Consequences of Violating a Franchise Contract?

State laws vary by state, which can cause a slight difference in franchise registration and relationships between states. Franchise disclosure is not affected by state laws because it’s a federal requirement. 

A franchise business should be regulated by the franchise laws of its legal domicile or the permanent state of operation. Violating a franchise contract can cause conflicts between the franchisor and the franchisee. According to one of the best attorneys for franchise disputes, the parties to a franchise should hire a franchise attorney to help them when disputes arise.

The Franchise Agreement

A franchise agreement is a legal document signed by the parties to a franchise—franchisor and franchisee. The signatures of the transacting parties are sufficient evidence of agreeing to the terms of the contract. 

Unfortunately, franchise agreements can have “boilerplate” provisions that can present various legal challenges, even if the signees understand all the aspects of the agreement. These challenges could include issues related to: 

• Ownership and transfer of property;
• Intellectual property protection;
• Consents and rights of refusal, and 
•  Breach of contract, among others.  

All contract breaches are not intentional. Most breach cases result from oversight, and the mistakes are discovered later when the franchisee wants to exit the contract or transfer their rights to a third party. Breaching a franchise contract can attract different consequences, as discussed below:

Cross Default

Franchise agreements contain many clauses that define different aspects of the franchise relationship, including leasing, rights and responsibilities, and financing agreements, among others. A cross-default clause defines what can constitute a breach and the consequences of violating any clause contained in a franchise agreement.  

For instance, a cross-default clause may state that the franchisee will forfeit their rights if they default on their lease. 

Simply put, the business reverts to the franchisor if the franchisee defaults on the lease agreement. The franchisee loses the business, but they’re still held liable for liabilities by their landlord.

Audits

Franchisors conduct financial and operational audits when the franchisee wants to transfer their ownership rights to another party or renew the contract. Such audits help franchisors identify compliance problems and the prevailing state of affairs. The franchisee should be allowed to fix any identified compliance issues. However, some franchisors use such opportunities to terminate franchise agreements.

Franchisor Liability

Franchisors should disclose all the aspects of their businesses to prospective buyers before any financial commitments are undertaken. That is a requirement of The Federal Trade Commission. The FTC can freeze the assets of a franchise or enter injunctions for failing to provide elaborate disclosures to prospects. 

Such offenses can be misdemeanors or felonies, depending on the seriousness of the violation. The penalties for such violations can include:

• Fines of up to $10,000 per day; 
• Monetary awards to the franchisee, including punitive damages and attorney’s fees, and 
• Cancellation of the franchise contract, with the franchisee receiving all monies paid as a franchise fee.

Contract Assumption

Contract assumption or assignment occurs when a third party assumes the franchisee’s position. The new franchisee potentially inherits the rights, obligations, responsibilities, and any other benefits or liabilities of the previous franchisee.

The outgoing franchisee must have a good or valid reason to take this route. In other words, they must demonstrate to the court that a contract assumption is in the interests of debtors, creditors, and other stakeholders. However, the franchisor has the right to accept or reject the new franchisee. 

While Chapter 11 of the Constitution allows business owners to wipe out liabilities, franchisors must assume the entire contract. 

Defaults

Non-monetary defaults present obstacles when assuming a contract. The franchisor may require the franchisee to fix a non-monetary default before assuming a contract. 

Otherwise, the new franchisee is responsible for the default if the franchisor accepts the assumption of the contract.

Settlement

A franchise agreement is an enforceable legal document. Legal action is not always the best option to resolve contract violations because it involves time and money. That said, contract violations can be resolved privately with some form of a settlement agreement. However, the facts of each case should be considered for the best outcome.

 Legal Action or Arbitration

While most people prefer pursuing legal action for breach of contract, it should be the last course of action. Most franchise contracts have alternative dispute resolution mechanisms to resolve arising disputes, such as arbitration and mediation. Such options are still viable even when not provided in the contract. The aggrieved party should only consider legal action if the damage suffered is beyond repair.

Violating the terms of a franchise agreement is a common cause of franchise conflicts. The points discussed in this article can help your case, depending on the seriousness of the violation. You can contact a franchise contract lawyer to learn more about this subject.