As a franchisee, if you are wondering about the consequences of ceasing to pay royalties, this likely means one of two things: Either (i) you are facing a dispute with your franchisor and you do not believe that you should have to pay, or (ii) you are unable to pay your royalties and pay your business’s other monthly expenses. While your desire to withhold payment of royalties (and potentially your advertising fund fees as well) is understandable, there are several reasons why this is not likely to be a good idea.
The Risks of Withholding Royalties as a Franchisee
Nonpayment of royalties is almost certainly considered a material default under the terms of your franchise agreement. Franchisors aggressively protect their “right” to payment, and many franchisors will not hesitate to declare a default when a royalty check or electronic funds transfer (EFT) doesn’t come through. Most franchise agreements also include a “no offset” provision, which states that the franchisee does not have a right to withhold payment on the grounds that it is owed money from the franchisor. So, if you stop paying your royalties, sooner or later your franchisor will declare a default; and, not only could you be on the hook for your outstanding royalties, but potentially for lost future royalties as well.
What if I Have a Claim Against My Franchisor?
What if you have a claim against your franchisor? What if your franchisor has not provided the support it promised? Or, what if your franchisor granted another franchisee an encroaching territory? While you may be entitled to damages, you likely are not entitled to withhold payment of royalties. If you withhold payment – even if your franchisor is in breach of your franchise agreement – your franchisor will almost certainly claim breach as well, and this will only further complicate the process of asserting your rights in litigation or mandatory arbitration.
What if I Can’t Afford to Pay My Royalties?
What if you cannot afford to pay your royalties because your franchise is struggling? This is a challenging scenario, and one in which you need to be strategic about protecting your financial interests as much as possible.
Do you need more time to start turning a profit? Or, is the franchisor’s business model simply unsustainable in your area? Is your franchisor willing to work with you? Or, do you need to try to find some leverage to mitigate your liability as much as possible? If you have a lease, small business loan, line of credit or any other financial obligation that you are considering paying at the expense of paying your royalties, you will need to carefully weigh your options and make an informed decision with your immediate and long-term best interests in mind.
Speak With an Experienced Franchise Attorney for Free
Jeffrey M. Goldstein is a national franchise attorney who exclusively represents franchisees and dealers. With over 30 years of experience, he has represented numerous franchisees in disputes with their franchisors and matters involving franchise terminations. To discuss your options in a free, no-obligation consultation, call the Goldstein Law Firm at (202) 293-3947 or request an appointment online today.