Can I Stop Paying Franchise Royalty Payments and Fees?

March 16, 2023

Franchisees frequently tell us that they are unhappy with their franchisors. This can be for any number of reasons inadequate training, poor marketing, lack of lead generation, ineffective website, etc. Often, it boils down to the following statement: “I am making franchise royalty payments, but I’m not getting anything in return.” 

These franchisees ask us if they can stop with the franchise royalty payments because the franchisors are not performing as the franchisees expected. The short answer is no as a franchisee, stopping franchise royalty payments results in taking on substantial risk and can harm the franchisee’s bargaining position.

What is the Royalty Fee in the Franchise?

Part of buying a franchise is agreeing to a Franchise Disclosure Document and Franchise Agreement. The royalty fee in the franchise, as part of the agreement, is based on what is owed to a franchisor — often paid on a monthly or quarterly basis. How much money in royalties do franchisees pay? The amount is typically a percentage of gross sales, with percentages of 4 to 9% being common.

Truth in the Complaints

When franchisees complain about poor franchisor performance or what the royalty fee for the franchise is, there is almost always at least some truth to their complaints. It may be that the franchisor has failed to properly maintain its website, resulting in a decline in rankings, or it may be that the franchisor has squandered advertising funds on useless marketing endeavors, like sponsoring yacht races. The franchisor may also not be providing any ongoing support.

Unfortunately, poor performance on the part of the franchisor is not necessarily unlawful, but it is frustrating and it can exacerbate concerns over what the royalty fee pays for. Therefore, if a franchisee is unhappy with the franchisor’s performance, ceasing franchise royalty payments could result in a situation where the franchisor has leverage over the franchisee for breaching the contract and the franchisee has no viable claims against the franchisor, even if the franchisor is not running a sound operation, and even if the franchisee does have viable claims, failing to make royalty payments still gives the franchisor additional leverage that it would not otherwise have

Don’t Make Your Problem Worse

Ceasing franchise royalty payments can accelerate and exacerbate problems in the franchisor-franchisee relationship beyond what the royalty fee for the franchise is used for. Once a franchisee stops making franchise royalty payments that is often the end of the franchise relationship, unless the franchisee cures the default. 

Get Legal Representation To Help Your Franchise

Franchisees that decide to stop paying royalties can expect to get a notice of default and a notice of termination. While many franchisees would be fine with this outcome, the relationship does not end with termination; there are almost always post-termination non-competes that would prevent a terminated franchisee from continuing independently, and franchisors have had some success suing a terminated franchisee for lost future profits (e.g., the amount of royalties that would have been owed over the remaining life of the franchise is less than the franchisor’s expenses saved by not having to support the terminated franchisee). 

Termination also often results in the franchisee’s default of its lease obligations, leaving the franchisee on the hook for the remaining lease payments owed over the remaining lease period and with no business to generate revenue to make such lease payments.

Negotiate to Avoid Disputes

In most cases, franchisees have legitimate gripes with the franchisor when they get to the point of no longer wanting to make franchise royalty payments. These complaints about franchisor behavior and franchisor performance can often be resolved through negotiations with the franchisor before a full blown dispute arises. If, however, a franchisee stops making franchise royalty payments, it makes a negotiated resolution less likely because the franchisee and the franchisor both entrench themselves when an aggressive move like this takes place.

Additional Concerns About Franchise Royalty Payments

This is not to say it is never a good idea to cease with franchise royalty payments, but the occasions when it makes sense to do so are rare. Part of the analysis depends on the state in which the franchisee is located and the state law that applies to the relationship, as set forth in the franchise agreement which includes what the royalty fee is for the franchise. Some jurisdictions, for example, are less likely than other jurisdictions to award a franchisor for lost future profits upon termination resulting from a failure to pay royalties. Contract lawyers can work with you to determine whether there was a breach of contract. Franchise encroachment and territorial protection may also be a factor. Other questions to consider include: 

  1. Whether there is a post-termination non-compete that would prohibit the franchisee from engaging in a business in which he or she would like to participate.
  2. How strong are the franchisee’s claims against the franchisor?
  3. Is there a liquidated damages provision in the franchise agreement that should be taken into account?
  4. Does the franchise agreement or a state franchise law provide the franchisee with an opportunity to cure if the franchisor sends a notice of default?
  5. Can the franchisee afford the risk associated with withholding royalties?
  6. What is the financial state of the franchisor and what are its short-term and long-term plans?

In fact, if a franchisee does decide to cease with franchise royalty payments, it may want to consider paying royalties into an escrow account or saving royalties in a separate account. This would offer at least some leverage to the franchisee in negotiating with the franchisor because the franchisee can tell the franchisor it has the money accounted for and available, which it will release upon resolving its concerns with the franchisor. Even this is an aggressive approach to negotiations, however, and it must be undertaken only after a detailed analysis of the positives and negatives associated with it.

Should You Keep Making Franchise Royalty Payments?

When a franchisee asks me if he or she can stop paying royalties, my first response is this: “We almost always advise franchisees to continue paying royalties to avoid giving the franchisor significant leverage.” The subsequent portion of my response relays some of the above issues to the franchisee so that he or she understands the risks associated with this approach. I will not foreclose this strategy outright because I think, at least at the initial stage, you want to consider all possible options. Nonetheless, withholding royalties is not something a franchisee should do without seriously considering and analyzing the potential risks and rewards of this action. 

Before reaching a decision to halt franchise royalty payments, or perhaps leave a failing franchise, franchisees need to seek legal counsel to help understand and analyze the risks and potential rewards of how to proceed.