Transferring your Franchise? How to Get the Franchisor’s Consent

It’s possible, even probable, that during the course of your franchise agreement, you’ll want to transfer or assign your franchise.  Whether this is an assignment to heirs or a cash-out to liquidate investment by selling to a third party or escaping a poor performing business, transfers are common.  But, while this is an ordinary occurrence, it’s not always easy, and conflict can quickly arise between franchisor and franchisee. One reason for this is that the franchisor may terminate the agreement if an assignment or transfer occurs without the franchisor’s consent.  Below, we’ll discuss why it’s imperative to obtain the franchisor’s consent and exactly how to get that consent before transferring your franchise.

Why is Consent So Important?

In a nutshell, most franchise agreements and state statutes require a franchisee to obtain the franchisor’s consent to transfer or assign their franchise. What happens if you don’t get consent? You may not be able to transfer your franchise and your franchise might get terminated.

The first thing franchisees should do is wipe the dust off their franchise agreement and review the transfer provisions.  There is almost always a detailed section in the franchise agreement that describes step by step what a franchisee must do to obtain the franchisor’s consent to a transfer. 

But the franchise agreement doesn’t tell the whole story.  Agreements often, for example, include requirements such as the franchisee may not be in default to transfer the franchise.  But one of the reasons a franchisee may want to transfer is because it’s in default and doesn’t want to face a termination.  So it’s important to consider whether the franchise agreement’s requirements for a transfer are enforceable or whether they are superseded by a statute.  In California, for example, that would not be a viable ground to withhold consent to transfer under the California Franchise Relations Act (“CFRA”)

Section 20028 of the CFRA sets forth that “[i]t is unlawful for a franchisor to prevent a franchisee from selling or transferring a franchise, all or substantially all of the assets of the franchise business, or a controlling or noncontrolling interest in the franchise business, to another person provided that the person is qualified under the franchisor s then-existing standards for the approval of new or renewing franchisees…”  This means, that if the prospective buyer meets the franchisor’s current standards, the franchisor may not withhold approval on the ground that the selling franchisee is not in compliance with some part of the franchise system.

Ultimately this statute puts the emphasis on the buyer as opposed to the seller, which is contrary to many franchise agreements, which contain significant restrictions on both seller and buyer before a transfer may occur.

Other State Statutory Laws to Consider

Franchise Relationship statutes have been enacted in twenty-three states or territories. Out of these twenty-three, nine specifically address the issue of transfer.  Its important to review the statutory requirements and restrictions when running into transfer issues to see whether the statute may be applicable and how it differs from the franchise agreement. 

In addition to the franchise relationship laws and franchise disclosure statutes discussed above, all fifty states have enacted industry-specific statutes for franchise relationships within specified industries.  These laws prohibit franchisors from unreasonably withholding consent to the transfer of a franchise in the specific industry regulated.  These vary significantly from state to state and from industry to industry but generally, they prohibit franchisors from unreasonably withholding consent to a transfer in a specific industry.  For example, almost every state limits the transfer restrictions a franchisor may impose in the motor vehicle industry.  Additionally, at least thirty states regulate transfers in the beer, wine, or liquor industries.

Requirements and Considerations for the Franchisor’s Consent

If you are going to seek the protection of the franchise statutes, it is best to show you complied with any procedural requirements.  Following these requirements can be necessary to obtaining the protections of the statute.  And beyond the statutes, there are additional key contractual requirements and considerations to keep in mind.

Statutory Requirements

The California Franchise Relations Act requires the franchisee to obtain prior written consent from the franchisor before transferring the franchise.  CFRA Section 20029 states the franchisee shall, before the transfer, notify the franchisor of the franchisee’s “intent to sell, transfer, or assign the franchise, all or substantially all of the assets of the franchise business, or the controlling or noncontrolling interest in the franchise business.”  This notice must be in writing and delivered to the franchisor by business courier or receipted mail.  The notice must include:

1. The proposed transferee’s name and address.
2. A copy of all agreements related to the sale, assignment, or transfer.
3. The proposed transferee’s application for approval to become the successor franchisee. This application should include “all forms, financial disclosures, and related information generally utilized by the franchisor in reviewing prospective new franchisees.” After receipt of the proposed transferee’s application, the franchisor must notify in writing the franchisee as well as the proposed transferee regarding any additional information needed to complete the transfer application.

After receipt of the proposed transferee’s application, if additional information is needed to complete the transfer application, the franchisor shall notify, in writing, the franchisee and the proposed transferee.

If the franchisor’s then-existing standards for the approval of new or renewing franchisees aren’t available to the franchisee when the franchisee notifies the franchisor of their intent to transfer or assign the franchise, the franchisor must communicate the then-existing standards to the franchisee within 15 calendar days.

After all necessary information and documentation required by CFRA Section 20029 (a), is received, the franchisor shall notify the franchisee of the transfer or assignment’s approval or disapproval in writing delivered by business courier or receipted mail.  If the notice of disapproved, the franchisor must state the reasons for the disapproval.

Transfer Fee

When the franchisor consents to a change in ownership, there’s usually a payment of a transfer fee.  The amount of the fee varies, although it is often tied to some percentage of the franchisor’s initial franchise fee.  The amount could be based on reimbursing the franchisor for costs associated with the transfer and training the new franchisee or the goodwill value the franchisee has built using the franchisor’s intellectual property.  Transfer fees are often reduced when selling to a current franchisee as opposed to someone from outside the system.  The reason being that a current franchisee needs less training and administrative support to take over a franchise location. 

Allowing the Franchisor to Vet the Buyer

It’s common for franchisors to perform credit and background checks on franchisee candidates.  Most important typically is the capital or money that the buyer brings to the table and determining whether the buyer has enough capital to invest and grow the franchise.  Experience and education in the franchisor’s industry are typically not prerequisites, but can be.  In situations where a franchisor requires a certain level of experience that a buyer does not have, the issue can often be solved by hiring a manager or operator with that experience.  Franchisors are also looking for buyers that fit the mold of franchisees who have been successful in their system.  In some systems, franchisors prefer larger entities with more capital who are focused on multi-unit ownership as opposed to single unit owners.

Signing a Then-Current Franchise Agreement

Franchise agreements may require: 1) the buyer to assume the existing franchise agreement of the seller; 2) sign the then-current franchise agreement; or 3) either #1 or #2 at the option of the franchisor.  Sometimes the current franchise agreement may not have as good of terms as the prior one the seller operated under and that needs to be taken into consideration in the purchase price and the decision to acquire the franchise.  If the seller operated under negotiated terms it is also important to determine whether those negotiated terms are assignable or personal to the seller.  In some situations where a franchisor is not properly registered to sell franchises, it may simply allow for the assumption of the then existing franchise agreement without the need for signing a new one.  Where a new franchise agreement is provided, the Federal Trade Commission’s 14 day waiting period will be applicable to the related disclosures, which should be kept in mind when setting a timeline for the sale.

General Release

At the transfer time, franchisors typically require transferors or sellers to sign a general release. This is considered standard routine to franchisors, but sometimes franchisees may see it differently, which can cause conflict.  An excellent example of this is seen in Franchise Management Unlimited v. America’s Favorite Chicken, 561 N.W.2d 123 (Mich. Ct. App. 1997).  This Michigan case supports the enforceability of a unilateral release requirement.  In this case, a franchisee’s refusal to provide a release gave the franchisor good cause to deny consent to the assignment.

It’s also important to note that this Michigan case is not alone.  The issue of general releases is frequently raised, and courts generally uphold the rights of Franchisors to require a release when a franchised business is transferred.

One common complaint, though, is that the franchisees are required to give up valid claims in what they might believe is tantamount to economic coercion.  Franchisees who have potential claims against the franchisor need to consider whether they are willing to relinquish those claims to sell the business. 

The Timeline for Selling Your Franchise

As discussed above, it can take many weeks and possibly months to go through the process of notifying the franchisor about a potential buyer, the franchisor vetting the buyer, getting approval, disclosing the buyer the new franchise disclosure document and agreement and then closing the sale.  So its best that franchisees proactively reach out to the franchisor when deciding to sale and get the franchisor’s input on what procedures or process to follow.  Most of the time, with strong communication, the parties can work together to successfully transfer the franchise.  But where the franchisor withholds consent without good reason, there can be grounds for a lawsuit.   

Another factor that affects the timeline is the right of first refusal. The CFRA does not prohibit a franchisor from exercising the contractual right of first refusal to purchase a franchise after receipt of a bona fide offer from a proposed purchaser to purchase the franchise, assets, or interest.  In situations where a franchisor has a right of first refusal, the franchisee will usually need to bring the letter of intent or term sheet to the franchisor’s attention and determine whether the franchisor is willing to acquire the franchise on the same terms.  The franchise agreement typically provides the franchisor 15-30 days to consider exercising its right, which can push back the timeline as well as is a contingency that should be accounted for in the sale agreement.

Work With an Experienced Franchise Lawyer 

Transferring or selling your franchise business is complicated and often involves intricate legal issues.  We help clients buy and sell franchises.  Even where a multi-unit franchisee has other counsel handling the deal, its important to have franchise counsel advising on the franchise specific elements of the deal and transfer procedures.  If you need an experienced California franchise lawyer, contact Luther Lanard, PC, to schedule on consultation.