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Many franchisees are experiencing financial difficulties during these turbulent economic times and franchisors are increasingly considering what their options are in dealing with underperformance. Natalie Wood advises

Franchisors need to look to the legal documentation and operations manual setting out the requirements the franchisee must meet in terms of performance and quality of service. The documentation will set out the rights of the franchisor (and the franchisee) and the structure of the franchise. It will be necessary to follow the procedures set out in the documentation so as not to lead to unnecessary and costly litigation.

Things to look out for:

  • Performance targets and an ability to terminate the agreement if the franchisee fails to meet the targets
  • A right for the franchisor to enter a franchisee's premises and inspect their records in order to keep a check on performance and identify whether a franchisee is running into financial difficulties
  • A requirement for the franchisee to supply VAT records and other financial information - this might also prevent cash sales not being put through the company books
  • A right for the franchisor to require that the franchisee's accounts and records be audited
  • A right to terminate if the franchisee fails to pay you any amount due
  • A right to terminate if the franchisee becomes insolvent or becomes unable to pay its debts when they fall due for payment
  • Clauses setting out what amounts to breach of the agreement and rights to terminate for breach by the franchisee
  • Other termination rights which could be relevant such as persistent complaints about service, doing things which could bring the brand, the franchisor or the business into disrepute
  • Post-termination restrictions preventing the franchisee from competing in the territory or with other franchisees and soliciting clients
  • Post-termination provisions requiring the transfer of telephone numbers and giving the customer lists to the franchisor
  • Guarantee from the principal individual in a franchisee company if the franchisee is about to become insolvent
  • A right to terminate the lease for the premises from which the franchisee operates.

Most smaller franchises are simple contractual arrangements where an individual or an individual through their limited liability company will enter into a franchise agreement with the franchisor. Many well-known brand franchises are structured so that a principal individual and the franchisor jointly own a joint venture company, which enters into the franchise agreement with the franchisor. In these latter cases, look for provisions in the joint venture company shareholders' agreement to transfer back the principal individual's shares to the franchisor or a new franchisee or to wind up the company.

Make sure you decide how to measure performance (eg, revenues, sales volumes) and what level of performance is expected. Use the mechanisms to obtain performance data, review it regularly and decide early how to address underperformance.

Among the options you have are the following:

1. Work with the franchisee from an early stage to identify reasons for low sales and develop a strategy to improve sales
2. Negotiate for the franchisee to purchase the business
3. Assist the franchisee to find a buyer for the franchisee business
4. Terminate the franchise and the lease.

If you haven't got a set of procedures in place or adequate provisions to identify and deal with underperforming franchisees, you could consider updating the franchise agreement with a view to new franchisees signing up to the new agreement and existing franchisees signing up on their next renewal. A relatively small sum getting the legal documentation right can save thousands of pounds in legal fees as well as the internal resources of the franchisor spent dealing with underperforming franchisees and conflicts arising.

For assistance with your documentation or advice regarding underperforming franchisees, please contact Natalie Wood, Morrisons Solicitors LLP, 01737 854544, email natalie.wood@morrlaw.com