Franchising an Existing Business: A Guide to Early Termination and Exit Procedures
Franchise exit arrangements need more than a termination fee. Explore the rules an existing business needs when franchising in Japan, from notice and opportunities to remedy breaches to customer care and final settlement.
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When turning an existing business into a franchise, exit procedures for franchisees are often given less attention than support before opening. Yet unclear termination conditions can create difficulties not only for franchisees, but also for customers and suppliers. To build a sustainable franchise network, establish exactly how agreements will end before you start recruiting franchisees.
1. Distinguish voluntary early termination from termination for breach
Start by distinguishing early termination at the franchisee’s request from termination for breach of contract. Combining the two in a single clause risks treating a simple enquiry about leaving as a breach, or delaying action on a serious violation.
At a minimum, consider the following scenarios separately:
- Voluntary early termination: The franchisee can end the agreement on specified terms, even where no breach has occurred.
- Termination after an opportunity to remedy a breach: The franchisee fails to resolve an issue, such as late payment, despite being asked to do so.
- Termination involving urgent action: Serious unlawful conduct or similar circumstances make it difficult to continue the relationship.
- Termination by mutual agreement: The franchisor and franchisee agree an end date and terms in light of circumstances such as illness or a natural disaster.
If you allow voluntary termination, specify how notice must be given, who must receive it, the notice period and how the termination date is determined. Work backwards from the practical time needed to stop purchasing supplies, inform customers and remove signage. Japanese law does not prescribe a uniform notice period for franchise agreements generally.
The date a shop stops trading may also differ from the date its franchise agreement ends. Ceasing operations does not necessarily stop contractual charges, so make the obligations attached to each date clear.
2. Reflect Japan’s disclosure rules in your termination arrangements
Japan has no single comprehensive statute governing all franchise agreements. However, Article 11 of the Act on the Promotion of Small and Medium-sized Retail Business requires franchisors operating a ‘specified chain business’ under the Act to provide written information and explanations before a contract is signed. Termination conditions are important information for prospective franchisees deciding whether to join.
Whether the Act applies depends on the substance of the business, not its label. Check whether the business meets the relevant criteria, including primarily serving small and medium-sized retailers, continuously supplying goods or arranging sales under standard-form agreements, providing management guidance, permitting the use of trade marks and collecting money on joining. Do not assume that a business falls within scope simply because it operates in retail or food service.
Even where the Act does not apply, Japan’s Antimonopoly Act still does. The Japan Fair Trade Commission’s guidelines on franchise systems under the Antimonopoly Act should be consulted beyond the retail and food-service sectors too. If a franchisor uses a superior bargaining position to impose terms that unfairly disadvantage franchisees, this may raise concerns such as abuse of a superior bargaining position.
The Civil Code is also relevant to termination and damages. Do not assume that any termination condition is valid simply because it appears in a signed agreement. Ask a lawyer to review the grounds for termination and the reasonableness of financial obligations. Rather than merely reading out the terms to prospective franchisees, explain them through practical exit scenarios to check their understanding.
3. Separate termination charges and explain how they are calculated
Avoid bundling all exit costs into an unexplained ‘penalty fee’. Start by itemising the costs the franchisor wishes to recover and the reasons for recovering them.
| Item | Points to clarify when designing the terms |
|---|---|
| Outstanding royalties and other charges | Calculation period, billing cut-off date and final invoice date |
| Cost of returning loaned items | Items covered, transport costs and treatment of damage |
| Financial charges arising from termination | Triggering conditions, calculation formula and the losses or costs covered |
| Security deposit settlement | Liabilities that may be deducted, provision of an itemised statement and timing of any balance refund |
| Removal and reinstatement costs | Differences between obligations under the franchise agreement and the premises agreement |
If you set a termination fee, ensure that you can explain internally what the amount reflects, such as unrecovered initial support costs. Being able to explain a cost does not, however, establish that the clause is legally valid.
If the proposed charge is equivalent to royalties for the remaining contract term, consider support costs the franchisor will no longer incur after termination, as well as any overlap with separately charged costs. Assess each arrangement to ensure that it does not impose an excessive burden that makes leaving impracticable.
Illustrative calculations with clearly stated assumptions can help explain the terms to prospective franchisees. Show outstanding amounts, termination fees, removal costs and security deposit refunds separately. This also helps prevent the mistaken belief that a security deposit rules out any additional payment.
4. Establish procedures for checks and opportunities to remedy breaches
Where a breach is suspected, you need a process that prevents termination decisions being based solely on a staff member’s impressions. First, document the conduct in question, the relevant contractual provisions, when it occurred, the franchisee’s explanation and the supporting evidence.
For issues that can be remedied, explain in writing what must change, by when and what an acceptable outcome looks like. Avoid vague wording such as ‘improve to the franchisor’s satisfaction’. Instead, specify verifiable actions, such as submitting missing documents or addressing overdue payments. When setting deadlines, consider both the seriousness of the breach and the time needed to put matters right.
Serious safety issues, by contrast, may require urgent measures such as temporarily suspending trading. Even then, record interim steps to protect customers separately from the decision to terminate the agreement. Simply including a clause allowing termination without a prior demand to remedy a breach does not necessarily permit immediate termination in every situation.
In practice, a defined sequence—fact-finding by operational staff, a response decision by the responsible manager, legal review and formal notification—can reduce inconsistency. Also identify who will receive explanations or objections from the franchisee.
5. Build an exit checklist by working backwards from the termination date
An exit manual does not cease to be useful once a termination notice has been issued. Continue tracking responsibilities and deadlines until customer matters and the final financial settlement are complete.
Pay particular attention to services not yet delivered, bookings, advance payments, repairs and warranty obligations. Confirm who is party to each customer contract and assign responsibility for fulfilment or refunds. If customer care is to move to another franchisee, separately confirm the receiving outlet’s agreement and the requirements for handling personal data. Do not assume that responsibilities transfer automatically.
Ending use of the brand should cover not only signage, but also uniforms, packaging, websites, map listings and social media pages for the outlet. Decide whether accounts should be deleted or their content updated, who will carry out the work and who will confirm completion.
Plan separately for disabling access rights on the termination date and providing records needed later for final settlement. If sales records and similar information become inaccessible, checking the final invoice may be difficult. Include fields to record completion of the return of loaned items, confirmation of outstanding payments and the security deposit refund.
Before recruiting franchisees, run a desk-based exercise using a hypothetical outlet, following the process from the first discussion about leaving through to final settlement. Start with three essentials: a list of grounds for termination, a cost calculation sheet and an exit checklist with named responsibilities. Being able to explain the entire process, including departure, lays the foundations for a franchise network that people can join with confidence.
