What franchisees and franchisors need to know

This can be due to the franchisee/franchisor relationship. Either party entering an insolvency process will generally have a knock on effect on the other party. With the current spate of high street and restaurant insolvencies, this article will seek to clarify these interactions.

As mentioned above, we will discuss what the franchise agreement means in terms of insolvency, and the advice we can provide your business.

What is the franchise relationship?

A franchise relationship is a business concept where an established business allows another business to utilise its business model and branding. The franchise agreement has a dual benefit. The agreement allows the franchisee to benefit from the experience and reputation of the established business. The franchisor also benefits from expanding its own name and brand.

The nature of the franchise relationship will, generally, be dictated by a robust franchise agreement. This will set out points, such as terms of use and the fees payable for the use of the franchise business model and branding. Unlike many other countries, franchise agreements are not specifically regulated in the UK.

However, there is some self regulation from the British Franchise Association (BFA). Members of the BFA adhere to their rules and code of ethics in dealing with the franchisees. Therefore, serious due diligence should be carried out before entering into a franchise business agreement with a non-BFA member.

As well as the interactions, the franchise agreement will also likely stipulate that the assets are owned by the franchisor. They are simply leased to the franchisee, rather than ownership being passed to them. Consequently, the implications will be fairly significant on the insolvency of a franchisor.

Insolvency of franchisor

Due to the nature of franchising, it is likely with large franchises that if the franchisor enters formal insolvency, it will be more likely administration or a company voluntary arrangement.

This is due to the complexity of the business, and the need for orderly dealings with the franchisee. Insolvencies of a franchisor are much less common than that of a franchisee by nature. In the event of these insolvencies, however, the franchisee will need to liaise with the administrator to establish:

  • Will there be a buyer for the franchise branding?
  • Will stock supplied by the franchisor continue to be provided?
  • Are there likely to be any other interruptions to the business they need to be aware of?
  • Is there an opportunity to buy the assets leased to the company to set up as independent?

As stated in the last point, some franchisees may be able to create new businesses from their franchise experience and assets, by purchasing the assets they are currently using. Being that the assets are on the franchisee’s site, they are likely in the best place to put forward an offer for these items. This is assuming there is not a purchaser for the overall franchise.

If it is the case that the franchise is being put through a pre-pack administration, there will likely be a new owner in place before franchisees’ are even aware of the insolvency. In these circumstances, it is likely the administrators will seek to transfer the franchise agreements to the new company as an asset. Therefore, any franchise fees are due to the new owner. However, if you have any doubts over the implications as a franchisee, you should seek independent legal advice.

Insolvency of a franchisee

Franchisees entering formal insolvency is a much more common occurrence. Due to the franchise agreement, it will generally be creditors voluntary liquidation. There are several points leading to this conclusion:

  • The assets the businesses uses, including the stock, are likely to be the property of the franchisor. It’s unlikely there is anything to sell to justify administration.
  • The franchise agreement will likely have a break clause on insolvency. This allows the franchisor to terminate the agreement, meaning a company voluntary arrangement is not possible.

There will be instances where the above does not apply, meaning more options are available. However, these points will apply in the majority of cases. The other potential alternative is that a creditor decides to issue a winding up petition against the company, resulting in compulsory liquidation.

Where possible, if it is necessary to enter formal insolvency, a franchisee should try to take control of the situation due to the relationship with the franchisor. If you intend to start up again after entering voluntary liquidation, the franchisor will need to be involved at an early stage. You will need to negotiate with them to either transfer the franchise agreement or obtain a new franchise agreement for your new business.

Many franchise agreements also contain personal guarantees for unpaid fees. Therefore, you will need to consider your own position or include this in your negotiations with the franchisor.

Moving forward

There are a number of additional complexities when dealing with a franchise business and insolvency, whether it is the franchisor or franchisee going through the process. Our BusinessRescueExperts have dealt with numerous insolvencies on both sides of the coin and can be contacted for some free impartial advice.