Are You Going to Feel Heartache or Experience Success? This Is the Franchise Riddle!

Monday, May 28, 2018

Setting up a franchise is a serious investment for any business owner. But what are your options when the franchise does not perform well? In particular, what if it sounded like a dream investment but is now only causing tears?

A franchise is an authorisation given by a company (franchisor) to an individual or company (franchisee) enabling them to carry out specific commercial activities under the banner of their company.

The advantages of owning a franchise are often spoken about, particularly the ability to operate within an established brand, reputation and product or service, not being required to establish and develop internal systems, policies and procedures and not having to produce marketing materials..

An example of a franchise that did not perform well is Sizzler. At the time, Sizzler was experiencing a drop in sales and the franchisor of Collins Foods (at the time), Kevin Perkins, admitted that Sizzler had not performed well in the year, and that menus and restaurant formats were to be reviewed to improve profitability.

This article focusses on the advice we offered to a client who operated a major national pizza chain who was determining what options were available to them if there was a slump in profits across an entire chain.

The first step was to complete a detailed review of the Franchise Agreement (”Agreement”). This Franchise Agreement, like most others, did not contain a standard clause that would have allowed our client to terminate the Agreement on the basis of a ‘slump’.

One reason why such a standard clause is not used by a franchisor is because it is very difficult to define a slump. For example, if we applied a comparative definition of ‘recession’ and said that a slump was two consecutive quarters of negative growth, then there would be many franchisees that may have closed their doors during the ongoing ‘GFC’. A slump however is not necessarily a reflection of the performance or quality of the brand but often times a reflection of market trends, something for which a franchisor cannot control and should not be punished for.

We explored other avenues that might be available to protect the interests of our client. Many Agreements have similar characteristics as they have stringent requirements set out in the Franchising Code of Conduct (Trade Practices (Industry Franchising) Regulations 1998).

The first place we looked at in the Agreement was ‘franchisor’s obligations’ as we thought that there may be an obligation on the part of the franchisor to act in good faith in the management of the brand, yet no such obligation existed. We then searched the Agreement for a ‘good faith’ clause, yet this clause only imposed an obligation that the parties acted in good faith towards each other and not any specific obligation regarding the management of the franchise.

The view was made that there was little scope for our client to terminate the Agreement, in circumstances where the franchise suffers a ‘global’ downturn in sales. The “good faith’ clause would only be successful in the event where a franchisee sues a franchisor for a deliberate or negligent failed management of the franchise, that causes serious negative consequences for its franchisees. The ‘good faith’ argument would be difficult to apply in the Sizzler example, as it is hard to imagine a scenario where a franchisor would deliberately harm its own business.

It is critical that due diligence be conducted in order to obtain all necessary information before you enter into a franchise agreement. The due diligence needs to pay particular attention to information disclosed in the Disclosure Document that accompanies the Agreement at the time of entering into the Franchise, particularly as these documents can be in excess of 100 pages.

The Code of Conduct implies very stringent obligations on franchisors in respect of disclosure and so it is important for potential franchisees to peruse this document in consultation with their lawyer and accountant.

Article mentioned in this post:
Title: Sizzler weighs on Collins Foods
Date: 25 June 2013
Outlet: AAP
Author: AAP

How We Can Help

Quinn & Scattini Lawyers regularly assist prospective franchisees in drafting agreements and offer advice with all issues relating to entering (or exiting) a franchise. Our business lawyers expertly guide you through the franchise documentation and identify potentially problematic clauses to ensure your franchise is a success.

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