Ending a franchise relationship what happens when the franchisor terminates unlawfully?

Franchising lawyers are often asked to advise on the correct pathway to termination of franchise agreements. Although frustrating for franchisors, who have often reached a point where they simply want the franchisee gone, taking the most cautious route often proves to be the best route, in the long run. The franchisor in the recent case involving the Spazio Casa Franchise system learned this lesson the hard way.

The brand, Spazio Casa, is well known. It is a system for the retail sale of high end flooring and bathroom items.

In this case, the franchisee had held the territory for Christchurch since 2008. It initially paid a hefty $1,000,000 for the business assets of the franchise, including the fit-out of a shop at premises in Christchurch and a further $200,000 by way of up front franchisee fee. It thus began the Christchurch business from scratch. The business however came to a halt on 22 February 2011, following the earthquake of that date.

The franchisor set about looking to secure new premises, however, the already somewhat brittle relationship between the parties began to flounder. The franchisor became impatient and terminated the franchise agreement. That termination was ultimately found to be unlawful, largely because the franchisor had not followed the correct process set out in the franchise agreement for termination.

The dispute went to arbitration and the arbitrator confirmed that the termination notice was unlawful. The franchisee was therefore entitled to damages. The arbitrator went on to consider what amount to award the franchise by way of damages, being loss of profits sought by the franchisee of a whopping $800,000.

He declined to accept the franchisee’s expert evidence they had suffered losses of profits of that level, and looked to find an alternative basis on which he could award damages. There was little evidence available to him in order to assess damages via any alternative method, and in the end he awarded the franchisee $200,000, being his assessment of the franchisee’s lost goodwill, based on the franchise fee paid at the outset of $200,000.

The franchisor appealed the decision to the High Court. The High Court upheld the decision that the franchisee should be awarded damages for its loss, based on the value of its lost goodwill, assessed at the amount it had paid by way of the franchise fee. Whilst that may have seemed a disappointing outcome for the franchisor, it was certainly an awful lot better than the franchisee’s claim for loss of profits of over $800,000.

The case is interesting as it serves as a warning to franchisors to terminate only with proper cause and in good faith, and by correctly adhering to the process contained in the franchise agreement. It also highlights the difficulties litigation lawyers face in formulating claims for damages in this situation. It seems clear from reading the decision, there was little evidence available to the arbitrator to assess damages and that the franchisee had largely relied on presenting the case as one for loss of profits. It therefore highlights the need to carefully think through, and formulate, alternative methods of damages claims and to ensure there is ample evidence to support all alternatives.
(30 January 2014)