unfair contact terms

THE RISK OF FRANCHISE BUSINESS FAILURE

The recent newspaper reports of the closure of two franchised Brumby’s bakery stores in Gladstone and two franchised Brumby’s bakery stores in Rockhampton show that the acquisition and ownership of franchise businesses, even well-known franchise businesses, and the ownership of multiple franchises, is no guarantee of business success and profitability.

The newspaper coverage of this unfortunate matter indicated that the four stores were closed abruptly and not reopened after the Easter holidays with staff receiving only limited notice.

Although it is not apparent from the newspaper articles it may be assumed that the franchisee was a company and that the persons behind the company signed a franchise agreement which contained personal guarantees of the franchisee’s obligations. The newspaper articles indicate that the persons standing behind the company that owned these four franchised businesses were left with no choice but to place the franchisee company into liquidation. This happened after a year of declining business which saw them use their personal funds to support the businesses.

Persons standing behind a franchisee company that owns franchised businesses are often asked by the franchisor to sign personal guarantees making them liable for all the obligations of the franchisee company. If the business fails, the persons standing behind the company may be liable for future franchise fees that will not be paid to the franchisor because of the closure of the stores and the liquidation of the franchisee company.

Many persons who start a business, including a franchised business, own and operate the business through a company. Often this is for reasons of tax minimisation or asset protection purposes.

There are many advantages in purchasing a franchised business from a franchisor with a proven business model and using a company as the franchisee. Unfortunately, one possible disadvantage for the persons behind a corporate franchisee, is the difficulty in deciding to close the doors without financial consequences for the personal assets of the person standing behind the franchise the company.

One of those consequences, which the owner of an independent business does not have to deal with, is the fixed term of the franchise agreement. Many franchise agreements are for terms of five or six years, although it is not unusual for franchise agreements to be for longer terms.

If a franchisee stops operating a franchise business due to lack of profits, or the persons behind a failing franchisee place that franchisee company into administration or liquidation, the franchisee will usually be in breach of the franchise agreement. The persons standing behind a franchisee company who have signed guarantees, or a franchise agreement containing guarantee clauses that bind them, may be liable to the franchisor for damages for unpaid future franchise fees and unpaid future marketing fees.

This is a risk that persons considering the purchase of a franchise should consider before they sign a franchise agreement. It is also important, once franchisees reach a point where they are struggling financially and at risk of business failure, to obtain legal and accounting advice and to consider negotiating with the franchisor for an agreed exit from the franchise agreement, rather than simply close the doors and being sued for damages for abandoning the franchise.

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