The franchisor/franchisee relationship

Due diligence

What due diligence should both parties undertake before entering into a franchising relationship?

A franchisor should have each franchisee complete a detailed franchisee questionnaire to evaluate the candidate’s business acumen, financial fitness and personality fit for the franchise system, including whether the prospective franchisee’s background reflects a desire and drive to operate the franchise. The franchisor should request financial statements from the prospective franchisee to determine whether the candidate has the requisite ability to invest in and financially support the franchise and should also obtain information regarding the persons that will serve as the owners of the franchised business, including background checks and credit reports. The franchisor should speak with, meet and interview with the prospective franchisee.

A prospective franchisee should thoroughly analyse a franchise system before investing in any particular one. The franchisee’s due diligence should assess the system, including its size, rate of growth, the amount of time the system has been operating, the experience level of the franchisor’s officers and directors, the franchisor’s training programs, the start-up and ongoing support offered by the franchisor and how the franchise is different from the competition. A prospective franchisee should consider how much it must invest initially and on an ongoing basis to establish and operate a franchised business. This involves reviewing the franchisor’s estimates of the initial investment to establish and operate the franchised business and the fees payable to the franchisor, its affiliates and vendors. A prospective franchisee must review the franchisor’s disclosure document, franchise agreement and all other agreements as part of the diligence process. The prospective franchisee should also speak to and meet with the franchisor’s officers, directors and sales personnel to learn more about the franchise system and attend any “discovery day” presentation offered by the franchisor. Other sources of information about the franchise system and its personnel that a prospective franchisee should evaluate are current and former franchisees (a list of which should be readily provided to the candidate and otherwise available in the disclosure document), franchisee forums and franchise industry associations. The prospective franchisee should also understand the industry and market demand for the products and/or services offered by the franchise system, particularly in the geographic location from which the franchisee will operate the franchised business.

Regulation of ongoing relationship

Do any state laws regulate the ongoing franchisor/franchisee relationship after they enter into the franchise agreement?

There are no statutes of general applicability governing the ongoing franchisor/franchisee relationship.

For motor vehicle dealers, termination is prohibited unless the Texas Motor Vehicle Commission and dealer receive 60 days’ notice of termination and notice of the dealer’s right to request a hearing on such termination. A manufacturer is required to compensate a terminated dealer for certain costs and amounts and is required to repurchase equipment from the dealer. For farm and industrial equipment franchises, termination without good cause is prohibited, and the supplier must give the dealer at least 30 days’ prior written notice of termination. For boat dealers, dealerships selling boats more than 14 feet long or motorboats may not be terminated unless the dealer defaults. The manufacturer must repurchase inventory from the boat dealer within 30 days of termination. For distributors of alcoholic beverages, Texas law requires good cause and at least 90 days’ notice of termination. Any manufacturer who terminates the distribution agreement without good cause must pay the fair market value of its business derived from the affected brand or brands. For distributors or dealers of equipment, termination by a supplier of a dealer agreement without good cause is prohibited, and, except in certain enumerated cases, a supplier must give at least 180 days’ notice of termination with an opportunity to cure. 

With respect to discrimination, a manufacturer or distributor of motor vehicles may not unreasonably discriminate among motor vehicle dealers, including in calculating dealership performance or in requiring a dealer to purchase special tools or equipment.

Amendment of terms

What rules and restrictions govern the amendment of franchise agreement terms?

A contract, including a franchise agreement, generally can only be amended by the mutual agreement of the parties. A franchisor is not permitted to unilaterally alter the terms of the franchise agreement. Franchisors commonly reserve the right to alter the operations manual in order to modify brand standards to reflect trends in the marketplace or new marketing techniques, technologies, and products and services. However, franchisors generally will not revise the system standards in such a way that would materially alter a franchisee’s rights under the franchise agreement.

Renewal

What rules and restrictions govern the renewal of franchise agreements?

There are no rules and restrictions of general applicability governing the renewal of franchise agreements.

For motor vehicle dealer franchises, nonrenewal is prohibited unless the Texas Motor Vehicle Commission and dealer receive 60 days’ notice of nonrenewal and notice of the dealer’s right to request a hearing on such nonrenewal. For farm and industrial equipment franchises, nonrenewal without cause is prohibited. For boat dealers, however, good cause is not required for nonrenewal of a franchise agreement of at least one year duration. For distributors of alcoholic beverages, Texas law requires good cause and at least 90 days’ notice of nonrenewal. Any manufacturer who fails to renew the distribution agreement without good cause must pay the distributor the fair market value of its business derived from the affected brand or brands.

Sale and transfer

What rules and restrictions govern the sale and transfer of a franchised business?

There are no rules and restrictions of general applicability governing the sale or transfer of a franchised business.

For motor vehicle dealers, a manufacture may not unreasonably withhold consent to a proposed dealership sale or transfer. For farm and industrial equipment franchises, a supplier may not prevent a dealer from transferring a non-controlling interest in the dealership; however, a dealer may not transfer a controlling interest in the dealership without the supplier’s written consent, which consent may not be unreasonably withheld. For boat dealers, a manufacturer may not unreasonably withhold approval of a transfer. For distributors of alcoholic beverages, a manufacturer may not withhold consent to the transfer of a distributor’s stock or assets. Any manufacturer who withholds consent to the transfer of a distributor’s stock or assets must pay the distributor the fair market value of its business derived from the affected brand or brands.

Integration and no-reliance clauses

What effect do integration and no-reliance clauses in franchise agreements have on claims of prior oral misrepresentations?

Under Texas law, while the parol evidence rule does not bar use of extrinsic evidence to prove fraudulent inducement, the presence of an integration clause and no-reliance clause in a contract can preclude statutory and common law claims based on alleged pre-sale misrepresentations. Texas courts have rejected fraud claims where the alleged prior oral representations were directly contradicted by the express, unambiguous terms of the parties’ contract that contain a merger and integration clause stating the contract represented the entire understanding of the parties.

When a contact is fully integrated, the parol evidence rule generally prohibits the introduction of prior or contemporaneous outside agreements, negotiations, or representations to modify, supplement, or contradict the written contract. While an integration clause is evidence that a contract is fully integrated, it is only one factor in determining whether an agreement is fully integrated under Texas law. Texas courts also consider whether the contract was negotiated between sophisticated parties, and whether it was specific about the type of outside evidence that should be excluded. 

Courts in Texas allow parties to use parol evidence to provide they were fraudulently induced to enter into a contract. To prevail on a fraud claim under Texas law, a party must show actual and justifiable reliance. While courts have generally upheld fraudulent inducement as grounds to set aside a contract despite an integration clause, Texas courts recognize the power of contracting parties to create contractual provisions that disclaim reliance on prior representations or promises. Parties must use clear and specific no-reliance language. Courts consider a disclaimer’s language alongside the circumstances surrounding the contract’s formation to determine the enforceability of the disclaimer. An unequivocal no-reliance clause between sophisticated parties represented by counsel generally negates any reliance on purported pre-sale misrepresentations, precluding statutory or common law fraud claims based on such alleged misrepresentations.

Good faith and fair dealing

How have the courts and legislature in your state dealt with the implied covenant of good faith and fair dealing in relation to franchises?

Texas law does not recognize an implied covenant of good faith and fair dealing in contracts, absent a “special relationship” between the contracting parties. Texas courts have held that a franchisor-franchisee relationship is not a special relationship. As a result, Texas law does not impose an implied covenant of good faith and fair dealing in franchise agreements. 

The Texas Uniform Commercial Code (UCC) imposes an obligation of good faith in the performance and enforcement of contracts for the sale of goods. Under the Texas UCC, “good faith” means “honesty in fact and the observance of reasonable commercial standards of fair dealing.” Failure to act in good faith in connection with a contract for the sale of goods can support a breach of contract claim.