Franflash: Why simple administrative errors can lead to expensive court cases

The ruling of the Outer House, Court of Session in Scotland in the case of SJD Group Limited v KJM (Scotland) Limited [2010] CSOH 13 is a timely reminder to franchisors that they should be extremely careful to ensure that on expiration of a franchise agreement, a renewal agreement is promptly signed or the franchisee ceases to trade.

In the SJD case the franchisor had granted the franchisee a five year agreement, with a right to renew for a further five years. After the expiration of the initial term, the parties just carried on as before with the franchisee providing the relevant services under the franchisor's brand name and being invoiced for, and paying, the franchise fee.  However, a few months later, the franchisee told the franchisor that he intended to cease to trade immediately.

It was common ground between the parties that there was an implied contract between them following the expiration of the initial term but the precise terms of that implied contract were in dispute. The English Courts are reluctant to imply terms into complex commercial agreements like franchise agreements unless certain strict criteria are met: the two main tests being whether an "officious bystander" would consider that such a clause would be implied or the implication is necessary to give business efficacy to the agreement (the rules in Scotland are broadly the same). 

In the SJD case the Court of Session held that the officious bystander would consider that the parties had continued to trade on the same terms as those in the franchise agreement, save that the agreement had not been renewed for a further five year term but could be terminated by either party giving "reasonable notice" to the other.  The Court ruled that the reasonable notice period for an agreement of this type and length was six months.

This case can be contrasted to the decision of the High Court in England in The Flat Roof Co Limited v Bowden [2009] EWHC 2894 Ch in which the franchisor applied for an interim injunction against a former franchisee who gave notice that he intended to cease trading but then continued to trade in the same line of business in his former territory.  The franchise agreement had expired over a year previously but the parties had carried on as before until the franchisee walked away from the franchised business. 

The High Court refused the franchisor's application on the grounds that the post termination restrictive covenant would not be implied into the relationship between the parties after the franchise agreement had expired.  This case was only an interim application, it did not go to a full trial, so the Court did not fully analyse the facts nor did it properly explain on what basis the parties had continued to trade.

Lessons for Franchisors

The implications of these cases are clear.  It is vital to ensure that renewals or extensions of franchise agreements are dealt with promptly and formally in writing.  Litigation is expensive, both in terms of legal fees and management time, but these two cases could so easily have been avoided by the franchisors in question implementing a few simple administrative procedures.

Some franchisors become nervous when the end of a franchise agreement approaches that the franchisee will not sign a renewal agreement but will leave and run a competing business and the franchisor will lose an income steam, so the franchisor just allows the franchisee to carry on trading to maintain the status quo. It is far better to grasp the nettle when there is (or should be) an enforceable post-term non-compete still in place; and be prepared to enforce it to make a statement to the network, than to let things drift (as in the Flat Roof case) which is much worse, and where the signal then sent to the network is disastrous for discipline.