Terminating International Master Franchisees

06/30/2014 / Cyndi Klaus and Jim Susag

International expansion of a franchise system is often accomplished through master franchising, in which the master franchisee develops the territory, sells franchises, trains franchisees, and supports and oversees the franchisees in the market as if it were the franchisor. However, sometimes the relationship between the franchisor and master franchisee deteriorates, leading the franchisor to terminate the master franchisee. Larkin Hoffman’s franchise litigation team received a favorable decision this year on a very significant international franchise termination case, which led to a number of lessons learned. 

The particular case involved Anytime Fitness, LLC, which terminated a foreign master franchisee for a variety of reasons, ranging from failure to meet development schedules to failure to follow standards. The former master franchisee brought a claim in arbitration for wrongful termination, ultimately seeking nearly $25 million in damages. After a two-week arbitration, the arbitrator rejected all the master franchisee’s legal claims and requested damages, and awarded Anytime Fitness $1.9 million for damages associated with the master franchisee’s breaches of the master franchise agreement, failure to de-identify properties after termination, and attorneys’ fees. Of course, the pain in getting to that point was significant. Hence, the lessons learned from the termination. 

Before issuing a termination notice, franchisors need to make certain that the operational and business consequences of the termination are analyzed. Anytime Fitness representatives had made numerous visits to the territory throughout the relationship to gain and maintain an understanding of the local market, the franchises in the territory, and the local vendors and suppliers. These visits not only can aid the parties in avoiding situations that may lead to termination, but they can prove to be extremely valuable to the franchisor in the aftermath of the termination, when the franchisor must regain control of the market to protect the system and the brand in the territory. 

When a franchisor decides to terminate the master franchise agreement, it should carefully consider the requirements for delivery and form of the notice of termination. Generally, the franchisor will issue a notice of default, specifying the defaults of the master franchise agreement and the applicable cure period, if any, and then follow it with a notice of termination immediately after the expiration of the cure period if the master franchisee has not cured the defaults. The notices should be delivered to the master franchisee in strict compliance with the requirements of the master franchise agreement, as well as any laws governing the parties’ relationship with respect to format and substance, timing and method of delivery, and the required cure period. Non-compliance with any of these important issues may leave the notices open to attack. On the other hand, as long as the defaults have been clearly documented, a termination notice that was less specific about the actual grounds for termination actually gave us the opportunity in the Anytime Fitness case to use additional acts of the master franchisee that were harmful to the brand, to justify the termination not only on breach of contract grounds, but also on the need to protect the brand, and the public, from actions that occurred after the initial default letter was sent.

One of a franchisor’s immediate challenges after terminating a master franchise relationship, in addition to damage control, will be to install new leadership in the market. The franchisor should consider whether to step in and franchise the territory directly without a master franchisee or to replace the master franchisee. Regardless of the choice made, at least in the interim period, franchisees in the local market may look to the franchisor for answers and to provide services and support. In the Anytime Fitness case, the franchisor was ready to install a new master franchisee in the territory within a few months after the termination became effective. Not only was that important from a business standpoint, but the initial success of the new master franchisee helped dispel the claims of the terminated master franchisee that the franchisor’s standards did not work in this market. 

If the most important criteria for the success of a retail business is “location, location, location,” the lesson that was driven home time and time again in the Anytime Fitness case was the importance of “documentation, documentation, documentation.” When a master franchise relationship terminates, there are frequently large dollar amounts at risk for all parties. Memories fade, and witnesses in a foreign country may sometimes lose a handle on the facts when faced with a need to testify against “one of their own.” The need for documenting the issues that led to termination, and the reaction of both the master franchisee and franchisor to initial attempts to resolve those issues, are often more critical in these cases than they would be when the termination involves a single-unit franchisee in a neighboring state.