Transferring a franchised business from one owner to another can be awkward for all involved. It’s a legal balancing act: The franchisee wants to cash out and move on; the franchisor wants to make sure that the contractual obligations are in place with a qualified purchaser and to see that the business continues in good health; and the buyer wants a franchise that has already been built, but can be improved so that it is more profitable. Those ends can certainly all be accomplished, but it must be done while meeting all of the transfer requirements in the franchise agreement.
The Franchise Agreement Rules. This document spells out exactly what constitutes a transfer and the steps that the players must take in order to accomplish a transfer. Read the transfer/assignment provision carefully; there may be a couple of surprises in it. For instance, the franchisor may have included a Right of First Refusal, by which the company can step into your planned transfer and buy it itself on the same terms. This allows franchisors to exercise control if they have other plans for your market. Even without a Right of First Refusal provision, the franchisee does not have an unqualified legal right to sell a franchised business. The agreement spells out the conditions that will apply to the transfer, and usually requires a notice to the franchisor of the proposed transfer, giving the franchisor an opportunity to consider the prospective buyer and the terms being offered.
The Request. Just about every franchise agreement I have seen or written contains a provision that requires the franchisee to submit not only a request to approve a proposed transfer but also detailed information about the qualifications of the buyer, a terms sheet, and the draft sales agreement for the proposed transaction. The franchisor then usually reserves a reasonable period of time in which to consider the proposal and advise if it is approved. Some franchisors will want to put the proposed buyer through the same application process and series of interviews required of new franchisees.
What Does the Franchisor Look For? The franchisor’s accounting department will review the numbers, and legal counsel will review the sales agreement, to make sure that the sale does not mistreat the company’s trademark rights, counter the terms of the franchise agreement, or suggest that the franchise agreement rights are something they are not. I once reviewed a sales agreement that purported to assign ownership of the franchisor’s primary trademark to the buyer (rather than assign rights existing under the franchise agreement), and another that split apart and purported to sell to separate buyer corporations the franchise agreement rights and the assets of the franchised business. Both proposed transfers were rejected until the deals were restructured and the paperwork corrected.
Can a Proposed Transfer Be Rejected for Financial Reasons? Can the franchisor reject the proposed transfer? Sure it can. If the buyer does not meet the qualifications required of all other franchisees, the deal may be bounced. Same for the financial terms of the deal: If the franchisor concludes that the franchised business cannot carry the financial burden of the transaction without threatening the viability of the franchised business, the franchisor has every right to reject the proposed transfer.
This stuns some franchisees. After all, the selling franchisee wants to maximize the purchase price, right? What right does the franchisor have to push in the other direction? The court cases that have weighed these arguments have found that the franchisor has a legitimate interest in seeing that its franchised businesses remain healthy and stay in business. If the business cannot sustain the debt service from the acquisition or if some other term of the sale threatens the continuing viability of the business, then the franchisor has every right to reject the proposed transfer. You have been warned.
What About a Franchise Disclosure Document? If the proposed transaction is approved (make sure that approval is given in writing) and will be closing in a few weeks, is there an obligation (on the part of either the franchisor or the franchisee) to provide the buyer a Franchise Disclosure Document (FDD)? Franchisees are not subject to the disclosure rules in this circumstance; and the rules for franchisors say that they need not provide an FDD if they are not involved in the sale beyond approving the qualifications of the buyer and the terms of the transaction. If they are more involved (for instance, if they require that a new form of franchise agreement be signed by the buyer), the franchisor will be required to provide disclosure.
A franchisee has no absolute right to sell a franchised business. Like other aspects of the franchise relationship, a transfer is entirely and inescapably subject to the terms of the franchise agreement.
Andrew Caffey is one of the nation’s leading franchise legal specialists and he represents franchisors across the United States. Caffey served as General Counsel of the International Franchise Association, a member of the Governing Committee of the ABA Forum on Franchising, and Chair of the ABA Forum on Franchising. He also is a member of the bar in Maryland and the District of Columbia, and a member of the Panel of Neutrals of the American Arbitration Association.