By Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a Freehold, NJ Franchise Law Attorney
In the world of franchise laws and legal issues impacting franchisees it’s important to get the vocabulary right. Vocabulary terms have a precise legal meaning. First off the term ‘franchisee’ means the person or entity that is receiving the rights to operate a franchised business. A ‘franchisor’ is the entity which grants to the franchisee, rights to operate the franchised business system. Before any franchised business can legally get going, there must be a franchise agreement. Most typical franchise agreements have a term of five to ten years. Some go as long as twenty years. The focus of this post will be the termination of a franchise relationship. Many people hold a misconception that terminating a franchise relationship is quite similar to terminating any other contractual agreement. However, there are franchise termination laws that have to be taken into account which do not make it so easy to terminate a franchise agreement.
Can a Franchisor Just Terminate the Relationship?
First, there must be a valid reason to terminate the relationship. The franchisor has to issue a notice to terminate the franchise. Some valid reasons to terminate the relationship include, for example that the franchisee did not pay the royalties they were supposed to. Another reason may be that the franchisee’s business is non-compliant with New Jersey safety and health codes, if it’s a food service business.
What are the Benefits and Costs to Avoid Termination?
If a franchisor terminates the relationship he or she will no longer be receiving royalties and advertising fees. Additionally, a termination causes a closure of the business location. The actual termination of the relationship will make certain that the franchisor receives absolutely no payments. What’s the point of all of this? Well, termination should truly be one of the last options.
Termination of a franchise also means that the franchisor can suffer in other indirect ways. The termination process can be very expensive in legal fees, time, effort, and risks the potential of damaging the franchise name and brand.
Brand detriment is a real concern. If one of the locations closes down because of a termination of the relationship, the public might perceive that the whole chain of franchised businesses is not doing well. The public might not understand that the business was owned by an independent franchisee.
How Will the Franchised Brand be Affected?
One of the most common alternatives to a franchise termination is known as a “workout.” This is a form of an agreement between the franchisee and the franchisor along with other related parties, in which the franchisor gives assistance to the franchisee and usually agrees to waive certain payments and/or obligations. Workouts tend to be much more beneficial and cost effective than a termination.
However, if there is no alternative to termination, then one must seriously consider how the brand and the business system will be affected. One obvious negative effect aside from negative public and customer perception is the negative effect upon other franchisees. For example, in a smaller franchise, if there are one or two terminations, franchisee morale can significantly suffer. In order to deal with this possibility, the franchisor must come up with a way to explain the termination to the other franchisees in the system. In this presentation, the franchisor can turn a negative into a positive by expressing and addressing some of its concerns.
Another possible negative effect of termination can be that bank lenders, vendors, and suppliers will choose to stop doing business with the franchise altogether if the franchise has been involved in too many terminations. Perception of stability is key.
The Legal Mechanics of a Franchise Termination
First a franchisor should get together all of the relevant facts relating to the franchisee. The franchisor should then compile its electronic communications with the franchisee and also get all relevant documents from the legal, operations, and accounting departments. It is key to review all factors to get a complete view of why exactly a termination is occurring. Other good sources of information can be emails from people who have interacted directly with the franchisee.
State Relationship Laws
There are state laws which govern the termination of franchise agreements. Franchisors should investigate if any state laws apply and if so how they apply to the termination proceedings. Many times, franchisors will rely only on the terms of the agreement and forget to address state relationship laws. This is problematic because if a franchisor goes through with the termination in New Jersey without consulting state laws he can face sanctions under the New Jersey Franchise Practices Act. A violation falls under what is known as a “wrongful termination.” New Jersey is among 21 other states that have laws which govern the default and termination of the franchise relationship by the franchisor. New Jersey has one of the narrowest jurisdictional applications. In states like NJ, the relevant law applies to termination provisions if the franchised business if it is located in the state.
Overall, franchise terminations are never simple. If a termination can be avoided, it probably should. This is because there are a host of complex state relationship laws that may or may not apply. Additionally, terminating a franchise agreement and closing down one of the businesses can create a negative impact on the brand as a whole. Customers will wonder what is wrong, other franchisees will begin to lose confidence, and other related business parties will become more pessimistic in future business dealings. Then there are the subsequent legal battles that ensue which require a lot of effort, time, and money.
To discuss your NJ Franchise matter, please contact Fredrick P. Niemann, Esq. toll-free at (855) 376-5291 or email him at firstname.lastname@example.org. Please ask us about our video conferencing consultations if you are unable to come to our office.