Ending a franchise relationship often not a black and white excercise

The ending of franchise relationships can be as complicated as marriage breakups. For a start, they are often fraught with all the same sorts of emotions, such as anger, upset and the desire to level blame and exact revenge. Many legal issues arise, as the tension erupts between franchisees seeking to achieve a return on their investment, and the franchisor’s need to protect and preserve the goodwill of their system as a whole. Throw into the mix that each franchise system is different, and you have all the essential ingredients of an expensive and protracted legal fight.

An example of what can go wrong after a franchise termination, with an interesting twist not often confronted, is a recent decision involving the Cookright Filtering Services System, a system of kitchen and cleaning for commercial organizations that cook using deep fryers.

The franchisee held a franchise for the Invercargill, Southland and Central Otago territories. Disputes arose between the parties and eventually a settlement agreement was reached whereby the franchisee agreed to hand back these territories to the franchisor, in return for $70,000. The franchisee agreed to ensure the smooth transition of the business operation back to the franchisor, including sending a transition letter, forthwith, to all its customers to the effect that the plaintiff was now providing the services it had previously provided. As is normal with settlement agreements, it was agreed that the terms of the settlement agreement were to be kept confidential as between the parties.

In the event, the franchisee did not send the transition letter forthwith and proved to be otherwise obstructive in the process of handing back the business. In the meantime, a third party (being a director and her company), who had previously had a close business relationship with the franchisee, was able to conveniently step in and approach all the customers, with the result that the customers became very confused as to who was actually taking over the services which had previously been provided by the franchisee.

The franchisor sought an injunction not only against the franchisee, but also against the third party, with whom it had no contractual connection at all. The injunction was sought to stop all parties from continuing to carry on a business similar to that of the franchisee, within 100 kms of the territory.

The franchisee did not oppose the application, it said the new business had nothing to do with it. The case was therefore dealt with as between the franchisor and the third party.

Franchisors will be pleased to hear the Court came down hard on the conduct of the third party, relying on claims in tort, including “unlawful interference with contractual relationship”, “inducing breach of contract” and “conspiracy by the use of unlawful means”. Amongst other findings, the Court found that the third party must have had knowledge of the terms of the settlement deed. It rejected as barely credible the explanation of the third party that it simply saw a business opportunity and took advantage of it. The Court found that the third party had arguably acted in such a way as to induce breach of contact between the franchisor and the franchisee and that there was evidence the third party and the franchisee had unlawfully conspired to defeat the interests of the franchisor.

The injunction was therefore duly granted, although it was limited to a period of one month from the date of the Court order.

The case shows the lengths to which a disgruntled franchisee will go in order to defeat the interests of the franchisor, even where it had actually reach a settlement with the franchisor. There was no evidence of any money changing hands between the franchisee and the third party. The motivation must have been purely a desire to cause injury to the franchisor. The case is probably a salutary reminder of the caution that needs to be taken to “tidy up all the loose ends” and ensure all options are properly considered, when negotiating with outgoing franchisees and reaching a settlement in writing.
(January 2014)