Franchise M&A: Issues to Consider when Drafting a Franchise Agreement

Have you ever thought of owning a franchise? Or are you in a business where you hope to have franchisees? Many businesses are set up as a franchisor/franchisee relationship. In these situations, it’s important to draft agreements not only to cover the immediate terms of the relationship — but also to incorporate a potential future change in ownership of the franchisor.

The reason: Many times, franchise owners would like to reap the benefits of their success and sell or merge with other businesses. While this is a potential growth opportunity, it can also lead to growing pains. A solid franchise agreement can limit conflicts that can occur with future changes in ownership.

Example: Let’s say Franchisor #1 acquires or merges with Franchisor #2. Along with this acquisition or merger, the successor Franchisor may want the newly merged or acquired franchisees to assume new products, a new marketing strategy, a new territory, or even a new trade name. The issue is whether a new franchisor is legally capable of doing so. And if so, whether there is a way to formulate a franchise agreement to allow for such a scenario in the future. Anticipation of certain issues is important because of the potential lawsuits which can arise, based on, for example:

  • Wrongful termination,
  • Forced sale, or
  • Forced changes.

M&A Factors to Consider

When deciding to merge or acquire a franchise, the parties must determine whether there is:

  1. Adherence to the explicit terms of the agreement;
  2. Permissible modification to the agreement;
  3. Sufficient notification;
  4. An explicit right to renew;
  5. Discriminatory action; and
  6. Constructive termination.

Just Cause Requirement and Covenant of Good Faith

Many states have statutes that require just cause to alter a contract. This may include a just cause requirement for both terminations and non-renewals. Courts interpret just cause differently. Some states interpret just cause broadly (for example, basing it on a franchisor’s legitimate business reasons) while other states interpret it narrowly (for example, holding that a business justification argument is meaningless because a franchisor could always claim a plausible business reason for termination).

Courts in some jurisdictions will also determine whether a covenant of good faith and fair dealing is applicable. Courts generally use a measure of the justifiable expectations of the parties. As a result, where one party acts arbitrarily, capriciously, or unreasonably, the court may decide to compensate the second party for its damages, or excuse it from performance.

Terms and Provisions of an Agreement

Next, consider what terms you need to put into the agreement that are pertinent to a potential future merger or acquisition including the right to:

  • Add or delete products;
  • Add new franchisees to geographical areas;
  • Alter or change the trademark;
  • Advertise new products or services;
  • Terminate a business or product line due to a merger or acquisition; and;
  • Request a remodeling or redecoration.

When drafting a franchise agreement, you must decide what can potentially happen in a merger. Each of the above terms should be accounted for in the agreement. Further, consider whether there is a statute in your state requiring a just cause basis for a merger, acquisition or termination, or whether there is an implied covenant of good faith in your jurisdiction. These are complicated

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