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Term Expiry: How Not Being On Top Of Franchise Expiry Terms Causes Issues

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By Alicia Hill, Principal, MST Lawyers

Franchise agreements are established for a fixed term.  Often they contain options which can be exercised to acquire an additional term, subject to the franchisee not being in breach of the existing franchise agreement.  When an option is not exercised or exercised improperly, and the franchisee continues to operate the franchise after the expiry of the term the chances of a dispute arising are significantly increased as the legal basis for the continued operation comes into question.

On what basis is the franchisee operating?

The first question asked in these situations is on what basis is the franchisee continuing to operate the franchise?

The three standard responses are:

  1. The franchisee is not permitted to operate the franchise; it is an infringement of the intellectual property of the franchisor, misleading and deceptive conduct or passing off on the part of the former franchisee.
  2. The franchisee is continuing to operate under the same terms as the previous franchise agreement (save for there being no agreed term, nor any option to extend) for a regular period. This is often described as ‘holding over’ similar to lease expiry situations with the continuation based on regular short periods of time that rollover (e.g. month to month on payment of a monthly franchise fee).
  3. The franchisee is operating under an implied franchise agreement for a new fixed term period, on either the same or new terms which have been supplied to the franchisee. The franchisee’s conduct indicates it has consented to the new franchise agreement terms.

Each of these situations causes franchisors and franchise systems different issues.

Unauthorised trade as a franchise

A franchisor who does not shut down, as soon as practicable, a franchise store that is trading without authorisation (and presumably without payment of royalties) devalues the franchise brand.

After all, why would potential franchisees be willing to pay for a franchise and the exclusive use of its intellectual property if anyone can operate a franchise without compliance with the franchise agreement? Why would a franchisor forgo its right to royalties for the effort and time it has invested in developing a franchise brand and system?

Usually, franchisors are quick to address this type of scenario. A franchisor will make it clear to the operator its non-consent and the steps required to avoid further action soon after the unauthorised trade becomes known.

Holding Over

Where it becomes murky is where a period of time has elapsed since the expiry of the franchise agreement, and the franchisor has not made any efforts to prevent the trade occurring or assessing on what basis the franchise is permitted to trade.

The law in this area has been developed over a substantial period and is very much case by case specific. On what terms the continued operation of the franchise will be sanctioned will be dependent upon the conduct of the franchisor and the franchisee.

The key points in time which are relevant are:

  1. prior to the initial expiry of the term; and
  2. post the expiry during the trade on period.

Where the continued conduct of the franchise is on the same basis as had occurred under the operation of the original franchise agreement, it is often viewed that the prior agreement continues on the same terms. Such as week to week or month to month period.

Implied franchise Agreement

Where the conduct of the parties was varied from the prior agreement to reflect some new terms or a different basis, then it is often argued that a new franchise agreement has been entered into on the new terms for a specified period.

For example, the original term is about to expire, and the franchisor sends out its disclosure pack containing its then current franchise agreement; containing additional terms to the original franchise agreement. The franchisee fails to return the signed franchise documents but continues to operate post expiry of the original terms paying the increased royalty and marketing levies in accordance with the new franchise agreement.

Why this is problematic

When attempting to determine on what basis continued operation occurs, each of these cases will turn on their own facts and depend on who says what to another party and when. Different outcomes occur because of the individual differences between what happens in each case.

Recourse to the courts to determine these issues is expensive, and what decision will be made is often unclear. Courts have made comments over the years that:

  1. whether the parties entered into a new contract has to be implied from the course of the conduct after expiry of the original agreement; and
  2. the conduct of a party had to be such that the actions resulted in them being bound by the terms of the expired agreement;
  3. there needs to be a degree of mutuality by the demonstration of some positive statement or conduct on the part of one party which signified an intention to establish or maintain a legal relationship with another;
  4. a court will not impose an obligation on a party to notify the other on expiry of an agreement where it considers it is no longer bound by the terms;
  5. existence of a contract of variation must be demonstrated by reference to the usual rules about contract formation.  A definite agreement going beyond discussion or negotiation must be established. However, as with any contract, such an agreement may be inferred from conduct.  Consideration must also be established.  Where a variation is made in favour of one party ostensibly without advantage to the other, the element of consideration may be missing.

How to avoid these issues

Maintain a system

The most obvious method of preventing the uncertainty of a franchisee continuing to operate after the expiry of a term is to have a system in place which records dates of expiry and the steps that a franchisor will take in the lead up to that date to deal with expiring agreements.

Act Speedily

If a franchisee does inadvertently continue to operate, then a franchisor needs to consider its position as soon as possible after it becomes aware of the continued operation. In particular:

  1. can the franchisor insist on the cessation of operation (if too long a period has passed and the franchisor has continued to accept payment of royalties then it may not be able to insist immediately on cessation of operation);
  2. can the franchisor assert that a holding over period on a specific time period exists (e.g. Month to month, or week to week) and provide notice of an intention to terminate such an arrangement and insist on the cessation of operation unless a new franchise agreement is entered;
  3. can the franchisor assert that a new franchise agreement has been entered by the conduct of the parties and that all that remains is the execution of that agreement by the parties.

Once the franchisor has identified what it considers is the position this needs to be communicated to the franchisee as soon as practicable and steps taken to regularise the relationship (e.g. have a new franchise agreement signed).

Legal action may be available to parties where there has been delay in acting on the matter, or conduct by the parties occurs which does not match the communicated position of the basis for continued operation.

Get into Dispute Resolution before recourse to Courts

If the franchisee holds a different opinion to the franchisor regarding the basis upon which the continued operation is permitted, then the parties need to reach a mutually agreed position.  If they are unable to resolve the matter between themselves, they can seek a resolution through the Office of the Franchising Mediation Adviser via mediation or as a last resort, through court litigation.

If you would like to discuss any aspect of this update further, please contact Alicia Hill by email or call +61 3 8540 0200.