try to collect future royalties from terminated franchisees. Most courts that have addressed the issue have ruled in favor the franchisor! No wonder many franchisees feel like they are slaves to their franchisor.

If you are a prospective franchisee, you should closely examine Item 17 of the UFOC and the termination provision of the proposed franchise agreement to find out your rights to terminate the franchise. If there is no right for a no-fault termination, you should propose to the franchisor to attach a rider to the franchise agreement giving you the right to terminate on reasonable notice. A form for such a rider is attached below. If the franchisor refuses to attach a rider, you should seriously consider not buying the franchise. This is especially true if the franchise agreement is for a long term, such as 10, 15, or 20 years and the franchisor is not one of the well established (and well regarded) franchisors. If Item 3 of the UFOC indicates that the franchisor has had a great deal of litigation, you should be even more wary.

* * * * *
RIDER TO

_________________ FRANCHISE AGREEMENT

This Rider to ____________ Franchise Agreement (“Franchise Agreement”) is made between ___________________ (Franchisor) and the undersigned franchisee (“Franchisee”), effective the _____ day of ______________, 20___.

Notwithstanding anything to the contrary set forth in the Franchise Agreement, Franchisee shall have the right, without cause, to terminate the Franchise Agreement upon ninety (90) days prior written notice to Franchisor.

FRANCHISOR
By: ___________________
Title: __________________

FRANCHISEE
_____________________________

 

About our Author:

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.

DISCLAIMER: Johnson, Hearn, Vinegar & Gee, PLLC, provides this newsletter for general information only. The materials contained herein may not reflect the most current legal developments. Such material does not constitute legal advice, and no person should act or refrain from acting on the basis of any information contained In this newsletter without seeking appropriate legal or other professional advice on their particular circumstances. Johnson, Hearn, Vinegar & Gee, PLLC and all contributing authors expressly disclaim all liability to any person with respect to the contents of this newsletter, and with respect to any act or failure to act made in reliance on any material contained herein. Distribution of this newsletter does not create or constitute an attorney-client relationship between the firm and any reader or user of such information.

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