A topic that has received interest before, during and after the GFC has been what options are available if a franchise does not perform well. In particular, what if it sounded like a dream investment, but now is only causing tears?
A franchise is an authorisation given by a company (franchisor) to an individual or group (franchisee) enabling them to carry out specific commercial activities under the banner of their company.
It is often spoken about how the advantages of entering a franchise enable a business to operate within an established brand, reputation and product or service; does not require an owner to establish systems as they are already in place; and much of the advertising is already done for you.
A recent article by the AAP talks about concerns investors have with the struggling Sizzler businesses, which is experiencing falling sales. It was mentioned in this article that the chief executive of Collins Foods (Franchisor) Kevin Perkins admitted that Sizzler had not performed well in the year, and that menus and restaurant formats will be reviewed to improve profitability.
Liam Kirby, an experienced business and franchising lawyer from the Quinn & Scattini Lawyers Gold Coast office, explains the advice that he is offering to a client at the moment when determining what options are available to them if there is a slump in profits across an entire chain.
“I am presently reviewing a Franchise Agreement for a major national pizza chain. This Franchise Agreement like most others does not contain a standard clause that would allow a Franchisee – such as my 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.
“I explored other avenues that might be available to protect the interests of my client. Most Franchise Agreements are very similar as they have stringent requirements set out in the Franchising Code of Conduct (Trade Practices (Industry Franchising) Regulations 1998).
“The first place I looked was ‘Franchisor’s obligations’ as I thought that there may be an obligation on the part of the Franchisor to act in good faith in the management of the brand, alas no such obligation existed. The next place that I looked was a ‘Good Faith’ clause, however this obligation 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.
“I would submit that there is little scope for a Franchisee to terminate their Franchise Agreement, in circumstances where the Franchise suffers a ‘global’ downturn in sales. The only situation that I could imagine the ‘Good Faith’ argument being successful is where a Franchisee sues a Franchisor for a deliberate or negligent failed management of the Franchise that causes serious negative consequences for its Franchisees,” Liam said.
Liam mentions that the ‘Good Faith’ argument would be hard to use to terminate a Franchise Agreement in the context of a Franchisee of Sizzler based upon the recent struggles as reported.
“It would be incredibly perilous with little to no chance of success, moreover it is hard to imagine a scenario where a Franchisor would deliberately harm its own business,” Liam said.
Liam explains the importance of conducting due diligence and the best methods of doing this before entering a franchise.
“It is imperative to conduct due diligence in respect of the brand and the business and to pay particular attention to information disclosed in the Disclosure Document that would accompany the Franchise Agreement at the time of entering into the Franchise,” he said.
“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.”
“I go to great pains to stress this to all of my clients, or even to those making enquiries regarding a franchise. This is even more pertinent when one considers it is not uncommon for a Disclosure Document to be in excess of 100 pages.”