Before signing a franchise agreement a person thinking about buying a franchise should consider the risk of the franchisor becoming insolvent during the term of the franchise agreement. The recent placing into administration for unpaid debts of such a high profile franchisor as the Eagle Boys franchisor shows that even franchise networks with widely recognised brands may find themselves in financial difficulties.
The insolvency of a franchisor could impact a prospective franchisee in multiple ways. These possible adverse impacts of franchisor insolvency should be considered by franchisees before they sign a franchise agreement. These adverse impacts are as follows:
- For franchises that require leased premises, if lease is held by franchisor, the insolvency of the franchisor will be a problem for franchisee. The insolvency of the franchisor may allow the landlord to terminate the lease. In this instance, the franchisee may lose its right to occupy the premises on the franchisor. The landlord may enter into a new lease with the franchisee but it would not be obliged to so. One way to avoid this problem is for a franchisee to lease the business premises from where the franchised business is to be operated. There are disadvantages and advantages to a franchisee holding the lease rather than the franchisor. A business lawyer is able to give advice on these advantages and disadvantages.
- For franchise systems in which the franchisor or an associated company supplies products to the franchisee, and the franchise agreement requires the franchisee to acquire products from a preferred supplier associated with the franchisor or from the franchisor there is a risk that if the franchisor or the associated supplier becomes insolvent the franchisee not be able to acquire the same products that were supplied by the franchisor or the associated entity, or may only able to acquire them at a higher price from another supplier not connected to the franchisor or the franchise network.
- Many franchisors license the intellectual property from a related or foreign company, which may include images, brands and logos, from another entity that is not a party to the franchise agreement. The franchise agreement grants to the franchisee the use of the franchisor’s intellectual property. If the franchisor becomes insolvent it may lose the right to license the franchise brands and logos. Further, the liquidator of the insolvent franchisor may not continue with the franchise agreements. This may mean that if the franchisee wants to conduct the business after the franchisor becomes insolvent it would need to do so without using the brand or logo of the franchisor and do so outside the franchise network.
- If a franchisor is placed into administration as recently happened to the Eagle Boys franchisor, the franchisees may be required to keep paying franchise royalties and other fees pursuant to the franchise agreement, even though the administration of the franchisee may have negative consequences for the franchise network and the business and financial performance of franchisees. If the franchisee owes debts to the franchisor, the administrator of the company may chase payment of the debts. If the franchisor owes money to the franchisee the administrator may disclaim (bring to an end) the franchise agreement. If this happens the franchisee will not be able to recover these debts the franchisor owes it except as an unsecured creditor in the administration.
- Perhaps the worst outcome of franchisor insolvency is the end of the franchise system. The franchisee will not be able to continue the business as a franchise under the name, logo and images of the franchisor but may have entered contractual arrangements during the franchise that require the franchisee to continue to make payments to suppliers, a landlord and employees even if the franchisee in no longer earning income from the business to meet these expenses. Persons standing behind a franchisee company who have acted as guarantors of the corporate franchisee’s obligations under leases, supplier agreements and business loans may have to meet the franchisee’s continuing obligations under the lease, loan agreement or supplier agreements.
A prospective franchisee should consider obtaining advice about the financial performance or financial condition of the franchisor before signing a franchise agreement. A starting point is the financial reports of the franchisor. The disclosure document provided by the franchisor must include a solvency statement that reflects the franchisor’s financial position and provide financial reports for the last two completed financial years.
Further, the financial situation may have changed since the prospective franchisee received the disclosure document and the date on which it is ready to sign a franchise agreement. If there has been any significant period of time that has passed between receipt of the disclosure document by a prospective franchisee and the date of signing a franchise agreement the prospective franchisee should make enquiries as to whether there are new or updated financial reports prepared since the disclosure document was prepared.
If you wish to further discuss the issue of risk of franchisor insolvency please do not hesitate to contact us.
This publication is only intended as a general overview of issues relevant to the topic and is not legal advice. You should not rely on it in place of legal advice. If you need legal advice, you should obtain legal advice from your lawyer. If you have any questions, please contact us firstname.lastname@example.org.