As a struggling franchisee, you might think that your franchisor signaling its intent to terminate your franchise agreement represents the end of a long nightmare. Unfortunately, in many cases, it is just the beginning.
This is because, with increasing frequency, franchisors are including “liquidated damages” clauses in their franchise agreements. A typical liquidated damages clause may look something like this:
Within 30 days of the Franchisor’s termination of this Agreement, the Franchisee will pay the Franchisor, as liquidated damages and not as a penalty, an amount equal to three (3) times the royalty fees payable either (i) during the last twelve (12) months of the Franchisee’s active operations, or (ii) the entire period that the Franchisee has been in business, whichever is the shorter period.
In plain English, what this says is that, 30 days after the franchisor terminates the franchise agreement, the franchisee must pay the equivalent of three years’ royalty fees to account for the royalties that the franchisor theoretically would have earned had it not terminated the agreement. This is true even though the franchisor is electing to terminate the agreement—presumably because the franchisee has been unable to meet its royalty obligations while actually trying to operate the business.
Sounds fair, right?
Unfortunately, many, many franchisees have liquidated damages clauses in their agreements, and several courts around the country will enforce these clauses without regard to the often-devastating financial effects they have for terminated franchisees.
Challenging the Enforceability of a Liquidated Damages Clause
That said, there are grounds on which franchisees can seek to challenge their obligation to pay liquidated damages. The options available will depend on the specific language of the franchise agreement and the governing state law; however, two potential grounds to challenge a liquidated damages clause are:
- Franchisors are not entitled to lost future royalties following franchisor-initiated termination. In some jurisdictions, the prevailing law states that franchisors cannot seek liquidated damages when they are the parties initiating termination.
- Your liquidated damages clause constitutes an unenforceable “penalty.” As a general principle of contract law in most, if not all U.S. jurisdictions, in order to be enforceable a liquidated damages clause must be based on a calculation of anticipated future losses. It cannot be an arbitrary amount that essentially serves as a penalty for termination.
Of course, if a court deems your franchise agreement’s liquidated damages clause unenforceable, this does not mean that your franchisor is not entitled to damages. It simply means that your franchisor will have to prove its actual recoverable losses during the litigation.
Discuss Your Options with an Experienced Franchise Attorney
If you are facing a dispute with your franchisor, contact the Goldstein Law Firm for a free initial consultation. With over 30 years of franchise litigation experience, attorney Jeffrey M. Goldstein represents franchisees nationwide. To learn about your options based upon your current circumstances and the language in your franchise agreement, request a consultation online or call (202) 293-3947 today.