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Aspects of A Franchise Agreement – Breaches and Termination

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Part two of our Aspects of a Franchise Agreement discussed the obligations of the franchisee. A breach of any of those obligations will be a breach of the agreement. In some situations, the breach may also be grounds for termination of the franchise agreement.

Breach of The Franchise Agreement

In the event that the franchisee is in breach of the franchise agreement, the franchisor will issue a notice of breach of franchise agreement. The agreement will set out what the notice should contain, such as the reference to the clause that the franchisee has breached and the time frame to remedy the breach. If permitted under the franchise agreement, the notice may also refer to a clause in the franchise agreement that allows for the franchisor to recover its legal costs due to the franchisee’s default. All notices must include evidence of the breach (e.g. emails, photos or a statement of arrears). It should also state that failure to comply with the notice may result in the termination of the agreement. The notice must be correctly served on the franchisee and guarantors.

A notice of breach starts the process of terminating the franchise agreement. In most cases, the franchisee will comply with the notice, remedy the breach and the parties will move on.

Termination of The Franchise Agreement

If a franchisee does not comply with the notice of breach, the franchisor will need to assess whether that would be grounds for terminating the franchise agreement. Termination of a franchise agreement is not undertaken lightly as the franchisor is taking away the franchisee’s business. However, the franchisor cannot risk brand damage or other franchisees questioning why the franchisee is being permitted to act without any punishment.

Any ground for termination of franchise agreement must be contained in the agreement. Ideally the franchisor should talk to the franchisee and advise that it has grounds to terminate the agreement, but is willing to negotiate a termination and handover of the business. This is a ‘friendly’ way in the sense that the franchisee agrees that it cannot comply with its obligations under the agreement and the parties can negotiate the terms of the termination. However, the franchisee may not agree to this. Accordingly, the franchisor should issue the notice of termination of franchise agreement, and wait until the end of the working day to take over the premises and change the locks. As a part of this, the franchisor should also talk to the landlord (if it does not hold the lease) and explain the background to the termination.

Termination Due to Its Default

Termination of the agreement does not forgive any debts owed by the franchisee and guarantor and they must still pay any amounts owing to the franchisor up and including the day that the agreement was terminated. Furthermore, any termination of the agreement is without prejudice to the franchisor’s rights in the agreement and at law. Finally, the franchisee will be liable for the franchisors costs in issuing the notice of termination due to its default.

In conclusion, if you are a franchisee who has been issued with a notice of breach of franchise agreement, you should review your rights under the agreement and seek urgent legal advice.

This article was written by Khushbu Sundarji and Stewart Germann.

Aspects of A Franchise Agreement – Part One Territory

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You have decided to buy a franchised business. As a part of this you receive a copy of the franchise agreement, but you are unsure about your obligations. Our series ‘aspects of a franchise agreement’ will provide clarity on the main parts of a franchise agreement.

Your franchise agreement should clearly set out your territory. Franchisors would have already divided up the country (or state) into concise and separate territories which will be allocated to each franchisee. You should look carefully at the details of the territory to ensure it matches what you have discussed with the franchisor.

When we use the word territory, we mean a specific area where you will be able to conduct the franchised business. If the premises is within a shopping mall what will be the territory? Is it just the mall or does it include the area surrounding the mall? Ideally your territory should be identified on a map with clear boundary lines.

There are two types of territory:

Exclusive. The franchisor is not permitted to appoint another franchisee within your territory.

Non-exclusive. The franchisor can appoint another franchisee in your territory, subject to offering the new location within the territory to you first.

Some franchise systems prescribe no territories at all. If that is the case with your business, then you should be concerned about the saturation of the area of your proposed franchised business. This is especially relevant when in the case of a new system there are no actual (as opposed to hypothetical or anticipated) figures to justify a viable business. You could request a limit on the number of franchisees to operate in the area although this can also be counterproductive because it may stop the establishment of and/or the growing of brand awareness to the public.

Premises and territory are two separate matters. You can have a premises within a territory. If you move premises during the term of the franchise agreement but it is still within the territory, then that move will not be considered an assignment or transfer under the franchise agreement. However, franchise agreements usually contain a requirement that you must have the prior written approval of the franchisor in regard to any alternative premises.

Your territory can become non-exclusive or be modified if you do not comply with the terms of your agreement – for example minimum performance criteria or if the franchisor, having reviewed your performance feels you are not adequately servicing the territory. Should this occur, it must be subject to consultation with both parties.

In conclusion, you should always take great care when reviewing the territory and you must know what you are getting in relation to a territory or area.

New Unfair Contract Terms and Unconscionable Conduct Regime

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The Fair Trading Amendment Act 2021 (“Amendment Act”) extends the existing prohibition on unfair contract terms in consumer contracts to standard form small trade contracts worth under $250,000 (including GST). The Amendment Act also introduced a new prohibition on unconscionable conduct.

These changes will come into force on 16 August 2022 and affect standard form small trade contracts. A contract is a standard form small trade contract if it falls within the following definition:

  • Each party is engaged in trade (i.e. two businesses);
  • It is not a contract between a business and a consumer; and
  • The relationship between the two parties in trade in relation to the goods, services or interest in land provided does not exceed the annual value threshold of $250,000 (including GST) per annum for goods, services or an interest in land when the relationship first arises (i.e. when you first sign the contract).

Any contract signed prior to 16 August 2022 will not be subject to the new amendments. However, if the contract is varied, amended or renewed and it falls within the definition of a standard form small trade contract above then the new regime applies to the varied, amended or renewed contract.

The unfair contract terms previously only applied to contracts between a consumer and a business, for instance gym membership agreement. The new amendments will ensure that small businesses also receive protection against any unfair contract terms.

The following is taken into consideration when assessing whether a term is unfair:

  • Whether the term would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
  • Whether the term is reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
  • Whether the term would cause detriment (whether financial or otherwise) to a party if it were applied, enforced or relied on.

The new amendments will not apply to the following contractual terms:

  • Definition of the main subject matter of the contract.
  • Setting the upfront price payable under the contract, so long as the price term is clear and unambiguous.
  • Any terms that are required or expressly permitted by any legislation.

The extent to which the term is clear and the context of the contract as a whole will also be taken into account. However, the new amendments will not disadvantage a business that has a legitimate business interest and the term is necessary to protect that interest. At this stage the Commerce Commission has not updated its guidance regarding unfair contract terms but we assume this will be issued soon to assist businesses.

Penalties

The Commerce Commission can apply to a Court for a declaration that a term in a contract is unfair. If it is found to be unfair by a Court then that business must not include a term (or is amended with the Court’s approval) or attempt to enforce or rely on the term. A business may also face:

  • In the case of an individual fines not exceeding $200,000 and a company a fine not exceeding $600,000.
  • Court orders stopping that business from applying or enforcing that term and or orders directing a refund or payment of damages.

Unconscionable Conduct

The unconscionable conduct in trade provisions are much broader as it applies to all conduct not just contractual terms. The term unconscionable conduct is not defined but the Amendment Act states that a Court can take the following into consideration:

  • The relative bargaining power of the parties;
  • The extent to which the parties acted in good faith;
  • Whether the affected person was reasonably able to protect their interests; and
  • Whether unfair pressure or tactics were used.

It may be that New Zealand will take guidance from Australian cases but at this stage no guidance or comment has been provided by the Commerce Commission.

Penalties

The Commerce Commission can seek penalties and fines as above. The Commerce Commission could also could bring civil proceedings; for example seeking a declaration from the Court in relation to unfair contract terms. The remedies include damages, injunctions and other Court orders.

Conclusion

Whether the new amendments apply to any contract will depend on whether it falls within the definition of a standard form small trade contract. When looking at the annual value threshold this is assessed when the relationship first arises.

Khushbu Sundarji is a franchising lawyer and partner of Stewart Germann Law Office at Auckland, New Zealand. She can be contacted on 09 308 9925 or at khushbu@germann.co.nz.