Franchisee Exits
BY ERIC H. KARP, ESQ., GENERAL COUNSEL TO NCASEF
Over the last two years, the most frequent subject matter of inquiries I get from individual franchisees or from FOA leaders on behalf of their members, relates to navigating the process for “giving back” a store. From a legal perspective, giving back a store involves termination of the franchise agreement under section 27(b) of the franchise agreement. While the reasons for these terminations are certainly debatable and beyond the scope of this article, they most certainly involve a combination of factors including the store level economic model, evolving customer habits stemming from the pandemic, significant labor shortages, and perhaps many other factors.
One of my roles as General Counsel is to carefully monitor systemwide developments, so that franchisees can understand how the challenges they may be facing fit into the overall picture. We have developed an analysis that involves calculating a turnover rate, which captures the number of franchise units in a system that are involved in franchisee-to-franchisee transfers, as well as those where the franchisee terminates, elects not to renew, sells the store back to the franchisor, or simply abandons the location. We then divide the resulting number by the average number of franchised stores during the year.
The chart below illustrates that there was a significantly higher turnover rate in 2019 (nearly 6 percent) than the negligible turnover in 2011, and then a steady increase in the ensuing two years to the point where more than 9 percent of the franchised stores turned over in 2021. This is a very significant increase, which is consistent with the experience that we have had in dealing with franchisees that desire to terminate.
By digging a little deeper into the numbers reflected in the foregoing analysis, we can determine that while the number of franchisee-to-franchisee transfers over the last three years increased steadily, the number of store closures more than doubled from 2020 to 2021, as illustrated by the following chart.
Here are some typical questions that are posed to me by franchisees and the answers that hopefully will help those in the process of giving back stores. Capitalized terms are defined in the franchise agreement, usually in Exhibit E, which contains many pages of defined terms.
Is there a penalty that I have to pay?
If you give SEI at least 30 days written notice of your intent to give the store back, there is no termination penalty. If you give SEI 72 hours’ notice, then there is a $5,000 termination penalty which is debited to your Open Account. For some franchisees, the decision whether to give 30 days notice is based on whether they will lose more or less than $5,000 in continuing to operate the store during that month.
How do I give the written notice?
The franchise agreement has a very specific procedure for giving written notices. You must send the notice in writing by certified mail or recognized overnight carrier. It should be addressed to the Director of Franchise Operations. A telephone conversation with, or a text message or an e-mail, to your Market Manager is alone not sufficient. We have developed a template for the form of written notice, which you can obtain from the National Office.
What do I do after I give the written notice?
Operate the store as you always have. Clean and maintain the store in the normal course. You will be required to surrender the store in the same condition as it was when you received it, normal wear and tear accepted. If you do not clean the store or maintain the store, SEI has the right to perform those functions and charge you for them.
What about the Inventory?
You will receive a credit on your open account for the Cost Value of the Inventory. We urge franchisees to insist that they be present when the final inventory is taken in order to reduce the possibility of disputes later on. You also should consider videotaping the process if you suspect that it may be problematic.
What happens on the day of surrender?
You need to peaceably surrender the store and turn over any undeposited cash receipts as well as the cash register fund and any money order blanks, bank drafts, and lottery tickets. The franchisee must cease using any of the 7-Eleven trademarks, cease using any confidential materials, and execute whatever documents are necessary to transfer licenses and permits relating to the store.
When do I get my first payment?
Within 30 days following the surrender, SEI must credit your Open Account with cash receipts, the cash register fund, prepaid operating expenses and the value of store supplies and inventory. SEI is permitted to debit your Open Account by $200 as a closing fee. SEI must then pay you the amount by which they estimate your Net Worth to exceed the greater of $10,000 or 25 percent of your total assets.
When is the final payment made?
The Final Financial Summaries are due 105 days after the last day of the month in which you surrender the store. Thus, the period of time between the date you surrender and the date you receive the Final Financial Summaries can vary significantly depending on what day of the month you surrender the store. For example, if you surrender a store on August 2, your final payment is due 134 days later, but if you surrender the store on August 30, your final payment is 106 days later.
If the Open Account has a positive balance, SEI is required to pay you that balance with the Final Financial Summaries. It is very important that you carefully scrutinize the Final Financial Summaries because if you cash the check, you waive any right to contest the calculations.
Do I have to sign any contracts or agreements in connection with the store surrender?
As noted above, you are required to execute whatever documents are required to transfer licenses and permits relating to the store and in order to negotiate the final check, you will need to endorse it. These are the only documents you are required to sign in connection with a store surrender. If you are presented with a store surrender agreement, you should read it carefully and consult legal counsel before signing it.