Franchise agreements and their termination

Franchise agreements and their termination

November 9, 2016

Many chains choose, instead of opening more and more branches, to enter a franchise agreement with a third-party. This manner of growth has advantages and disadvantages, but one of the main issues that often come up is the chain’s ability to "terminate" the franchisor and replace it with another or even to make the branch an integral part of the chain and thus “eat the cake and leave it whole”.  If the franchise agreement does not explicitly deal with such issue, may the chain do so?

A duly written franchise agreement, grants the chain the ability to fully monitor and control the franchisor and in such manner to grow and open branches with minimum risk, with the franchisor bearing all costs of development of the new branch. The franchisee also enjoys many benefits, such as the reputation of the chain, its experience in the opening of new branches and its support.  However, and despite these benefits for both sides, many claims are filed with the Israeli Courts concerning the termination of franchise agreements by the chain and the right to compensation by the franchisee.  In many cases the franchisee paid for the right to become a franchisee, spent hundreds of thousands of Shekels for the development of the branch, contributed greatly to the reputation of the chain and the even made the chain most profitable in such franchise region. Then, one morning, the chain “saw that it was good”, and announced the franchisee that it decides to terminate the franchise and undertakes the management of the branch or transfer the franchise to another and new franchisee.

In a case recently decided in the Court of Tel Aviv, a chain terminated a franchise in accordance with the franchise agreement that allowed it to do so upon deterioration of the trust relationship between the parties or if the franchisee did not follow the chain’s regulation. The Court dismissed the claim of the franchisee for compensation despite the large investment made for the developing of the brand and its reputation and he expected loss of revenue, all due to the fact that the franchise agreement allowed the chain to cancel the agreement upon breach. A franchisee, and certainly one making its first steps in the field, may find itself in several breaches of the agreement until learning to run its business and therefore it is vital that an attorney with experience in franchise agreements will ensure that not any breach of the agreement will enable the chain to use it for the purpose of terminating the franchises without compensation.

Naturally, franchise agreements (and certainly those of large chains) include many draconian provisions aimed to protect the chain and derive from the difference in bargaining positions. Although in most of the time the franchisee will not be able to change such provisions, it is important at least to understand the risks involved (preferably before execution of the agreement), and to be able to act correctly and with the proper legal assistance in order to ensure compliance with the terms of the agreement. In addition, it is important before execution of the agreement to check the reputation of the chain and how it acts with its franchisees in order to avoid contracting with a chain with a tendency to cancel franchise agreements.