When prospective franchisees are investigating a franchise opportunity, they tend to focus on the terms that will have the most immediate impact on them—the amount of the initial franchise fee, the ongoing royalty obligations, the timeline for build-out and opening, etc. Unfortunately, as a result of this near-sightedness, franchisees (except for those who retain experienced franchise counsel to review their prospective agreements) tend to ignore the provisions in their franchise agreements related to renewal until it is too late, i.e., the point in time when their franchise agreements are up for renewal.
Set forth below are a few of the key issues that arise related to renewal in the overwhelming bulk of franchise agreements we see on a daily basis, as well as some tips on how to proactively deal with the issues before signing your next franchise agreement.
While the specific language in the renewal section of a franchise agreement differs among the different franchise systems, in nearly every agreement we see, there are a number of similarities.
Additional Renewal Rights—While most (but not all) franchise agreements grant the franchisee the right to renew, how many renewals a franchisee is entitled to receive varies widely between franchise agreements. For example, some franchise agreements only grant the franchisee one renewal term. After that renewal term expires, the franchisor may not (absent some statutory protection to the contrary) have an obligation to offer the franchisee any further renewal rights. Therefore, we always like to ensure that our clients have the right to receive several renewal terms (e.g., four renewal terms), or, if possible, the right to obtain an unlimited number of successive renewal terms of a specific length.
Signing the Then-Current Form of Franchise Agreement—Franchisees often believe that the terms they are currently operating under (including the royalty rate and the size of any territorial protection they might receive) are fixed forever. Unfortunately, that is not generally the case, and, in order for franchisees to renew their franchises, franchisors often require they agree to sign the “then-current form of franchise agreement,” which can contain material differences from a franchisee’s prior franchise agreement, including higher royalty, marketing and other fees. To prevent the franchisor from changing the material terms of the franchise agreement upon renewal, we always attempt to negotiate changes to the franchise agreement to ensure that certain provisions will remain the same in all future forms of the franchise agreement, e.g., keep the same royalty rate, marketing, and other fees, the same protected territory, and any other key negotiating points that the franchisee was initially able to obtain.
Written Notice—Franchise agreements generally require the franchisee to provide the franchisor with written notice that the franchisee wants to renew on or before a specific deadline, e.g., the franchisee must give written notice between six months and one year prior to renewal. While providing notice is simple (a relatively short letter to the franchisor saying you want to renew and asking what the next steps are will usually suffice), failing to provide notice can have drastic consequences. Indeed, a franchisor that was looking for a reason not to renew a franchisee could argue that the failure to provide timely written notice means that the franchisor has no obligation to renew. There are certainly defenses to this argument, but the best course of action is to simply ensure that you comply with the notice requirement in the first place.
Assuming that a franchisee has provided the franchisor with the required notice requesting a renewal, the franchisor will usually respond in one of three ways.
First, the franchisor may send a written response stating that it will renew the franchisee, usually conditioned upon the franchisee meeting the other requirements related to renewal, e.g., the franchisee agreeing to remodel or reequip the franchise and agreeing to sign the then-current form of franchise agreement. As discussed above, given that the terms of the new franchise agreement can differ significantly from the franchisee’s previous franchise agreement, retaining experienced franchisee counsel to review the terms of the new franchise agreement is highly recommended. Indeed, we have had a number of clients ask us to review their renewal agreements, and, in doing so, we discover that the franchisor did not comply with the franchisee’s right to keep certain provisions the same upon renewal, e.g., the franchisor attempted to increase the royalty rate when it had no right to do so. In short, while receiving notice from the franchisor that it is going to renew a franchisee is certainly a good thing, ensuring that a franchisee is being renewed in the appropriate manner (i.e., under an appropriate written agreement and with appropriate conditions to be satisfied) is something that every franchisee needs to keep an eye out for.
Second, the franchisor may send a written response back saying that it does not intend to renew the franchisee. If that happens, hopefully the franchisor has explained the reasons for non-renewal in the letter. If this is not the case, asking the franchisor to explain the reasons for non-renewal would be, in most cases, a prudent course of action. Once the reasons for non-renewal are identified, we generally ask our clients whether the factual allegations in the letter are correct. If the franchisor has its facts wrong, clearing up those misunderstandings can often lead to a reversal of the franchisor’s position and a renewal for the franchisee. Another important thing to keep in mind is that the franchisor’s announced reasons for non-renewal may not be the franchisor’s actual reasons for non-renewal. For example, while a franchisor might claim underperforming sales are the reason for non-renewal, there may be other reasons why the franchisor has made the decision not to renew (e.g., the franchisor may not like the franchisee’s manager). Attempting to address the issues (stated and unstated) underlying the non-renewal is usually a good first step in attempting to have the franchisor reverse its decision. In the event that the issues cannot be resolved (or there are no good reasons for non-renewal in the first place), the next step is to see whether the franchisor’s notice of non-renewal complies with the franchisee’s rights under the franchise agreement and any applicable state franchise laws, many of which require the franchisor to give the franchisee significant, advance written notice and an opportunity to cure. Receiving a notice of non-renewal is certainly a stressful situation, but doing nothing about it (or simply hoping things will improve) is almost never in the franchisee’s best interest. Instead, if the franchisee receives a notice of non-renewal, being proactive, with the assistance of counsel, can oftentimes lead to a reversal of the franchisor’s decision and result in the franchisee being renewed.
Third, franchisors may attempt to have the franchisee agree to a “conditional renewal.” Conditional renewals are situations where a franchisor is unwilling to give the franchisee a full renewal term, and, instead, renew the franchisee, but only for a short period of time, during which the franchisee must, in essence, prove to the franchisor that he or she is a good franchisee by meeting certain criteria, e.g., minimum sales levels, improved inspection results, etc. While a conditional renewal is better than not being renewed, it is important for a franchisee to not be set up for failure. Indeed, the conditions placed on conditional renewals oftentimes are so onerous that no franchisee could succeed. Further, conditional renewals often require the franchisee to sign a general release in favor of the franchisor. Therefore, prior to agreeing to a conditional renewal, a franchisee should, at a minimum, determine whether he or she has the right to be unconditionally renewed (i.e., has the franchisee met all of the required conditions for a complete renewal), and, in addition, attempt to negotiate more favorable criteria in order to receive the unconditional renewal.
Dealing with issues related to renewals can be a difficult and stressful part of being a franchisee. Those issues, however, are made even more difficult and stressful when they are not addressed proactively. For example, rather than waiting to negotiate the terms of the renewal until the initial term of the franchise agreement has expired, we recommend negotiating some of those terms when the franchisee signs his or her first franchise agreement (i.e., rather than agreeing to sign the then-current form of franchise agreement, attempt to negotiate for the right to keep certain terms the same upon renewal). Similarly, rather than waiting until after the franchisee has been non-renewed and has ceased operating to challenge the franchisor’s decision not to renew, we recommend that a franchisee take action immediately after receiving a notice of non-renewal or notice of default and see what, if anything, can be done to change the franchisor’s mind.
In the end, proactively addressing issues related to renewal almost always produces better results for franchisees than doing nothing. If you find yourself with an issue or question about renewal, do not hesitate to call one of the attorneys at Dady & Gardner or to contact us through our website.