Franchise Pacts Unfairly Weighted Toward Franchisors

Franchise Pacts Unfairly Weighted Toward Franchisors

Reprinted from Advanstar
Hotel & Motel Management Magazine
November 6, 1989
By Jeff Wilder
Wilder Group, L.L.C.

In September, Robert Nozar wrote a stinging editorial that highlighted the franchisee's predicament when a franchise system is sold. Currently, the situation is a heads-I-win, tails-you-lose arrangement for franchisors. Equity dictates that a change is necessary. Franchisees who wish to terminate license agreements when franchisors change owners can't without stiff penalties.

When you execute a franchise agreement, you've signed a contract that calls for a franchisor to provide a range of services and a reservation system. The franchisee commits to meet standards for the term that he agrees to stay with the system. If he defaults on standards he can, and should have his license canceled.

Weighted Agreements

Franchise agreements, having been written by the franchisor's lawyers, rarely discuss franchisor default arising from a significant balance-sheet reduction in franchisor net worth. Since the franchisor is free from virtually any charge of license default, the contract cannot be broken by the franchisee without a major termination penalty. Therefore, the franchise-fee income is a lock for the franchisor corporation.

When a franchise corporation's income stream is sold to a new party, usually at a premium price, interest costs on acquisition debt (or equity-yield demands) often eat up most, if not all, franchisor net income. The result is diminished franchisor services, firing of hundreds of corporate franchisor personnel, and/or a pell-mell expansion of franchisee license agreements. It is disgraceful that the franchisee cannot opt to cancel his agreement with the franchisor when such major changes to the franchisor corporation occur. After all, franchisors always cancel existing license agreements when a majority interest in a franchise is sold.

Stiff Termination Fee

When you, as franchisee, try to cancel your license because the company you entered into a contract with changes hands, the franchisor, or its lawyers, will tell you that you'll owe a termination fee equal to the discounted value of your franchise fees times a number of years, often the term remaining on your contract. Since this results in potential liability running into hundreds of thousands of dollars, you back off and suffer in silence. The franchisee population is a fractured one and your dilemma personal. But that doesn't alleviate the unfairness to the franchisee.

A Time For Action

As the proliferation of franchise products expands and the franchisor's need to write new franchises to cover costs escalates, the franchisee's, or potential franchisee's, power to negotiate increases. I urge all those who are going to enter into agreements in the future to insert a clause in the franchise contract similar to that which already exists for franchisees:

"If more than 50 percent of the stock of a franchisor changes hands, or the franchisor's net worth is significantly diminished, the franchisee may cancel the contract without a termination penalty fee."

Are you an unhappy franchisee locked into a franchise agreement with new franchise shareholders? Do you want out? Why not write your congressman or The Federal Trade Commission? See whether you can dislodge the termination penalty concept that inhibits the franchisee from making a free-market decision to switch franchises if the franchisor corporation is sold. Write and let us know the results. You'll be doing a favor to many in the lodging industry.

Somebody should stand up and get "mad as hell."