Disputes can often arise between a franchisor and franchisee during the course of their business relationship.
Franchisors have a legal entitlement to formally place a franchisee on notice if a franchisee breaches a provision of the Franchise Agreement. Formal breach notices are generally issued once a dispute escalates and a conciliatory resolution cannot be achieved. However, this is not always the case and some franchisors may resort to issuing a breach notice straight away.
Breach notices must be taken seriously by franchisees because failure to act can put their business at risk. When issuing breach notices, franchisors must ensure that they are at all times acting strictly in accordance with the law.
What is a breach notice?
Under the Franchising Code of Conduct (Code), a franchisor can terminate a Franchise Agreement if they provide a breach notice to a franchisee and the franchisee fails to remedy that breach in accordance with the requirements within (and timeframe of) the notice.
Issuing a breach notice is essentially Step 1 in the termination process, and used as a formal warning to a franchisee that their business and/or conduct is non-compliant.
To be valid under the Code, a breach notice must:
be in writing;
specify the exact breach of the Franchise Agreement;
set out what the franchisee must do to remedy the breach; and
provide a reasonable time for the franchisee to remedy the breach (which doesn’t have to be longer than 30 days).
If the franchisor wants to rely on the breach notice to terminate the Franchise Agreement, the notice must also state that the franchisor proposes to terminate the Franchise Agreement if the breach is not remedied accordingly.
If the franchisee remedies the breach fully in accordance with the requirements of the breach notice and by the due date, then the franchisor cannot rely on that breach to terminate the Franchise Agreement. Otherwise, if the franchisee fails to comply with all conditions of the breach notice, the franchisor can terminate the Franchise Agreement.
A breach notice will often also require a franchisee to pay the franchisor’s legal costs associated with the breach if that’s allowed by the terms of the Franchise Agreement.
There are certain circumstances under the Code where a franchisor can immediately terminate a Franchise Agreement without following the breach notice process. This includes the franchisee becoming bankrupt/insolvent, acting fraudulently in connection with the franchised business, endangering public health and safety, or simply abandoning the franchise.
How to respond to a breach notice?
As a starting point, a franchisee should read the breach notice carefully together with their Franchise Agreement, and diarise the deadline that has been given to remedy the breach.
The breach notice must clearly specify what the franchisee has allegedly done wrong and how that constitutes a breach of the Franchise Agreement. A franchisee should ensure they fully understand exactly what the franchisor requires them to do. If the notice requires the franchisee to do multiple things to remedy the breach, but the franchisee only does 1 of those things within the deadline, that’s still grounds for the franchisor to terminate the Franchise Agreement because a breach notice must be complied with in full.
Remedying a breach can sometimes be simple. Overdue payments can be remedied by paying the arrears and any overdue interest, whereas failing to stock approved products can be remedied by ordering, acquiring and stocking those products.
If the breach can be fixed easily then a franchisee should remedy it immediately. As the saying goes, pick your battles. Franchisees refusing to remedy a breach of principle because they are trying to prove a point will place their business in jeopardy.
Once a franchisee remedies the breach, it’s good practice to provide the franchisor with evidence of the actions taken. This gives clarity so everyone is on the same page. If the franchisee disputes the alleged breach or doesn’t believe the action required or the time is given to remedy is achievable, then that’s when they should try to negotiate a resolution with the franchisor, and/or seek legal advice.
Franchisees must be given a ‘reasonable’ time to remedy the breach. What is a ‘reasonable’ time will depend on the circumstances. 7 days may be reasonable to pay an overdue fee, but 1 day may be reasonable to clean a store. In any case, a franchisor does not need to give more than 30 days to remedy a breach (which can be problematic if the breach relates to failing to achieve ongoing KPIs or meet minimum performance criteria).
If a franchisee considers that the franchisor hasn’t provided enough information in the breach notice to substantiate their allegations, then the franchisee should immediately ask for more information to be provided. A franchisor should act reasonably and provide this promptly.
If a franchisee and franchisor are unable to resolve the issues at hand, then either of them can invoke the dispute resolution procedure under the Franchise Agreement or under the Code. This procedure means that both the franchisor and the franchisee must attempt to agree about how to resolve the dispute, failing which, either party can call for mediation. Importantly, invoking this procedure doesn’t prevent a franchisor from terminating a Franchise Agreement in the interim if the breach notice isn’t complied with.
No matter what a franchisee decides to do, it’s key that both parties communicate in a conciliatory manner. Sometimes breach notices are the result of simple misunderstandings, but sometimes they can be intended by franchisors to trigger an aggressive response. Both a franchisee and a franchisor should remain reasonable and professional.
Is the franchisor acting in good faith?
The Code requires both franchisors and franchisees to act in good faith towards each other. This doesn’t prevent a party from acting in their own legitimate business interests. Just because the franchisor has issued a breach notice doesn’t necessarily mean they are failing to act in good faith, provided they have a reasonable basis for their actions.
By signing the Franchise Agreement, the franchisee agreed to comply with the terms of the Agreement and the franchisor’s policies, systems and procedures. The franchisor is entitled to enforce this, provided they act reasonably in the circumstances.
What are the consequences?
A franchisor can immediately terminate the Franchise Agreement if the franchisee fails to remedy a breach by the deadline within a valid breach notice. Termination will generally result in the franchisee losing their right to operate (or sell) the franchised business. The franchisor may also have grounds to sue the franchisee and their guarantors for damages.
A breach notice can also impair a franchisee’s future ability to:
renew their Franchise Agreement – it’s a condition under many Franchise Agreements that the franchisee ‘substantially complies’ with the Franchise Agreement during its term to be entitled to renew the Agreement. Even if they remedy the breach, the fact that the franchisee breached the Franchise Agreement in the past could entitle the franchisor to refuse to renew it in the future. If the breach hasn’t been remedied at the time of renewal, then this can also be grounds for a franchisor to refuse a renewal; or
sell their business – it’s generally a condition under the Franchise Agreement that if a franchisee wants to sell their business, then there must be no outstanding breaches of the Franchise Agreement at the time.
Franchisors must treat the preparation and issuing of breach notices with precision. High attention to detail is needed to ensure the facts and circumstances are correct, together with ensuring that the conduct actually constitutes a breach of the Franchise Agreement.
Franchisees should be mindful of several things:
Unless a franchisee genuinely disputes the validity of the breach notice, maintaining the ongoing working relationship with the franchisor should generally be prioritised. A breach notice will often be a wake-up call that a franchisee’s business values may not be aligned with those of the franchisor.
By showing the franchisor that they are taking the issue seriously and that the franchisee is actively taking steps to improve performance issues, will not only assist in salvaging the business relationship but will also help a franchisee’s position if a dispute arises from the situation.
This is not to say that franchisees should necessarily give in to a franchisor’s demands if the franchisee considers the franchisor is acting unreasonably, in bad faith or outside the scope of the Franchise Agreement.
Again, seeking legal advice from a specialist franchise lawyer is key if the franchisee doesn’t believe a breach notice is warranted. Time is of the essence, so a franchisee shouldn’t wait to obtain professional advice until the day the breach notice deadline expires. Franchisees should act early.
Sometimes the damage to the business relationship may already be done once a breach notice is issued, but often the relationship can be salvaged if both the franchisee and the franchisor are genuinely committed to resolving the issue.
The team at Salerno Law are experienced in acting for both franchisors and franchisees in all aspects of franchising law, including:
issuing breach notices for franchisors;
advising franchisees who have received a breach notice;
negotiations between franchisors and franchisees;
activating the dispute resolution procedure; and
mediating and litigating disputes.
Get in contact if you need our assistance.
By Luke McKavanagh
DISCLAIMER: This article is only meant to give you general information and should not be relied on as legal advice. Speak to one of our lawyers for more information.
Salerno Law is managed by Emma Salerno, Managing Partner and CEO, who has a wealth of experience from operating her own businesses across Australia as well as a range of in-house and commercial experience both in Australia and overseas.