By Marisa Rauchway and Lana Berman Israel
You can’t turn on the tv or look at social media these days without being overwhelmed by information about the impact of the Covid-19 coronavirus. And as the stock market’s volatility reflects, this virus is having an impact on businesses, large and small. But what does it mean for you as a franchisee, specifically?
If you are a franchisee and you’re worried about the coronavirus, it’s time to take a close look at your Franchise Agreement, which likely provides key information regarding who bears the risk of this pandemic. Some of the provisions you should look at are as follows:
1) Force Majeure Clause – These clauses may provide significant protection to franchisees for delays in complying with certain deadlines under the franchise agreement, which are simply impossible to meet as a result of the coronavirus. “Force majeure” generally refers to an unforeseeable circumstance that prevents someone from fulfilling a contract. These often include drought, flood, earthquake, storm, fire, and sometimes….epidemics. Most franchise agreements include “force majeure” clauses, whether by name or by their content, and are the most obvious provisions in the Franchise Agreement that may be triggered by the coronavirus. You should be reviewing any “force majeure” provision carefully and look to how force majeure is defined -- what it does, and doesn’t, excuse. Is epidemic included in its definition of force majeure? Is it arguably included?
Also, keep in mind that even if the coronavirus is potentially covered, the force majeure clause may not excuse all of franchisee’s obligations under the agreement. For example, while certain delays may be excused (e.g. time frames to open your location), royalty and marketing fees may not be excused during a pandemic.
Specific words in the franchise agreement matter.
2) Royalty Payment/Liquidated Damages – Most Franchise Agreements provide for a royalty payment of money (often a percentage of sales) from franchisee to the franchisor on an ongoing basis. Many Franchise Agreements also provide for either a minimum amount of royalty payments per pay period or a liquidated damages provision to calculate a minimum amount owed to your franchisor in the event of the shut down of the business. Depending on the language of your Franchise Agreement, you may still be on the hook for this amount, even if your business has slowed down significantly or even closed temporarily. Again, the “force majeure” clause discussed above may provide a shield against these provisions during a coronavirus pandemic.
What happens if you can’t get the supplies you need to run your franchise?
3) Supply Chain Issues – Many Franchise Agreements provide that you may only use or sell specific products. Often the franchisor will tell its franchisees what brand or what supplier they need to use. What we’re seeing with Covid-19 starting in China, is that it’s having an impact on supplies of certain products. Once again, pick up your Franchise Agreement and review the section entitled “Supplies” or “Products and Services”. What happens if you can’t get the supplies you need to run your franchise? Will the Franchisor bear the cost of evaluating a substitute supplier in the event the original supplier is unable to meet demand? Who bears the cost if there is an interruption in your franchise because of franchisor’s choice of suppliers? Will the Franchisee still be on the hook for lost royalty payments? Your Franchise Agreement will likely address some – if not all -- of these issues.
4) Insurance – Most Franchise Agreements require the franchisee to obtain specific amounts of certain insurance coverage. Often one of the requirements is business interruption insurance. Once again, the devil is in the details. While each insurance company drafts and interprets their policies differently (so you should look at your policy specifically), typically, business interruption coverage is triggered when there is physical damage to property -- think earthquake or tornado -- and unfortunately not by a sweeping pandemic. That said, business interruption insurance may cover your costs if it is determined that your shop has been contaminated and pay for decontamination and sanitation.
Are you at the beginning of your franchise relationship?
5) Establishment of Business – What happens if the novel coronavirus has struck just at the beginning of your franchise relationship, before you have even secured property or opened your business? Most Franchise Agreements set time limits on how long franchisees have to select a site, sign a lease and/or open their business. Failure to meet any of these dates can trigger a termination event that allows the Franchisor to terminate the franchise but keep the initial franchise fee. You should review your Franchise Agreement to determine if there is a right to reasonable extensions of these dates, and whether there are any exceptions that excuse such performance.
The New Jersey Franchise Practices Act -- may provide relief to qualifying franchisees
Finally, keep in mind that New Jersey state law – namely the New Jersey Franchise Practices Act -- may provide relief to qualifying franchisees, regardless of what is in a franchise agreement. This Act generally prohibits a franchisor from imposing “unreasonable standards” on a franchisee. Arguably, enforcing obligations rendered impossible by a pandemic could rise to the level of an “unreasonable standard.”
So what’s the bottom line? A global epidemic like Covid-19 coronavirus is scary for virtually everyone, including franchisees who have specific performance obligations under their franchise agreement. Hopefully your Franchise Agreement protects you from the worst financial impacts of this disease. Nevertheless, even if your Franchise Agreement doesn’t have all of the provisions you’re looking for, don’t panic. The good news is this -- it’s generally in both your and your franchisor’s best interest for you to succeed. And in franchise systems with a healthy franchise network, you’re likely not the only franchisee affected by this crisis. Therefore, regardless of the language in the franchise agreement, it would behoove a practical franchisor to work with you and its other franchisees to implement logical solutions to help you all weather this storm together.
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