My Business magazine -- Protecting yourself IF THE FRANCHISE FAILS

Protecting yourself IF THE FRANCHISE FAILS

In these uncertain times of rising interest rates, talk of recession and the credit crisis, it is more important for franchisees to take active steps to protect themselves in the event that their franchisor encounters financial problems. By Esther Gutnick

WHILST THE POSSIBILITY of the franchisee’s insolvency is a matter which franchisees are widely advised to consider before entering into a franchise agreement, franchisor insolvency is not generally given much forethought. However, in today's economic climate, and given the recent collapses of a number of large national retail franchise chains, it is a very real issue for franchisees.

A 2006 study by the University of New South Wales reported that, of Australia’s approximately 850 franchisors, roughly 40 had failed in the past 15 years, affecting around 1090 franchisees. Insolvency is simply the inability of an entity to pay its debts as and when they fall due.

What rules govern a franchisee’s role in its franchisor’s insolvency?

The Franchising Code of Conduct (“Code”) allows a franchisor to terminate a franchise agreement if the franchisee becomes insolvent. However, it does not grant equivalent rights to franchisees in the reverse situation. In fact, surprisingly, the Code does not deal at all with what happens if the franchisor becomes insolvent and goes into administration or liquidation.

In the event of franchisor insolvency, it is the franchise agreement that will govern the relationship between the franchisor's administrator or liquidator and the franchisee. Most franchise agreements do not adequately deal with the issue of franchisor insolvency and in any event the provisions of the agreement can be overridden by specific statutory provisions.

As a general rule, franchisees have no specific statutory rights. This is to be contrasted with employees of an insolvent company who are given certain priorities in the event of a liquidation of their employer.

If a franchisor becomes insolvent, the franchisee may be a debtor or unsecured creditor. If the franchisee is owed money by the franchisor, he/she will have rights to attend creditors meetings and lodge a proof of debt and possibly receive a dividend. As an unsecured creditor the franchisee will rank equally with all other unsecured creditors and behind secured creditors and employees of the franchisor.

What will the liquidator or administrator do?

An administrator will use the period of administration to endeavour to secure a buyer of the business or otherwise restructure the company to ensure its survival.

Administrators have wide powers and franchisees often feel frustrated and powerless in respect of their relationship with the administrator.

If a liquidator is appointed, the franchise agreements of the franchisor will be categorised by the liquidator as either assets or liabilities of the business, and the liquidator will proceed to deal with those assets and liabilities in accordance with its legal obligations. Franchisees are not considered genuine stakeholders in the franchise and their interests are not taken into account in the same way as those of employees in the case of their employer's insolvency.

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