Controlling the Transfer of a Franchise

Controlling the franchisee's right to transfer a franchise is a common goal of franchisors. Franchisors often want as much control over the transfer process as is possible. To maintain control, franchisors should ensure that the franchise agreement explicitly reserves to them the right to approve or disapprove transfers in their unlimited and sole discretion. With respect to the franchisor's consent to the transfer, franchise agreements generally apply one of the following standards:

1. The franchisor must act reasonably (or not act unreasonably) when exercising its discretion.
2. The franchisor must not act arbitrarily when exercising its discretion.
3. The franchisor has unlimited or sole discretion in deciding whether to consent to the transfer.

Reasonability standard

Some franchise agreements allow a franchisor to grant or withhold consent so long as it acts reasonably. In considering reasonability, courts have evaluated franchisors' denial of transfer requests under an objective standard focused on whether there is a reasonable concern about the viability of the franchise after the proposed transfer. Where a franchisor withholds consent without a strong and legitimate business interest behind it, courts may find it acted unreasonably (Town & Country Ford, Bus. Franchise Guide ¶8660; N.D. Ga. 1985). Some courts have considered it reasonable for a franchisor to require certain conditions, including the execution of a release, as a prerequisite to approval of an assignment (Franchise Management Unlimited v. America's Favorite Chicken, 889 F. Supp. 916; E.D. La. 1995). Franchisors should beware, however, because a court may find that too many conditions to the grant of consent is unreasonable.

Arbitrary denial of consent

As an alternative to a reasonability standard, some franchise agreements require that consent may not be arbitrarily withheld. In Perez v. McDonald's Corp., 60 F. Supp. 2d 1030; E.D. Cal. 1998, the court considered such an agreement. There, McDonald's refused to consent to a sale of the franchise, citing the purchaser's failure to complete the McDonald's franchise applicant training program, which was mandatory for all prospective franchisees. The court held that withholding consent on these grounds was not arbitrary primarily because McDonald's had established that refusing to admit untrained applicants was a legitimate business concern. Thus, where the franchise agreement precludes the franchisor from acting arbitrarily in withholding consent to a transfer and the franchisor can show that it based its decision on a rational business analysis of the effect of the proposed transfer, a court may be more likely to find that the franchisor did not act arbitrarily.

Unlimited or sole discretion

Other franchise agreements give the franchisor unlimited discretion when deciding whether to approve a transfer by the franchisee, and courts have enforced the franchisor's right to act in its sole discretion. For instance, in James v. Whirlpool Corp., 806 F. Supp 835; E.D. Mo. 1992, the court held that a clause in a distributorship agreement providing that the distributor could not assign the agreement without the manufacturer's consent gave the manufacturer unlimited authority to withhold its consent because the parties had agreed as such. That court opined that if the parties did not impose any reasonability or other requirements upon themselves in their agreement, then none was required.

Conclusion

When drafting or updating franchise agreements, franchisors will want to ensure that the franchise agreement gives them the greatest control possible over the transfer of the franchise by the franchisee. To do so, the franchise agreement should provide the franchisor with the right to approve or disapprove the transfer in its unlimited and sole discretion.

• If the franchise agreement provides that the franchisor must act reasonably when deciding whether to approve a transfer, the franchisor will likely be required to advance legitimate and specific concerns, grounded in an analysis of the operations of the business, to deny consent to a transfer.
• If the franchise agreement provides that the franchisor must not act arbitrarily when deciding whether or not to consent to a transfer, the franchisor may still be required to show some legitimate business reason for its decision.
• But where the franchise agreement permits unlimited or sole discretion, the franchisor will likely have more freedom in declining consent to a transfer for any reason or no reason.

Terrence Dunn and Julianne Lusthaus are partners of the New York-based law firm Einbinder & Dunn LLP. They can be reached at 212-391-9500.