dispute resolution

No exit for franchisees

As unlikely as it may seem, a case between competitor franchisors emphasises yet again the difficulty of franchisees seeking an early exit from a franchise agreement without the consent of the franchisor. It is not something that an existing franchisee should attempt before seeking legal advice from an experienced business or franchise lawyer. In the recent Federal Court of Australia decision in TSG Franchise Management Pty Ltd v Cigarette & Gift Warehouse (Franchising) Pty Ltd (No 2) [2016] FCA 674 the occasion of a franchisee seeking to exit a franchise was a dispute between rival franchisors, and the attempt by one of those franchisors to entice franchisees of the rival franchisor to exit their franchise arrangements with the rival franchisor and enter into franchise agreements with the competitor.

The facts of the case show that one of the franchisors was named Freechoice Australia (Freechoice) and operated in the market for tobacco products. The competitor was called TSG Franchise Management Pty Ltd (TSG). The franchisees of this franchisor traded under the name of Tobacco Station.

TSG sued Freechoice for the tort of interfering with the contractual relations between TSG and its franchisees. The Court found that Freechoice had approached successful franchisees of TSG to encourage to exit the Tobacco Station franchisees by offering financial incentives to sign new franchise agreements with Freechoice. The intention of Freechoice was to expand their franchise network in this manner by effectively poaching TSG’s Tobacco Station franchisee. Part of the plan was to pay monies to the Tobacco Station franchisees to enable them to exit their existing franchise agreements with TSG by paying compensation to TSG.

The dispute specifically concerned attempts to cause the franchisee of the Tobacco Station Armidale and Armidale Centro stores in New South Wales to enter into franchise agreements with Freechoice and to terminate her franchise agreements with TSG. Termination of the Tobacco Station franchises was before the expiration of the franchise terms of these franchise agreements.

TSG wanted an order from the Court to stop Freechoice from inducing Tobacco Station franchisees to terminate their franchise agreements with TSG before the expiry of the terms of those franchise agreement in order to sign new franchise agreements with Freechoice.

What is interesting about TSG’s response to what was happening is that TSG sued Freechoice to stop any further attempts by Freechoice to encourage Tobacco Station franchisees from exiting their existing franchise agreements. TSG did not sue the Armidale franchisee who terminated her franchise agreements but sued Freechoice. This does not mean that the conduct of the franchisee did not expose her to the risk of being sued for damages for unlawfully terminating the Tobacco Station franchise agreements. Walking away from a franchise usually means that the franchisee has abandoned the franchise agreement which is a substantial breach of contract putting a franchisee at risk of being sued for damages.

There was evidence before the Court that the Armidale franchisee had been dissatisfied with TSG for a number of years and did not wish to continue as a Tobacco Station franchisee. The terms of the Armidale and Armidale Centro franchise agreements had not expired and the franchisor was not prepared to release the franchisee from her obligations under the Tobacco Station franchise agreements.
The Court found that Freechoice knew that TSG had not released the Armidale franchisee from her franchise agreements and that by exiting the Tobacco Station franchises the Armidale franchisee was in breach of her franchisee agreements. Despite this knowledge, Freechoice entered into franchise agreements with the Armidale franchisee and, from 4 November 2014, the existing franchised businesses were continued under the “Freechoice” banner.

The Court found that Freechoice intended that the Armidale franchisee would sign with Freechoice regardless of the terms of her existing Tobacco Station franchise agreements. The Court made orders restraining Freechoice from further encouraging Tobacco Station franchisees to breach their Tobacco Station franchise agreements with TSG.

Not all franchisees wish to exit their existing franchise to enter into a franchise agreement with a competitor of the franchisor. Indeed, the situation in this case was unusual. In many instances franchisees wish an early exit from the franchise because the franchise business is not profitable and the persons behind the franchisee are paying their own money into the franchise business to keep it going.

In this case, the franchisor, TSG, was not prepared to allow its franchisees to walk away from the franchise agreements before the expiry of the terms of the franchise agreements because it was not in its commercial interests and would have assisted its competitor. In other cases, it may not be in the franchisor’s interests to lose franchisees and see a reduction in the size of its franchise network. For one thing this would have an adverse financial impact in the form of reduced franchise royalties and marketing fees. For another, it would give a signal to the remaining franchisees that they could walk away from their obligations under the franchise agreement at any time without a cost. In a sense, allowing franchisees to walk away from their contractual obligations without any consequences is just not good business.

Existing franchisees need to understand that exiting a franchise agreement, like signing a franchise agreement, is a time when they should consider obtaining legal advice from an experienced franchise or business lawyer. Before buying a franchise, prospective franchisees need to be aware of the consequences of signing a franchise agreement for a fixed term and of the consequences of exiting before that time has expired. On the basis of hoping for the best but planning for the worst, they should consider an exit strategy and the costs and risks of exiting the franchise early before they sign a franchise agreement. As contemplated by the Franchising Code of Conduct, prospective franchisees should obtain legal advice or give serious thought to not obtaining legal advice from a franchise or business lawyer. Failure to do so may mean that the prospective franchise signs a franchise agreement that contains terms that are the equivalent of a no exit sign.

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