How Does Termination of a Master Franchise Agreement Affect the Unit Franchisees?

A master franchise is quite different from other types of franchises such as the single unit, multi-unit or area development franchise. A master franchise agreement grants the right to another person or entity, the “subfranchisor,” or the “master franchisee,” to not only operate a franchise, but to sell units of the franchise to other persons or entities, known as “subfranchisees,” in a predetermined geographical area. A master franchise agreement will define the relationship and business operations between a subfranchisor and subfranchisee but the subfranchisors will have separate unit franchise agreements with actual units. There is no privity of contract between the master franchisor and the subfranchisees. Master franchises are commonly used when the franchisor is located in a geographically remote location from a desired market, which is why many international franchisors will utilize this system. Ideally, subfranchisors will offer a sense of familiarity and knowledge in regard to a given market area that the remote franchisor may not have.

A master franchise creates the existence of a “middle-man”, the subfranchisor, who stands between the franchisor and its relationship with subfranchisees. In the event of a default by the subfranchisor resulting in termination of the master franchise agreement, there becomes a disconnect between the franchisor and subfranchisees by virtue of the “middle-man’s” elimination. In such a scenario, several issues arise, the most significant being – what happens to the subfranchisees? Subfranchisees operate under unit franchise agreements that derive from a master franchise agreement. When that agreement has been terminated, the subfranchisees no longer have the rights and licenses required to operate a franchise business, exposing the subfranchisees to trademark infringement liability. Even if the license were to survive, subfranchisees face lack of support and management, potential issues with access to suppliers, and potential issues with landlords.

In the interest of protecting its business and brand, how does a franchisor properly prepare for a potential default leading to termination of the master franchise agreement? Ideally, a master franchise agreement will offer potential options to the franchisor. A franchisor may want to assign the subfranchisee agreements to itself. However, a franchisor is not always equipped, willing or prepared to take on such a role, hence the likely reason for choosing to engage in a master franchise arrangement in the first place. Therefore, a franchisor should also have the option to assign the subfranchisee agreements to another subfranchisor of its choosing. Alternatively, and typically undesirably, a franchisor may choose to have the subfranchisees close the businesses. Each option, and others, come with pros and cons that weigh on a franchisor’s choice on how to move forward after a master franchise termination. For further detail and discussion, please see our article in the Franchise Law Journal this spring, 2019.