The ugly side of franchising

The collapse of the Kleins Jewellery chain – and other franchise failures – has thrown the spotlight on the legal and business status of franchisees when a business goes bust. Specialist franchising lawyer, Esther Gutnick, outlines the issues that franchisees need to consider.

MIDWAY THROUGH last year, Kleins retail jewellery chain closed 130 franchised stores following the insolvency of the franchisor, creating one of Australia’s largest retail system collapses in recent years.

And Kleins is by no means alone in this category. A 2006 report by University of New South Wales academic Jenny Buchan named at least 40 Australian franchisors that “failed” between 1990 and 2005. Some of the more significant examples of franchise system implosions in the retail industry include systems such as the Traveland chain of travel agents (a former subsidiary of Ansett which involved roughly 270 franchisees), Cut Price Deli (with approximately 150 franchisees), and Century 21 Pty Ltd.

In each case, different reasons were cited for the collapse of the retail chain including problems peculiar to the particular company or the industry sector in which it operated. However, the real difference between the collapse of many other franchisors and the Kleins experience becomes apparent in the aftermath of the franchisor’s failure and lies in the effect that the franchisor’s failure has on its franchisees.

Certain brands have continued operating long after the franchisor’s collapse. Notably, most of the Century 21 franchisees have enjoyed prosperity under new ownership with an ongoing franchise model. The majority of Traveland franchisees were able to continue operating independently or by joining competitor’s chains when their franchisor went under. In other cases, groups of franchisees have formed buying syndicates to purchase the franchise system from the stricken franchisor, thus salvaging the brand, the retail chain and their livelihoods. For the unfortunate Kleins franchisees, none of these options were available.

What is common to all these scenarios is evidence that the fate of franchisees is inextricably linked to that of their franchisors. Buchan’s study found that 93 per cent of franchisees involved in a franchisor collapse lost substantial amounts of money and were forced to terminate the employment of their staff irrespective of whether their businesses continued.
In the face of what is being touted as the ‘worst global economic crisis since the Great Depression’ it is more necessary than ever for franchisees to turn their minds to what might happen to them if their franchisor does go under.

The collapse of the Kleins Jewellery chain – and other franchise failures – has thrown the spotlight on the legal and business status of franchisees when a business goes bust. Specialist franchising lawyer, Esther Gutnick, outlines the issues that franchisees need to consider.

MIDWAY THROUGH last year, Kleins retail jewellery chain closed 130 franchised stores following the insolvency of the franchisor, creating one of Australia’s largest retail system collapses in recent years.

And Kleins is by no means alone in this category. A 2006 report by University of New South Wales academic Jenny Buchan named at least 40 Australian franchisors that “failed” between 1990 and 2005. Some of the more significant examples of franchise system implosions in the retail industry include systems such as the Traveland chain of travel agents (a former subsidiary of Ansett which involved roughly 270 franchisees), Cut Price Deli (with approximately 150 franchisees), and Century 21 Pty Ltd.

In each case, different reasons were cited for the collapse of the retail chain including problems peculiar to the particular company or the industry sector in which it operated. However, the real difference between the collapse of many other franchisors and the Kleins experience becomes apparent in the aftermath of the franchisor’s failure and lies in the effect that the franchisor’s failure has on its franchisees.

Certain brands have continued operating long after the franchisor’s collapse. Notably, most of the Century 21 franchisees have enjoyed prosperity under new ownership with an ongoing franchise model. The majority of Traveland franchisees were able to continue operating independently or by joining competitor’s chains when their franchisor went under. In other cases, groups of franchisees have formed buying syndicates to purchase the franchise system from the stricken franchisor, thus salvaging the brand, the retail chain and their livelihoods. For the unfortunate Kleins franchisees, none of these options were available.

What is common to all these scenarios is evidence that the fate of franchisees is inextricably linked to that of their franchisors. Buchan’s study found that 93 per cent of franchisees involved in a franchisor collapse lost substantial amounts of money and were forced to terminate the employment of their staff irrespective of whether their businesses continued.

In the face of what is being touted as the ‘worst global economic crisis since the Great Depression’ it is more necessary than ever for franchisees to turn their minds to what might happen to them if their franchisor does go under.

Options for franchisees
Broadly speaking, when a franchisor ceases to operate, its franchisees have two options – to continue trading or to cease. Of course, this is not always a decision which is within the franchisees’ power to make and depends on a range of factors.
 
Most franchise agreements do not provide for what happens to the franchisee, its business or the premises in the event of the franchisor’s insolvency. The Franchising Code of Conduct (“Code”) is also silent on the issue.

Certain statutory provisions govern the process and relationship of the various parties where the franchisor has receivers, administrators or liquidators appointed to it. In the event of liquidation, the liquidator has the power to disclaim onerous contracts to which the insolvent franchisor is a party, including franchise agreements, leases and any sublease, licence or other agreement granting occupancy rights to franchisees.  

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