Legal Steps to Terminate a Franchise Agreement: Lawyers Advice
A franchise business is a quick way to get into the market and beneficial for both the parties in the Franchising agreement i.e. Franchisor and the Franchisee. The franchisee gets instant recognition, resources and established market and on the other hand, the franchisor gets royalties, vast reach and better business prospects by reaching different target countries.
However, sometimes the situations are not as it was expected before or there has been some change in the minds of either of the parties in regards to the Franchising pact.
Legal Implications of Termination vs. Non Renewal of the Franchise Agreement: In franchising business both would lead the same repercussions. The termination is putting an end to the contract whereas non renewal is after the term of agreement; the franchisor refuses to renew the agreement which also leads to end of the business pact between both the parties.
In some states, there are statutory provisions to protect such a situation which would harm the franchisee. The termination would only happen if there is a “Good Cause” to do so. Good cause includes failure of payment of royalties, material breach of the contract, failure to meet sales quotas, danger to public health and safety etc.
The Termination Clause in the Franchise Agreement
The termination clause mentioned in the agreement usually resorts to two ways of ending the agreement, it can be either:
• Suspension: where the performance of the party is suspended due to Material breach of the contract
• Termination: where there was a material breach of the contract and even after a reasonable period of time the conflict had not been resolved.
Material Breach means when the provisions of the contract has not been complied with, which has caused wrongful loss to either of the parties involved in the contract.
Legal Grounds on which Franchisor can terminate the agreement:
Franchisor can terminate on various grounds mentioned below, if the franchisee:
• Is convicted of a crime.
• Fails to pay royalties.
• Fails to correct default even after the notice given by the franchisor
• Becomes bankrupt/insolvent
• Fails to comply with franchisor’s prerequisites.
• Fails to comply with major requirements pertaining to location and appearance.
Legal Grounds on which Franchisee can terminate the agreement:
Usually, the clause where franchisees are allowed to terminate is not provided for. So the franchisee business should negotiate for the right to terminate clause in the agreement. When it’s been added to the agreement, the franchisee can terminate on various grounds mentioned below, if the franchisor:
• Fails to provide for training in the stipulated time period mentioned in the contract.
• Becomes insolvent/bankrupt.
• Commits fraud or misrepresentation.
• Fails to protect franchisee’s business avenues.
Consequences of Termination of the Franchising Agreement
The franchising agreement contains for post-term obligation clauses. Some are mentioned below:
• The franchisee must stop the usage of trademarks, names, service marks and label of the product or services dealt by the franchisor.
• Payment of all the outstanding dues by the Franchisee.
• Agree to not disclose the trade secrets of the franchisor’s business.
• Returning of the franchisor’s manual.
• Agreement to non-compete clause with the franchisor’s business.
• Franchisor’s right of repurchase which can include whole or part of the asset of the franchisee’s unit
In the case of Gujarat Bottling Co. Ltd. v. Coca Cola Co 1995 AIR 2372, 1995 SCC (5) 545 it is considered a landmark case where a contract between the plaintiff and the defendant was not considered to be a contract in restraint of trade. The purpose of the impugned clause was to promote the trade and the negative provision under challenge sought to achieve the said purpose. The negative covenant of the beverage company restricting the other party to deal with the competitors is a reasonable restriction.
The Courts have been cautious of a non-compete clause and evaluated its position which extends post-termination as well. A non-compete clause is also validated by the Indian constitutional provision under Article 19(1) (g) which confers on every citizen the fundamental right to carry any trade. But fundamental rights under Article 19 are also allied with reasonable restrictions which justify the legality of a non-compete clause. In the case of FL Smidth Pvt. Ltd. v. Secan Invescast (India) Pvt. Ltd C.S.No. 292 of 2012 the reasonable restrictions which can be placed to make a non-compete clause enforceable include:
• Geographical location: Often a non-compete is added to prohibit the employee in engaging with potential competitor in the same vicinity.
• Trade Secrets: A non-compete can be in place to protect trade secrets of the business.
• Time Duration: If the non-compete is in place for a fixed period of time then it’s reasonable.
The franchising agreement should be carefully drafted especially the termination clause. The termination may prove to be a wrongful gain and wrongful loss to either of the parties. Clear understanding of all the provisions along with negotiation should be done so that it does not tilt in anyone’s favor. Proper communication should be done by both the parties during the process of termination of the agreement and accordingly follow the obligations post-termination.
Authored By: Adv. Anant Sharma & Shivangi Ghosh