Franchisee found liable for franchise fees for entire term following breach of franchise agreement
Jemmeson & Fisher recently successfully acted on behalf of a franchisor, Century 21 Australia Pty Ltd (Century 21) in a case against a former franchisee for damages arising from breach and early termination of a franchise agreement.
As a result, the franchisee has been ordered to pay $204,925.38 in damages and interest to Century 21, together with legal costs.
FACTS IN THIS CASE
The franchisee had operated a profitable Century 21 real estate franchise in South Australia for around 12 years before termination under 3 consecutive franchise agreements (each for a 5 year term).
In October 2011 (2 years into the third 5 year term of the franchise), the franchisee expressed a desire to change her business name and model to something which was not in keeping with Century 21’s overall brand.
A meeting then took place between the franchisee and Century 21’s national franchise manager at which the change was discussed. The franchisee argued that the conversation which took place at the meeting constituted an agreement to terminate with a release of the franchisee from all liability and/or a waiver of its rights under the franchise agreement. Century 21 argued there was no such agreement and the franchise manager simply asked the franchisee to put her proposal forward in writing.
The franchisee then effectively ‘abandoned’ the franchise by ceasing to trade under the Century 21 brand, purportedly on the basis that the franchise manager had agreed to terminate the agreement.
Century 21 then issued a termination and breach notice in accordance with franchise agreement, requiring the franchisee to pay damages to Century 21 which totalled $164,433.15.
The amount of $164,433.15 was calculated in accordance with the franchise agreement which said that:
The parties acknowledge and agree that it would be impracticable or extremely difficult to calculate the actual amount of lost future profits payable by the franchisee, and that the following method of calculation represents a fair and reasonable estimate of foreseeable lost future profits; lost future profits shall be calculated by determining the average monthly service free payment and the average monthly MAF contribution payable by the franchisee to franchisor from the commencement date of this Agreement through the date of early termination and multiplying these average months by the actual number of months (and any fraction thereof) remaining between the date of early termination and expiration date.
The franchisee also tried to argue that:
The clause set out above was effectively a penalty clause (not a genuine pre-estimate of the loss or damage likely to be suffered) and therefore invalid.
Century 21 failed to mitigate its losses by failing to locate another franchisee to replace the defendant franchisee.
The franchisee’s actions which essentially constituted an abandonment of the franchise were a breach of the franchise agreement sufficient to entitle Century 21 to terminate the franchise agreement.
The Court held there was no agreement to terminate the agreement with a total release of liability at the meeting which took place between the franchisee and the national franchise manager.
The clause set out above was a genuine pre-estimate of likely damage to be suffered by Century 21 in the event of early termination or breach of the franchise agreement, and was not a penalty.
Century 21 did not fail to mitigate its losses by not replacing the defendant with another franchisee in the area as:
Century 21 does not generally provide for exclusive territories – other franchises made sales in the franchisee’s general area during and after the franchise.
Century 21 did take reasonable steps to find a replacement franchisee but none was located.
Accordingly, Century 21 was awarded the sum of $204,925.38 (including interest dating back to 2011), together with legal costs.
LESSONS FOR FRANCHISORS
Review your franchise agreement to consider whether any clause (like the above) which calculates damages or lost future profits is a “genuine pre-estimate” of the losses likely to be suffered if the franchisee breaches the agreement. If not, it may be a penalty clause and potentially invalid.
Review policies and procedures for complaints and disputes with franchises, and ensure that you document all meetings and conversations which take place with franchisees appropriately.
Ensure you have adequate procedures in place when entering into and terminating franchise agreements prematurely for breach by the franchisee, in case they are ever scrutinised by a Court.
If you are required to terminate a franchise agreement early for breach by the franchisee (and you do intend to sue for damages), consider whether the granting of territories requires you to use your best or reasonable endeavours to locate a replacement franchisee in order to mitigate your losses.
LESSONS FOR FRANCHISEES
Consider the practical implications of clauses which calculate damages or lost future profits like the one in this case when entering into and renewing franchise agreements – what fees might you be liable for if you breach the agreement or need to terminate the agreement early?
Never abandon a franchise – always follow the steps required in the franchise agreement.
Document all meetings and conversations which take place with the franchisor.
Seek legal advice before entering into or terminating a franchise agreement.
For further information, please contact:
Managing- Director Legal
Disclaimer: The information in this article is correct as at 19 May 2015. This information is not to be taken as legal advice and at all times we recommend you seek independent legal advice regarding your own individual circumstances from your legal representative.
 Century 21 Australia Pty Ltd v JLink Pty Ltd & Smith  SADC 58