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26 June 2018
What does the franchise agreement say?
Dangers of oral agreements
What if there is no discussion on renewal?
What does it mean when original agreement is extended by conduct?
What is the effect on post-termination restrictions?
With pictures of the recent royal wedding still gracing the covers of the glossy magazines, and as the happy newlyweds embark on their new life together, let us consider the parallels between the franchise relationship and a marriage.
The pre-contractual phase is when the prospective franchisee and franchisor get to know each other and decide whether they are well suited. From a legal viewpoint, this is a risky stage of the relationship, as both parties may be tempted to make wild promises about the future. The introduction of a disclosure document can help sober the mood before the parties decide if they are ready to tie the knot and sign the franchise agreement (which will contain a 'pre-nup' to clarify what happens in the event of a break up).
Franchise relationships are rarely life-long commitments, although there are plenty of examples where franchisees have operated successfully in a network for longer than the average marriage. Most franchise agreements will be for a fixed term with a right to renew. The renewal process provides an opportunity for both parties to re-assess and recalibrate the relationship, as well as to settle any issues before either renewing their vows or deciding to go their separate ways.
This all makes good commercial and legal sense; however, it is surprisingly common that the renewal process is not always followed, meaning franchisors and franchisees can find themselves in a contractual 'no man's land', continuing with the relationship after the expiry of the original or renewal term, without having a formal renewal franchise agreement in place.
This update discusses what happens when the parties do not formally renew their vows, and considers the implications of a recent Supreme Court case.
A failure to formally renew a franchise agreement usually arises when the parties:
There are three possible legal positions which could apply to each of these situations:
In relation to the first situation, if a franchisee fails to serve written notice confirming its intention to renew within the specified timeframe, there is a risk that it has waived its right to renew the franchise agreement, even if the franchisor has confirmed orally that the franchisee can renew.
Equally, if the parties decide to alter the terms of the franchise agreement – and most franchise agreements will include a clause allowing the franchisor to impose its then current franchise agreement on a franchisee at the point of renewal – but fail to record this in writing, there is a risk that any oral agreements to this effect do not form part of the existing franchise agreement, or the legal agreement which is deemed to apply to the renewal term in the absence of a formal renewal franchise agreement.
The risk of oral agreements was highlighted in a recent Supreme Court judgment (Rock Advertising Ltd v MWB Business Exchange Centres Ltd,  UKCS 24, 16 May 2018), albeit in a case which did not involve a franchise relationship, but a commercial relationship concerning a licence for serviced apartments.
Rock Advertising had accumulated substantial arrears of licence fees. It proposed a revised licence fee payment schedule for MWB Business. Rock Advertising contended that MWB Business had agreed to vary the licence agreement in accordance with the revised payment schedule, but MWB Business argued that no such agreement was reached between the parties and that it had considered the revised payment schedule a mere proposal on the part of Rock Advertising, which it ultimately rejected. Following this rejection it locked Rock Advertising out of the premises, terminated the licence agreement between the parties and sued Rock Advertising for the arrears. Rock Advertising filed a counterclaim against MWB Business for wrongful exclusion from the premises on the basis that the parties had agreed a valid and binding variation to the licence agreement.
The licence agreement contained a 'no oral modification' clause (also known as a variation clause), which is commonly found in the boilerplate sections of franchise agreements. These clauses require variations to a contract to be set out in writing and signed by or on behalf of each of the parties.
The first-instance judge held that even though the parties had agreed an oral variation to the licence agreement, variation was ineffective as it had not been set out in writing and signed on behalf of both parties as the 'no oral modification' clause required. The Court of Appeal overturned the decision and held that the oral agreement to vary the payment schedule also amounted to a valid variation to dispense with the 'no oral modification' clause itself.
The Supreme Court disagreed with this assessment. It pointed out that where the parties made the decision to impose on themselves a formal requirement by including a 'no oral modification' clause, a variation of that clause itself must be in writing in order to be effective. Unlike the Court of Appeal, the Supreme Court did not find this unduly restrictive of the parties' autonomy and highlighted that party autonomy operates up until the point when a contract is made, but thereafter only to the extent that the contract allows.
It is clear that without following the formal renewal process, unless and until the parties cross the point of renewal (at which point, an argument for renewal via conduct could be advanced) a franchisor can potentially refuse to renew. Also, failing to document the renewal (or any variations for that matter) represents a huge missed opportunity, either for the franchisee to ensure that certain special terms are incorporated into the agreement going forward or for the franchisor, which cannot introduce changes and updates from its standard franchise agreement.
If there has been no discussion between the parties about a renewal of the franchise agreement, the time for renewal has simply elapsed and the parties have continued to do business in accordance with the terms of the original agreement (or indeed there has been an express confirmation that there will be no renewal, but the parties continue to act in accordance with the terms of the franchise agreement after expiry of the term), the provisions of the original franchise agreement are likely to apply to the ongoing relationship, in whole or part.
The position will need to be determined on a case-by-case basis and any correspondence between the parties will be vital.
One of the most important questions for both parties will be what the term of the extended agreement is and how it can be terminated.
Where a franchise agreement has been extended beyond its original term by conduct, it will have been extended on an open-ended basis and will be terminable on reasonable notice 'at will' (which is why the franchise agreement in this case is sometimes referred to as a 'franchise at will').
What is meant by 'reasonable notice' will depend on the individual circumstances of each case and a court may consider various factors, including:
As a result, there will not be a 'one size fits all' termination notice period and each case must be looked at on an individual basis.
However, this situation is unsatisfactory to both parties. For the franchisor, it erodes the value in the system if franchisees are operating based on a franchise at will, as they can terminate on reasonable notice at any point, whereas typically a franchisee is committed for a fixed term. For franchisees, it erodes the value in their business, as they no longer have a business to sell for value. Conversely, if either party is looking to exit the relationship, then this situation is advantageous, but experience shows that interests are not always aligned in this situation and one party will be more at risk than another.
Under most franchise agreements a franchisee will be prevented from competing against the franchised business within a certain geographic area for a specified period following expiry and termination. With a franchise 'at will' it is not always certain when this restriction will come into force – either on expiry of the term of the original franchise agreement or after expiry of the reasonable notice period which terminates the franchise at will.
There is no clear answer to this question, as there is conflicting case law on this point. A franchisor will argue that the period for the post-term restriction should commence on termination of the franchise at will, which marks the official end of the franchise relationship. A franchisee may argue that the trigger event should be the expiry of the term of the original franchise agreement.
Both positions can and have been argued before the lower courts and in the absence of a decision by the Court of Appeal it is impossible to tell how a court may decide.
One of the ways by which to ensure a long and happy franchise marriage is to make full and proper use of the renewal process. It is all very well to spend money on a nice wedding, but franchisors must also continually invest in reviewing and updating their standard terms and putting in place robust and efficient contractual processes, which ensure that renewals, variations or breaches do not slip by unnoticed or without being adequately documented. After all, if a franchisor is ultimately looking to grow its business through third-party investment, or even exit and sell the business, one of the first parts of the business an investor or purchaser will look at is the health of the contracts which underpin the network.
For further information on this topic please contact Vicky Reinhardt or Gordon Drakes by telephone (+44 20 7861 4000) or email (email@example.com or firstname.lastname@example.org). The Fieldfisher website can be accessed at www.fieldfisher.com.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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