Franchisor Approval for Business Sale / Purchase

Buying and selling a franchise is rarely, if ever, a simply task - as there are all too often a multitude of complexities, hurdles and pressures bearing down upon the parties involved.

Contact Neufeld Legal PC for franchising legal matters at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com

The sale of a franchise cannot be undertaken without conforming to the requirements imposed by the franchisor and set out in the franchise agreement, which tends to not only require the prior approval of the franchisor, but also the payment of the prescribed transfer fee and the business purchaser entering into the franchisor's current form of franchise agreement.

Although the specific requirements for attaining the franchisor's approval to sell an existing franchise are set out in the Franchise Agreement, there are common requirements and conditions that franchisors typically impose to protect their brand and system:

A. Franchisor Approval and Vetting of the Buyer

• Franchisor Consent: The sale or transfer of the franchise is almost always subject to the franchisor's prior written consent.

• Buyer Qualifications: The proposed buyer must meet the franchisor's current criteria for new franchisees, which often include:

  • Financial Stability: Verification of the buyer's net worth and capital to operate and potentially grow the business, including servicing any debt from the purchase.

  • Experience and Background: Review of the buyer's business experience, managerial skills, and a clean background check.

  • Interview/Meeting: The franchisor may require a formal interview with the prospective buyer.

B. Status of the Existing Franchise

• Resolution of Defaults: The selling franchisee usually must resolve any outstanding defaults under the Franchise Agreement (e.g., unpaid royalties, failure to maintain standards, required renovations) before the franchisor will approve the sale.

• Renovations/Upgrades: The franchisor may require the existing unit to be renovated or upgraded to meet their current system-wide standards as a condition of transfer.

C. Legal and Financial Requirements

• Transfer Fee: The selling franchisee often has to pay a non-refundable transfer fee to the franchisor. This fee typically covers the franchisor's administrative costs, legal review, and training of the new franchisee.

• New Franchise Agreement: The buyer is typically required to sign the franchisor's then-current form of Franchise Agreement, which may have different or less favorable terms than the seller's original agreement.

• General Release: The selling franchisee and any related parties are usually required to sign a general release, waiving any potential claims or lawsuits against the franchisor.

• Right of First Refusal (ROFR): Many agreements grant the franchisor a Right of First Refusal, allowing them to purchase the franchise business on the same terms and conditions as a bona fide third-party offer.

Attempting to sell one's franchise without first obtaining the franchisor's approval carries significant dangers, primarily because it constitutes a breach of the Franchise Agreement. Among the major risks and consequences of attempting to sell a franchise without the franchisor's prior approval:

• Termination of the Franchise Agreement: This is the most serious and likely consequence. The franchisor can terminate your right to operate the business, leading to the loss of the business itself, its goodwill, and your investment.

• Legal Action and Financial Penalties: The franchisor can sue you for breach of contract. You may be liable for financial damages, including lost future royalties the franchisor expected to receive from the new owner, as well as the franchisor's legal fees and costs. The agreement may contain clauses for liquidated damages (pre-determined penalties) for an unauthorized transfer.

• Invalidation of the Sale: The franchisor may refuse to recognize the transfer, making the sale to the new buyer void or unenforceable. The buyer may then sue you to recover their purchase price and other losses, as you were unable to legally deliver the franchised business.

• Ongoing Liability: Even after the sale, you may retain legal responsibilities under the original franchise agreement because the franchisor never approved your release from the contract. This means you could be liable for the new owner's failure to meet operational standards or pay royalties.

• Compromised Brand Integrity: The franchisor's approval process exists to ensure the new owner meets their financial, experience, and training standards. By selling without approval, you risk damaging the brand's reputation and consistency, which is a major concern for the franchisor and another basis for legal action.

The approval of the franchisor is but one of the parties from whom permission is typically required when selling a franchise, with the seller also needing to engage with the landlord, the bank/financing company, equipment lessors, suppliers, and regulators.

Christopher Neufeld is a business lawyer knowledgeable in the rigors and challenges of the franchise business, together with the legal constructs that are critical to their effective operation. For experienced legal representation in starting, acquiring / selling, operating and managing a franchise, contact franchisee lawyer Christopher Neufeld at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or Chris@NeufeldLegal.com.