Growing a Franchise
A violation of a franchise agreement can lead to a notice of default and potentially termination, but the outcome often depends on the type of breach, the terms and how the franchisee responds.
Franchise agreements set rules that owners are expected to follow throughout the life of the business. When a franchisee falls short of those requirements, the next steps can vary depending on what happened and whether the problem can be corrected.
Craig Tractenberg, co-chair of the Franchise & Distribution and International Arbitration practice groups at Fox Rothschild, said breaches can range from day-to-day operational issues to more serious defaults that prompt formal action from the franchisor. How the franchisor responds often depends on the type of violation and the circumstances surrounding it.
“The most common breach of a franchise agreement is a failure to comply with system standards,” Tractenberg said. “The most common formal defaults are, number one, failure to pay monies owed and, number two, failure to open on schedule.”
A breach does not always produce the same response from a franchisor. Tractenberg said the circumstances that led to the problem can influence what happens next.
“The franchisor has to determine why the breach occurred,” he said. “Sometimes the franchisee doesn’t pay, and that is an indisputable breach. But what is the reason that the franchisee didn’t pay? Is it because their opening expenses were higher than they anticipated? Was it because a road was shut down that was crucial to their success? Was it mismanagement or something else?”
Understanding the circumstances can help the franchisor determine whether the franchisee needs additional support or whether the situation calls for more formal action.
Whether a franchisee has an opportunity to correct a default depends first on the franchise agreement and, in some cases, applicable franchise laws.
Monetary defaults commonly come with a specified period in which the franchisee can make the required payment. Some nonmonetary problems can take longer to resolve. A location damaged by a hurricane, for example, may not realistically be able to reopen within a standard 30-day period.
“The first thing to do if you’re a franchisee is talk to your franchisor about what [you can be reasonably expected to do] to cure that default will be and whether that’s acceptable to the franchisor,” Tractenberg said. “In 90% of the cases for a non-monetary default, if there’s good cause for doing that, a franchisor will accept that offer of cure, which may go beyond the literal statement in the franchise agreement.”
Some breaches may not be capable of being cured. Tractenberg pointed to issues such as an unauthorized transfer or misbranding as examples where simply correcting the problem later may not undo what has already occurred.
Franchisees should also understand that correcting one default does not necessarily erase it from the history of the relationship. A late opening, missed payments, inadequate maintenance, training problems or customer complaints may vary in seriousness. A pattern of defaults can create a more serious issue for the franchisee.
“I think the misconception is that once it’s cured, it’s forgotten,” Tractenberg said. “It is one straw that could break the camel’s back. When a franchisee has chronic defaults, even though the last one is not material, when you add them all up, it could be material. The franchisee should avoid defaults, make sure that the cure is totally effective and accepted by the franchisor, and understand that they may come back to bite them.”
A franchisee who receives a notice of default should first understand exactly what the franchisor says has been violated. Tractenberg recommends getting legal advice early rather than assuming the franchisor’s allegation automatically means a default occurred.
“I’m a lawyer, and in my experience, a franchisee who is at risk should contact a lawyer,” Tractenberg said. “An asserted default might not even be a default. It may look like, because of the words on the paper, a default, but it might actually not be a default.”
He pointed to a customer complaint as one example. A franchisor may receive an allegation that raises concerns about compliance with system standards and send the franchisee a notice based on that information. The franchisee may have additional facts that show the complaint is unfounded.
“The answer may be: It’s a nonissue. It’s a false claim. We’re going to solve the problem, and we’ll keep you advised,” Tractenberg said. “You want, ideally, total transparency.”
That communication can be especially important before the disagreement develops into a larger dispute. Tractenberg, whose practice includes franchise disputes and enforcement of franchise agreements, said the goal should be to “deescalate the situation in any way you can.”
Franchisees facing a possible violation can focus on three immediate steps:
Breaking a franchise agreement can have serious consequences, but every default is not handled the same way. The nature of the violation, the language in the agreement and the franchisee’s response can all affect what happens next. Addressing the issue quickly and keeping communication open can give both sides a better chance of resolving the problem before it grows into a larger dispute.
For more info on franchise agreements, defaults and legal obligations, check out these related stories on 1851 Franchise:
Sign up for the 1851 Franchise newsletter to get our biggest stories before everyone else
By signing up, you agree to our user agreement (including class action waiver and arbitration provisions), and acknowledge our privacy policy.
