Can a franchisor or franchisee terminate a franchise agreement? Let’s start this discussion by answering the question,
“What is a franchise agreement?”
A franchise agreement is a legally binding contract between a franchisor and a franchisee that outlines the terms and conditions for both parties when operating a franchise business. The agreement protects the integrity of the franchise’s operating system and the brand as a whole. While franchise agreement are typically the same for each franchisee, there might be room to negotiate certain aspects.
In most cases, a franchise agreement ends when the contract expires and is not renewed. While everyone involved in a franchise agreement hopes for a long and successful relationship, some circumstances will lead to an early termination of the contract. For this reason, every franchise agreement includes a termination clause.
While some agreements provide termination rights to the franchisee, most agreements only allow the contract to be terminated if there is a “good cause”, which is left to each state to define.
What Conditions Are Included in the Termination Clause?
A “material breach” of contract refers to a serious violation of the terms in the agreement that significantly impacts the interests of the other party. Typically, a breach of contract is a “good cause” for terminating the agreement. Here are a few examples that could be considered a material breach of contract.
When the franchisee:
- Is convicted of a crime
- Loses a license or lease essential to running the business
- Doesn’t pay royalties
- Defaults on a loan and fails to correct it
- Goes bankrupt
- Violates franchisor standards (location, appearance, etc.)
- Doesn’t comply with the franchise’s standard business operations
When the franchisor:
- Fails to offer the training and support outlined in the agreement
- Makes fraudulent or misleading claims regarding potential profits
- Fails to protect the franchisee’s territory
- Goes bankrupt
In addition to stipulating the conditions to end a franchise agreement, the termination clause will also outline the financial and legal consequences for abandoning the agreement without good cause.
5 Things to Consider Before Terminating a Franchise Agreement
Ending a franchise agreement is not a decision to take lightly. If a franchisee is thinking about closing their business, here are a few things to consider:
1. The Importance of Keeping a Detailed Record
If you want to end a franchise agreement, then it’s essential to document the reasons for it. Having detailed information that supports your cause for terminating the contract can help set you up for success.
2. Has There Been a Breach of Contract?
If there is a material breach of contract, then the termination clause in a franchise agreement typically allows for the following actions:
- Suspend business operations under the agreement
- Terminate the agreement if the breach of contract is not resolved within a reasonable time frame
3. The Consequences of Being Terminated by a Franchisor
If a franchisor has cause to terminate the franchise agreement, then the franchisee might face the following consequences:
- Must pay the franchisor for “future lost profits” or “liquidated damages”
- Lose the right to operate while also being responsible for fees and royalties
- Obligated to pay the franchisor for the remaining term of the contract
- Held to non-compete requirements, which would prevent the franchisee from opening a similar business on their own
4. What is a Franchise Non-Renewal?
Either party can choose not to renew a franchise agreement when it expires. While franchisees can walk away from the business at this point without violating the contract, they are still bound to certain terms in the agreements. Franchise agreements often require the return of items after the relationship is over. Many will also include a non-compete clause, which prohibits you from opening a business in the same industry. This prevents people from using the franchise as a “training ground” for running their own independent business.
5. Requirements to Renew Your Franchise Agreement
Most states won’t allow a franchisor to pick and choose which franchisees they want to renew. However, a franchisee must meet the renewal requirements and sign the new agreement, which might look a lot different than the original franchise agreement signed 5-10+ years before.
Renewing a franchise agreement might involve the following:
- Pay renewal fees
- Sign new franchise agreement
- Remodel or renovate the business
- Additional staff training
- Update equipment
- Increased royalty fees (typically applies to new franchises but not established ones)
3 Ways to Terminate a Franchise Agreement
Typically, ending a franchise agreement before it expires isn’t worth the consequences. However, there are a few options to consider if you’re looking to get out of the franchise business.
1. Work With the Franchise to Exit the Business
In some cases, a franchisor will work with the franchisee to find a “walk away” solution that allows for a quiet exit. Even so, the franchisee will likely be bound to the ongoing lease and other non-compete obligations.
2. Sell the Franchise Business to a Third-Party
This might seem like the best solution, but it won’t work in every situation. A couple of prohibiting factors include: 1) not being able to find a buyer in time and 2) not being able to sell for a price that will recoup enough of your investment.
Further reading: The Pros and Cons of Buying a Franchise Resale
3. Sell the Business Back to the Franchise
The franchisor might be willing to buy the business back from the franchisee, but it may not be at a price high enough to make you whole.
The path for leaving the franchise business will depend on each situation. Consider speaking with a franchise attorney who can help you navigate an option that works best for you.
Set Yourself Up for Success
No one starts out a franchise relationship with the intention of breaking their agreement before it expires, but some franchisees still have to face that decision. It’s important to carefully consider the consequences of terminating a franchise agreement, the options you have, and what you can do to set yourself up for success.
Step-by-Step Checklist for Leaving a Franchise
Step 1: Review Your Franchise Agreement
- Locate your signed franchise agreement, amendments, renewal documents, and any related agreements.
- Identify the agreement’s expiration date and any renewal or non-renewal deadlines.
- Review termination provisions, including grounds for termination, notice requirements, and opportunities to cure a breach.
- Review transfer provisions to determine whether the franchisor must approve a buyer.
- Identify any personal guarantees or obligations that could continue after the business closes or transfers.
Step 2: Understand Your Financial Obligations
- Calculate outstanding royalties, advertising contributions, vendor balances, and other amounts owed.
- Review business loans, personal guarantees, equipment financing, and commercial lease obligations.
- Determine whether the agreement includes early termination fees, liquidated damages, or other potential exit costs.
- Estimate the value of your business, equipment, inventory, and other assets.
- Consult an accountant or tax professional about potential tax consequences.
Step 3: Evaluate Your Exit Options
- Determine whether selling or transferring the business is feasible.
- Ask the franchisor about its transfer approval process and applicable requirements.
- If considering negotiated termination, identify the terms you would need in a written settlement.
- If the agreement is nearing expiration, confirm the process and deadline for non-renewal.
- Compare the potential costs, timing, and risks of each available option.
Step 4: Consult a Franchise Attorney
- Have an attorney experienced in franchise law review the agreement and applicable state law.
- Discuss potential termination rights, disputes, notice deadlines, and required procedures.
- Review any proposed termination notice, settlement, release, or transfer agreement before signing.
- Confirm whether any obligations could continue after termination or transfer.
Step 5: Plan the Transition
- Obtain written confirmation of the agreed exit terms and any release of liability.
- Determine how franchise branding, signage, proprietary materials, and confidential information must be handled.
- Review requirements for inventory, equipment, customer records, and online business accounts.
- Coordinate the transition with employees, landlords, lenders, suppliers, and other parties as applicable.
- Keep copies of notices, correspondence, payment records, and final agreements.
Important: Do not assume that closing your location, dissolving your business entity, or stopping royalty payments automatically ends your contractual obligations. Confirm the legal and financial consequences before acting.
Choose the Right Franchise From the Start
Ultimately, the best way to avoid termination of a franchise agreement is to set your business up for success from the beginning. If you buy a franchise that fits your goals and abilities, then hopefully you’ll never face a situation where you have to decide how to get out of the business. FranNet is here to help you get started on the right foot. Our expert franchise consultants will evaluate your unique goals, skills, and interests to connect you with the right opportunity. We have hundreds of verified brands to choose from. Schedule your free consultation today!
Disclaimer: This article is intended for informational and educational purposes only and does not constitute legal, financial, or business advice. Franchise agreements and applicable laws vary, and the options available for terminating an agreement depend on the specific circumstances. Consult a qualified franchise attorney before making decisions about terminating, transferring, or otherwise exiting a franchise agreement.