To answer this a franchisee should understand the underlying basis for the grant of the franchise in the first place.
When you enter into a franchise as a franchisee the franchisor agrees to provide you with certain rights for the term of the franchise agreement – these include the use of its “intellectual property” such as certain trade marks (E.g. brand logos) and other material owned by the franchisor such as software, recipes, procedures and methods that it has developed or has licenced. Much of the material you are provided with as a franchisee is “confidential information” which you agree to only use in your franchised business and not disclose to others. In return for the use of the franchisor’s property (among other things) you pay franchise fees or a royalties.
A sizeable part of the franchise agreement deals with your obligations about the use and protection of this property of the franchisor. Other rights that you may have during the term may include the right to use certain premises which are owned or leased by the franchisor.
When the franchise agreement ends whether because the term simply expires or it ends prematurely for some other reason such as breach or transfer, the franchise agreement will detail the consequences of the “termination” (end) of the franchise.
Most of these consequences deal with the fact that on termination you immediately lose the rights to use any of the intellectual property, premises or other property or rights granted by the franchisor. The other important consequences are concerned with protecting the franchisor’s property after termination – these are often called restraints, specifically “post –termination restraints”.
De-branding
As stated, on termination the franchisee can no longer make use of the trade name and marks of the franchisor. This often includes colours, finishes and the “get up” or appearance of the business.
You will be required to remove the signs and other visual indicators of the franchise brand. This is sometimes called “de-branding” or “de-imaging”. If you have a retail shop and you are remaining in occupation after termination you will often need to undertake substantial work to remove all signage and repaint/refinish in different colours so that the store no longer resembles one belonging to the franchisor’s brand.
If there are vehicles or other equipment involved you will need to remove any markings and of course you should stop wearing the franchisor’s uniforms.
You will also need to change all directory listings including on any websites to make sure that you no longer indicate that you are associated with the franchisor’s brand. You will need to change your registered business name with ASIC and possibly your company name if it refers to the franchise brand.
If you don’t take all these steps the franchisor may accuse you of continuing to trade using their intellectual property and demand that you pay royalties for that use.
Confidential Information and customer lists
Many franchises end when the franchisee sells the business to a new franchisee and usually the premises, vehicles, equipment and manuals and other materials will be transferred to the purchaser. If this is not the situation, the departing franchisee should make sure that they return all manuals (whether in hard copy or digital copies) and other confidential materials to the franchisor.
A common source of dispute can be customer lists and information particularly in franchises such as mortgage brokerages, real estate and similar businesses. Many franchise agreements will state that the customer list or database belongs to the franchisor (as its intellectual property or as confidential information) and must be returned to it or passed on to the new franchisee if there is one. The outgoing franchisee is prohibited from keeping a copy and there are often restraints which prevent the franchisee from actively contacting and marketing to (or ‘soliciting’) customers of the franchise.
Confidentiality obligations generally continue to apply after termination indefinitely.
Breaches of this type of restraint can result in the franchisor (or the purchaser of the former franchisee’s business) taking legal action to prevent the use of the customer lists or confidential information and it may seek to recover the profits generated from their use.
Premises
If the franchise is effectively tied to particular premises such as a retail shop, the termination of the franchise will often end your occupation rights. Many franchisees hold a licence of the premises for the term of their franchise and the franchisor holds a head lease or owns the site. Once the franchise ends the licence ends and you must vacate.
Where a franchise is terminated against the franchisee’s will due to the franchisee’s breach the franchisor may take action to take back possession of the premises and lock out the franchisee. A court order can be obtained by the franchisor if the franchisee does not cooperate.
In many franchise systems however the franchisee holds the premises lease directly from a third party landlord. On termination of the franchise there is often an option for the franchisor to require the lease be transferred to it. If the franchisor decides it wants to take over the lease in those circumstances it will notify the franchisee and the franchisee will need to approach the landlord for consent to the assignment of lease. If the franchisor indicates that it does not wish to take on the lease then the franchisee will be left with the liability of the balance of the lease term. Depending on the relevant restraints in the franchise agreement (see below) the franchisee may be able to “de-brand” (see above) and continue to trade under a new name or it may need to close the business, transfer the lease to a third party, find a subtenant or take other action to limit its liability for the ongoing rent.
The franchisor will usually also have the option to buy your premises fit-out, plant and equipment on termination which it may do if it intends to take over the premises and business. The franchise agreement will contain a method for valuing these physical assets, generally market value or depreciated value. No amount will be payable by the franchisor for goodwill.
Restraints of Trade – post termination
In order to protect the franchisor’s property rights and the patronage built up through operation of the franchise, the franchise agreement will contain some restraints or restrictions which apply to the former franchisee even after the franchise has ended.
These usually prevent you operating a business similar to or in competition with the franchisor or franchised business or soliciting employees or customers of the former franchise. These restrictions usually also apply to the directors and guarantors of the former franchisee company.
To be legally enforceable a restraint such as this must be reasonable and it is considered reasonable if it is no greater than is needed to protect the franchisor’s legitimate interests.
These restraints will often be framed so that there is a geographic territory and a time period applying to them. As what is “reasonable” to protect the franchisor’s interests is open to interpretation and may vary depending on the circumstances, the clause may have a “ladder” of gradually reducing time periods and areas.
For example, the restraint may say the franchisee is not to operate a similar business for a period of 3 years, 2 years or 1 year from termination in an area 25 kilometres radius from the premises, 15 kilometres radius or 5 kilometres. At a minimum therefore the restraint is 1 year long for an area of a 5 kilometre radius and at a maximum it is for 3 years in an area spanning 25 kilometres radius.
If the franchisor attempts to enforce a longer or wider restraint against a former franchisee than is reasonably necessary to protect its interests, it will fail however it may succeed it enforcing one of the shorter or narrower combinations the restraint clause gives.
Unfortunately these types of clauses do not give the franchisee the certainty of knowing precisely how long and how far the restraint applies and if faced with one of these situations a franchisee should seek legal advice before it embarks on any activity which may potentially breach the restraint.
The time therefore to read through and understand these restrictions is when you decide to enter into a franchise agreement as this is when you agree to them. The franchise agreement although for a limited term may contain obligations that continue beyond the end date and when you are planning an exit from a franchise you must bear these in mind.
Corinne Attard
Holman Webb Lawyers
Level 17 Angel Place
123 Pitt Street Sydney 2000
T: (02) 9390 8354
E: [email protected]
Corinne has been selected for inclusion in the 2014 edition of the International Who’s Who of Business Lawyers as one of Australia’s top franchise lawyers.