Difficulties with transfer provisions in franchise agreements

Most franchise agreements contain a provision relating to the process to be followed on assignment of the franchise. That process will generally provide for the need for the consent of the franchisor to the assignment or sale. A right of first refusal will often be included, in favour of the franchisor.

These clauses can create fair amount of tension between franchisee and franchisor. Typically, franchisees feel frustrated when the transfer process is so tightly controlled by the franchisor that it slows down a sale (or in some cases, loses a sale!).

These provisions are, however, important for franchisors. They give the franchisor the ability, for the overall benefit of the system, to control a sale process, so that the franchisor is happy with the incoming franchisee, just as they would need to be when selling a new franchise to an incoming franchisee. These clauses also enable the franchisor to retain a franchise business within their system in the event the franchisee wishes to move on.

A recent Court of Appeal decision (Wholesale Distributors Ltd v Songle Supermarkets Ltd and another) highlights the problems which arose when the process set out in a transfer clause was not followed by a renegade franchisee.

For some years, Songle Supermarket Ltd operated a SuperValue supermarket at Pauanui under a franchise granted by Wholesale Distributors Ltd (WDL). On 14 July 2014, Songle agreed to sell the business. The sale agreement was conditional on WDL’s consent to the purchase of the business by the purchaser and to the transfer of the franchise agreement to that purchaser.

The franchise agreement completed included, as is typically seen in franchise agreements, a right of first refusal in WDL’s favour if Songle wished to sell the business.

After the sale agreement was signed, the purchasers met with WDL representatives. The purpose of the meeting was to discuss the purchase of the business and the transfer of the franchise agreement. There is a dispute about some of what was said during these discussions but, on WDL’s case, the purchaser raised the possibility of a change of franchise to Four Square, a franchise operated by Foodstuffs, a direct competitor of WDL. The purchaser was told that a change to Four Square would not be approved.

The purchaser nevertheless declared the sale agreement unconditional, despite the fact WDL had not given their approval to the sale of the business.

WDL sought advice from the purchaser about their intentions. The purchaser advised on 22 September 2014 that they did not intend to become a SuperValue franchisee. The purchaser put their existing business on the market and sold it, in contemplation of being able to settle on the Songle Supermarket. The purchaser then took steps to move their family to Pauanui in anticipation of completing the purchase.

WDL then issued proceedings on 26 September 2014 against Songle and the purchaser for an interim injunction restraining the sale of the business.

In a judgment issued on 17 October 2014, the High Court dismissed WDL’s application for an interim injunction to stop the sale of the franchise. This was a decision which would have had serious negative commercial consequences for franchisors everywhere and was immediately appealed.

The Court of Appeal traversed the facts carefully, and decided:

a) There was a serious question to be tried that in reaching the agreement with the purchaser the franchise agreement had been breached.

b) That if the sale to the purchaser had proceeded, and the franchise “de-badged” and re-branded, this would have result in irreparable injury to WDL.

c) That the purchaser proceeded with all transactions with their eyes open.

The Court of Appeal therefore overturned the High Court and so an injunction was granted preventing the sale from proceeding.
The case sends a strong message to franchisees to proceed carefully when selling their businesses. Clauses which require a franchisor’s consent are there for good reason, and the Courts have shown they are willing to enforce them.

June 2015
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