Termination, Nonrenewal, and Transfer

• Author: Steven M. Goldman, H. Bret Lowell.
• Pages: 373-441

CHAPTER 6

Termination, Nonrenewal, and Transfer

Lisa Pender Morse and Ronald T. Coleman, Jr.

Contents

Introduction: The Importance of Establishing and Following

an Organized Compliance Program . . . . . . . . . . . . . . . . . . . . . . . . . 374

Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376

How Potential Termination Situations Typically Arise . . . . . . . . . . . . . . 376

Financial Difficulties of the Franchisee . . . . . . . . . . . . . . . . . . . . . . . 376

Disgruntled Franchisee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 376

Operational Problems. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 377

How to Evaluate Potential Termination Situations . . . . . . . . . . . . . . 377

Contractual Bases for Termination of a Franchise Agreement . . . . . . . . . 379

Statutory Restrictions on the Right to Terminate . . . . . . . . . . . . . . . . . . . 382

Has the Contract Been Modified?—Examination of the Parties’ Course

of Dealings and Subsequent Performance . . . . . . . . . . . . . . . . . . . . 383

Analyze All Potential Bases for Claims by the Franchisee. . . . . . . . . . . . 385

Nonrenewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 388

Differences between Nonrenewal and Termination . . . . . . . . . . . . . . . . . 388

Contractual Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 389

Statutory Restrictions on Nonrenewal . . . . . . . . . . . . . . . . . . . . . . . . . . . 391

Additional Legal Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 392

Analyze All Bases for Potential Claims by the Franchisee. . . . . . . . . . . . 392

Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393

Reasons for Transfer Requests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393

Transfer by the Franchisor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 393

Transfer by the Franchisee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394

Transfer for the Convenience of Ownership. . . . . . . . . . . . . . . . . . . . 394

Transfer as a Work-Out Option. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394

Transfer as an Early Exit Option . . . . . . . . . . . . . . . . . . . . . . . . . . . . 394

Transfer Due to Changes in the Effective Control

of a Corporate Franchisee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395

Transfer as a Business Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395

Transfer Due to Death or Disability . . . . . . . . . . . . . . . . . . . . . . . . . . 395

Transfer Due to Offering by Franchisee . . . . . . . . . . . . . . . . . . . . . . . 395

Transfer to a Family Member(s) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 395

Transfer Due to Offers by Third Parties . . . . . . . . . . . . . . . . . . . . . . . 395

373

Contractual Framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396

Personal Relationships. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396

Transfers Defined. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 396

Transfer Subject to Franchisor’s Prior Written Consent . . . . . . . . . . . 397

Conditions for Consent . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 397

Miscellaneous Provisions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398

Non-Waiver . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398

Right of First Refusal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 398

Deal Terms between Franchisee and Proposed Transferee

Subject to Franchisor’s Approval. . . . . . . . . . . . . . . . . . . . . . . 399

Death or Disability of the Franchisee. . . . . . . . . . . . . . . . . . . . . . 399

Statutory Restrictions on the Franchisor’s Right to Approve

or Disapprove a Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400

Common Law Restrictions on a Franchisor’s Approval

or Disapproval of a Transfer Request . . . . . . . . . . . . . . . . . . . . . . . 401

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 403

Appendix 6-A: Summary of State Franchise Relationship Laws

Regarding Termination and Nonrenewal . . . . . . . . . . . . . . . . . . . . . 405

Checklist No. 6-1: Default and Termination . . . . . . . . . . . . . . . . . . . . . . . . . 419

Checklist No. 6-2: Nonrenewal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 420

Checklist No. 6-3: Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 421

Exhibit 6-A: Notice of Termination for Financial Default . . . . . . . . . . . . . . . 422

Exhibit 6-B: Notice of Termination for Operational Default . . . . . . . . . . . . . 424

Exhibit 6-C: Notice of Termination . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 426

Exhibit 6-D: Voluntary Termination of Franchise Agreement between

[Franchisor] and [Franchisee] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 428

Exhibit 6-E: Letter Agreement of Termination. . . . . . . . . . . . . . . . . . . . . . . . 431

Exhibit 6-F: Reinstatement of Franchise Agreement between

[Franchisor] and [Licensee] . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 434

Exhibit 6-G: Transfer and Release Agreement . . . . . . . . . . . . . . . . . . . . . . . . 436

Exhibit 6-G-1: Guaranty and Subordination . . . . . . . . . . . . . . . . . . . . . . . . . 439

Exhibit 6-G-2: Scope of Work . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 441

Introduction: The Importance of

Establishing and Following an

Organized Compliance Program

A franchisor’s ability to enforce its contractual rights and policies with respect to

its franchisees depends, for both legal and practical reasons, upon the develop-

ment of reasonable standards and procedures and upon the consistent enforce-

ment of those standards and procedures throughout the franchise system.

Developing and consistently following such a compliance program is particu-

larly important in the areas of termination, nonrenewal, and transfer. Decisions

in these areas impact who will be presenting the franchisor’s concept and image

374 The Franchise Law Compliance Manual

to the public and how it will be presented. Moreover, decisions regarding termi-

nation, nonrenewal, and transfer most fundamentally impact the rights and inter-

ests of franchisees, and so these decisions therefore constitute the most fertile

ground for disputes and litigation.

This chapter will provide guidelines to assist a franchisor in developing and

implementing procedures regarding termination, nonrenewal, and transfer that

are (1) consistent with the defined business objectives of the franchisor; (2) fair

and reasonable in the context of the franchisor/franchisee relationship; (3) con-

sistently applied to all similarly situated franchisees; and (4) most likely to avoid

litigation concerning the franchisor’s decisions in these areas or, if litigation

occurs, best position the franchisor to prevail in any such dispute.

The development and implementation of a compliance program involves

three fundamental steps. First, the franchisor must determine what issues are

most important with respect to its particular business and franchise system, and

it then must establish its policies and procedures in accordance with and in fur-

therance of these particular business objectives. Second, the franchisor must

communicate its policies, procedures, and standards clearly and regularly to its

own personnel as well as to all of its franchisees so that there can be no reason-

able dispute over what the particular policy is and whether the franchisee was

aware of that policy. Finally, the franchisor must diligently monitor and apply its

policies, procedures, and standards consistently throughout its franchise system,

particularly to similarly situated franchisees.

The obvious goal of such a compliance program is to further the business

objectives of the franchise system while avoiding wherever possible disputes and

franchisee litigation. If a franchisor finds itself in litigation, however, a well

developed and properly implemented compliance program can serve as both a

sword and a shield to protect the franchisor’s legitimate business interests. For

example, reasonable and consistently applied procedures leading up to the ter-

mination of a franchise can be powerful evidence in an injunction action by a

franchisor against a franchisee who contests or otherwise refuses to acknowledge

that termination. Evidence that a franchisor consistently followed not only the

black-letter contractual requirements but also its reasonable policies and proce-

dures can help defeat a franchisee’s claim for wrongful termination under most

contractual or tort theories. The ultimate goal of establishing and consistently fol-

lowing a reasonable compliance program in these areas is to show that, regard-

less of the legal standard that might be applied, the franchisor acted fairly,

reasonably, and consistent with the parties’ legitimate contractual expectations.

This chapter is intended to provide practical guidance for franchisors to use

in establishing or evaluating their own compliance programs in the areas of ter-

mination, nonrenewal, and transfer. It deals first with termination, which is prob-

ably the most fertile ground for problems and disputes because termination often

results in a forfeiture of the franchisee’s rights and interests. It then addresses

nonrenewal and transfer, respectively. Within each of these subjects, the con-

tractual framework of the parties’ relationship, potential statutory restrictions on

the franchisor’s rights, and common law issues relevant to these situations are

each addressed. Although case law and statutes are discussed for illustrative pur-

Chapter 6 Termination, Nonrenewal, and Transfer 375