Challenges on the Horizon for International Franchising Post COVID-19

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The impact of COVID-19 has touched every business, franchise and industry.  This new landscape has forced franchisors and franchisees to work together to adapt.  

As anticipation for the availability of mass vaccination programmes grows, franchisors are now in a position to look ahead to consider their future in a post-COVID-19 landscape. This article will consider the potential challenges on the horizon for international franchising as we look ahead to a post-COVID-19 world.

Challenge 1: Disputes over variations of contract

The pandemic has brought unprecedented challenges to international franchises which could not have been anticipated when their franchise agreements were drafted. Many industries, particularly hospitality, leisure and retail, were forced to cease trading in many jurisdictions as a result of government-enforced lockdown or social distancing measures.

In these uncharted times, an emerging theme was a conciliatory approach between franchisors and franchisees in respect of obligations under franchise agreements. For example, many franchisors showed flexibility by suspending the minimum royalty clauses in agreements and granting "royalty holidays" during the toughest periods of restrictions. 

As many countries emerge from lockdown, now is the time to identify with certainty what was agreed between franchisors and franchisees during that period. In English law, subject to the terms of the franchise agreement, it is often possible for contracts to be varied verbally. Franchisors must now consider whether informal arrangements agreed during lockdown permanently varied their contracts with franchisors, and should not automatically assume that in a post-COVID-19 world they can rely on the original terms of their pre-COVID-19 franchise agreement. Any variations to the franchise agreement which are agreed should be documented in writing and in accordance with any variation clause in that agreement. If caution is not exercised, there is the potential for numerous disputes to arise relating to variations made to contracts during the pandemic. 

Challenge 2: Statements made during the COVID-19 peaks

It is anticipated that in the aftermath of the pandemic there will be a surge of litigation involving breach of contract claims. We are already seeing evidence of that. For many franchises, one or more parties is likely to have breached terms of the franchise agreement during the pandemic as a result of their reduced ability to trade.

One potential issue for disputes, where the agreement is subject to English governing law, is likely to be franchisees' reliance on the principle of estoppel. This can arise when one party makes a statement and the other party to the contract relies on it to its detriment. For example, during the pandemic a franchisor may have stated that a franchisee is not required to perform its contractual obligation to make a royalty payment. In some circumstances, the statement maker, here the franchisor, will then be prevented (or "estopped") from enforcing its contractual right to that royalty payment at a later date. There are notable limitations to the principle of estoppel. For instance, it does not itself give rise to a claim: it can only be raised in a defence or reply to a claim. However, franchisors should be wary of any statements made when considering whether to bring a claim against a franchisee. 

Franchisors should also consider whether during the pandemic they affirmed their franchisees' breaches. This can occur when the franchisee breaches a term of the franchise agreement, which is grounds for termination. At that point, the franchisor needs to decide on whether or not to exercise the right to terminate. A delay is likely to be construed as affirming the breach and losing the right to terminate. For example, as a result of reduced trade a franchisee may have failed to meet targets or payments. If the franchisor postponed a decision on whether to continue the relationship until after the COVID-19 peak, it may have lost the right to terminate the franchise agreement for that breach. 

Challenge 3: Claims for misrepresentation 

In these stressful times, franchisees will investigate grounds for ending a franchise agreement, including for misrepresentation. This is, in essence, the allegation that a party was enticed into signing the franchise agreement due to the side's purportedly untrue statements. In particular, franchisees looking to exit the relationship can bring misrepresentation claims on the basis that, during the franchise agreement negotiations, franchisors made exaggerated claims about the franchise's financial performance and potential. 

Moving forward, franchisors should continue to be wary of representations made to potential franchisees. This is especially necessary in the current landscape of uncertainty which makes it difficult for anyone to give projections on financial performance. Franchisors should also ensure that their franchise agreements are drafted to adequately protect their interests to exclude misrepresentation claims as far as possible. 

Challenge 4: Good faith obligations 

In jurisdictions such as Australia, France and Germany, there is some recognition of the overriding principle that parties to a contract should act in good faith. Under English law, courts have been resistant to implying a general duty of good faith to all contracts. 

On 7 May 2020, the UK government issued guidance which encourages contractual parties to "act responsibly and fairly." This includes "being reasonable and proportionate in responding to performance issues and enforcing contracts (including dealing with any disputes)."  This guidance encourages collaboration between the franchisor and franchisee in response to COVID-19. 

Implied duties of good faith in English law remain extremely narrow and this will largely be unaffected by the UK government's guidance. However, there are commercial advantages to following the spirit of the guidance and not automatically enforcing strict contractual rights during COVID-19 and its aftermath. For franchises, whilst relationships have been strained during the pandemic, co-operation between franchisor and franchisee has been integral to the survival of many businesses. Nonetheless, this must be balanced against the other risks mentioned above, and getting legal advice can be vital. 

Challenge 5: Adapting to a post-COVID-19 world

As franchisors learn to navigate these new challenges, Dentons will be there to support them. Dentons' New Dynamic hub contains a wealth of information that franchisors can use to understand the changing regulatory landscape. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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