How to handle renewals with a difficult franchisee

Inside Franchise Business: should you renew an agreement with a difficult franchisee?Dealing with a difficult franchisee can be problematic when locked into a contract and trying to maintain a business relationship. Whether it’s a clash of personalities or contrasting business values, a franchise relationship can easily become strained. Luke McKavanagh and Peter Rouse from Rouse Lawyers look at the issues.

A ‘difficult’ franchisee can range from someone who frequently questions your business motives, to someone who pushes every boundary under the agreement. They may or may not be a well performing franchisee.

Many agreements grant the franchisee an option to renew the agreement for a further term. Renewal is not an automatic right. The franchisee will only be entitled to exercise the option if certain criteria under the agreement are satisfied within a certain time.

Every agreement is different.

Some common criteria include there being no un-remedied breach, substantial compliance with the agreement throughout the term, executing the franchisor’s then-current franchise agreement, paying a renewal fee and refurbishing or upgrading the premises/equipment/vehicle to the franchisor’s then-current standards.

Timeframes are important. The franchisee must generally exercise the option within a certain time before the end of the agreement. The Franchising Code of Conduct also requires you to tell the franchisee whether you intend to renew the agreement at least six months before it expires.

If a franchisee is entitled to an option, has satisfied all the criteria set out in the agreement and validly exercises the option, you must honour the option. It is not sufficient to simply decide you no longer wish to continue with the franchise.

Why not renew?

A franchisee breach is the most common reason for not renewing a franchise agreement. It would generally need to be breach of a major obligation to justify grounds for non-renewal. This would be determined on a case-by-case basis with reference to the terms of the specific agreement. It may not be enough for the franchisor to simply believe that the franchisee is in breach. The formal procedure under the Code may need to be followed by telling the franchisee about the breach and providing a reasonable time for it to be remedied to constitute a valid breach. If the breach is remedied, you may need to honour the renewal.

If you wish to rely on past breaches, then the agreement must state that substantial compliance is a condition of renewal (rather than simply stating that the franchisee is not in breach of the agreement at the time of the renewal).

You must always act reasonably. You would be in a stronger position if the formal notice procedure under the Code is followed each time the franchisee is in breach.

In other words, there should be a written record of non-compliance clearly communicated to the franchisee.

The Code requires both franchisees and franchisors to act in good faith in dealings with each other. If you did not have a valid legal basis or reasonable and justifiable grounds for not renewing a franchisee, the franchisee may argue the good faith obligation has been breached.

However, the obligation to act in good faith does not prevent a party from acting in their legitimate commercial interests.

Standard treatment

You must also be mindful to treat franchisees equally. The same criteria for considering a renewal should be applied to all franchisees within your system. It would not be reasonable to renew one franchisee whilst rejecting another in the same circumstances.

It will often be a condition of renewal that the franchisee signs the franchisor’s then-current-form franchise agreement which may be on different terms to the existing agreement. It could be unconscionable for you to present an agreement with onerously higher payment obligations or vastly different terms to discourage the franchisee from proceeding with the renewal. However, courts have held that franchisors can change payment structures and other obligations on a renewal if such changes are reasonable and in response to the current commercial market.

If you don’t have clear grounds to reject the renewal but hold justifiable concerns, then it may be reasonable to impose certain conditions on the renewal. For example, the franchisee undergoing further training or formulating and committing to a business plan. The renewal could be seen as an opportunity to work with your franchisee to resolve issues and improve performance.

Disputes can be costly for both parties if the franchisee challenged your decision to not renew. The ACCC can also impose penalties for breaching the Code.

Note that in certain situations the restraint of trade provisions under the agreement may not be enforceable if you did not renew. This may apply if the agreement was entered after 1 January 2015, the franchisee was willing to extend the agreement, was not in breach, claimed compensation for goodwill of the business, and you failed to pay genuine compensation for goodwill.

The best advice for handling a renewal with a difficult franchisee is to maintain composure, act in a professionally commercial manner and keep communication open. While this is easier said than done, it is essential to remember that a franchise is a business relationship for the financial benefit of both parties. Sometimes the relationship may be beyond repair, but the commercial goal should always be remembered. Having a well-drafted franchise agreement from the outset will also improve your bargaining power should issues ever arise.