Franchisees - Damages Warning: Lost Future Royalties

As I mentioned a few posts back,  I was invited to co-present at this year's upcoming American Bar Association's Annual Forum on Franchising.  The title of the presentation is "Show Me the Money!" The presentation focuses on monetary damages in franchise disputes. The essence of this post was one of the subjects of that previous post BUT I wanted to emphasize the issue for franchisees.

When you sign a franchise agreement and things don't go well, you may be in for more trouble than just a failed business. Every franchise agreement contains a term of years that the relationship is expected to last (5 years, 10 years, 20 years). Franchisors "expect" that the franchisee will pay royalties and other recurring fees during the full term.

Unfortunately, not all franchisees succeed. Some stop paying royalties, some just close the door, and others tear down the signs and try to compete. (I strongly recommend against the last one) In these circumstances, the relationship ends ... and the franchisor may have the right to collect ALL lost future royalties that it was expecting. Fairness aside, courts have supported the recovery of these lost future profits and royalties.

While this is a complicated legal area that requires further explanation (visit with your franchise lawyer for more info), here, in a nutshell, is what I said in the previous post:

• Franchisor Recovery - Lost Profit - Lost Future Royalties: Although case law in this area is not completely settled, when there is a premature termination of a franchise agreement (not the full term), many franchisors seek the balance of the royalty payments due to the end of the contracted term as damages. A number of courts have permitted recovery of these "lost future royalties," especially when the franchisee abandons operation and simply closes. Some courts permit this recovery upon any "material" breach by the franchisee (i.e. failing to pay royalties). In this instance, from the franchisor's perspective, the worth of the franchise is the total amount of royalties to be paid. However, some courts have denied this type of recovery or have limited it, depending on whether the franchisor actually brought about the termination (instead of just suing for the past due royalties) or has not deducted its own service costs during the balance of the term.

So franchisees BE WARNED - you may have to pay more than you earn. An alternative is to seek a fixed amount of damages to be paid on any early termination - known as Liquidated Damages. Some franchisors already provide for this or are willing to negotiate to add it. BUT, you must reach this agreement in advance of signing the franchise agreement.