Franchise Contract Laws

If someone wants to start a business, they can decide what to sell or provide services for, and start a new business on their own. This can be risky; most new small businesses fail.

Another way to start a business is to pay money to a company (the “franchisor”) that already has a good track record of success, and open a new store in their name. The new business owner will be the “franchisee.” Examples of well-known franchises would include McDonald’s, H & R Block tax services, and UPS.

Advantages of opening a franchise instead of opening an independent business include:

• The cost of opening a franchise can be lower than opening an independent business
• The new business will have immediate brand recognition, an ongoing supply system, and will not have to develop its own marketing campaigns
• The franchisor wants the franchisee to succeed and will offer guidance and help

There are two basic types of franchises:

• Entire Business Format Franchise: The franchisee receives the use of the trademarks, reputation (good will), trade secrets, copyrights, and marketing and service information associated with the franchisor. Common examples of entire business format franchises include Subway sandwiches and 7-Eleven
• Product Distribution Franchise: The franchisor distributes a particular product to franchisees, such as vending machines. The franchisee is responsible for developing their own business, such as contracting with buildings for placement of the machines and obtaining products

What Is a Franchise Contract?

The franchise contract is the agreement that establishes the relationship, rights, and obligations of the franchisor and the franchisee.

Some common examples of what the franchise agreement includes would be:

• The amount of the franchise fee
• The cost to the franchisee for obtaining inventory from the franchisor
• The portion of the franchisee’s income that the franchisor will require from the franchisee, and when it will be calculated (e.g., weekly, monthly, quarterly, etc.)
• Restrictions placed on the management structure of the franchise
• The length of the contract
• A termination clause which specifies what events will cause the franchisor to terminate a contract. This might include failure to meet sales goals

To understand a franchise contract that you are considering signing, first speak with a franchise contract lawyer to make sure that the contract is fair and that it clearly sets forth your rights and obligations.

When Can a Franchisor Terminate a Franchise Contract?

State laws generally provide that a franchisor cannot terminate a franchise contract with one of its branches unless it had “good cause” to do so. What constitutes “good cause” varies from state to state.

Some of the general circumstances in which a franchisor could have “good cause” to terminate a contract include, but may not be limited to:

• If the branch has done anything to materially breach the contract, such as not paying required fees
• If the branch has committed any kind of fraud
• If the branch has committed a serious violation of the law
• If the branch has done anything to the detriment of its customers
• If the branch has filed for bankruptcy

If you are the owner of a franchise branch, verify the laws in your state for what constitutes good cause for terminating a franchise contract.

Many state laws also provide that canceling the franchise contract must be a reasonable remedy for the circumstances. An example of this would be that it would be reasonable for Burger King to terminate a contract with one of its branches when the branch files for bankruptcy. The purpose of the termination is to avoid further financial losses to the franchisor.

What Is the Termination Clause of a Franchisee Agreement?

Nearly all franchise agreements have a provision describing what can cause the franchise to be canceled. This is the “termination clause” of the franchise agreement.

In addition, every state requires that some type of notice must be provided to the branch before terminating the franchise contract. It must be in writing, and may need to comply with state laws that regulate what the notice should contain; for example, stating the reasons for termination of the contract.

What Are Some Ways That a Contract Can Be Breached?

Because a franchise contract operates in the same way as most other types of contracts, it is helpful to discuss breach of contract in general.

There are three ways in which a party can be held liable for breach of contract:

• Anticipatory breach: Also referred to as anticipatory repudiation, this type of breach occurs when the one party tells the other that they will not be fulfilling their obligations as set forth in the contract. Once the other party has been notified, they can sue for breach of contract
• Minor Breach: A minor breach of contract occurs when a party fails to perform a small detail of the contract. The entire contract has not been violated, and can still be substantially performed. An example of this would be a technical error with the contract such as a wrong date or price, or a typo
• Material or fundamental breach: The breach is so substantial that it renders performance by one or both parties impossible, essentially canceling the contract

While breaching a contract typically leads to serious problems for the one who breaches, there are reasons that give the parties the right to breach the contract. These include:

• When the contract was fraudulent from the outset (e.g. one party was tricked into signing the contract)
• Whether the contract was formed illegally (e.g. it had a fraudulent signature)
• Whether the contract is unconscionable (this means that the terms of the contract grossly favor one side over the other)
• When there is a mistake of fact present in the contract terms (e.g., the contract was meant to be for the sale of oak beams, but it says that it is for pine)

The parties may include in the franchise contract other conditions regarding breach of contract that are unique to their particular agreement, specifying when a party’s actions constitute a breach. Additionally, state laws may provide for other ways that the contract can be breached without penalty.

To understand all of the ways that a contract may be legally breached, as well as what remedies are available, contact a business lawyer.

A lawyer can do many things for you:

• They can help you understand the terms of the franchise contract, especially regarding termination
• A local attorney can help you understand which local laws will affect your legal rights and options
• A contract lawyer can help you negotiate with the other party
• A contract lawyer will also be able to represent you in court, should legal action become necessary, and help you get compensatory damages (money that compensates for your loss)

Do I Need a Lawyer if the Franchisor Terminates the Franchise Contract Without Good Cause?

If your franchise contract has been terminated in a manner that is not compliant with the law or the contract itself, you should contact a local franchise contract lawyer who has experience with franchise contracts.

A lawyer can assist you with the various legal requirements associated with obtaining a remedy for a dispute. LegalMatch can connect you with a contract lawyer in your area to guide you through the process.