Reading time: 5 minutes

Franchisors, as with any other business, are at risk of becoming insolvent. In recent years, some well-known franchise systems have been placed in administration including pastry chain, Pie Face. Franchisees should understand what a franchisor’s insolvency means for the operation of their business, and take steps before entering into a franchise agreement to minimise any potential risks.

What is Insolvency?

Insolvency occurs when a company can no longer pay their debts when they are due. There are three common methods for insolvency procedures: 

  • Voluntary administration 
  • Receivership
  • Liquidation

An administrator, receiver or liquidator will be appointed to represent the franchisor’s interests and may:

  • determine whether the company can continue operating; or
  • wind up the company and sell the company’s assets to pay back existing creditors (e.g. suppliers, landlords or employees).

How Does Insolvency Affect a Franchisee?

How a franchisor’s insolvency impacts a franchisee will largely depend on the arrangements between each franchisee and franchisor.

1. Operation

A franchisee will likely have an obligation to continue operating the franchise business despite the franchisor’s insolvency. This is because the administrator can continue to operate the franchisor’s business and collect franchise fees, maximising the asset pool to pay back creditors. This will occur unless the franchise agreement includes specific clauses stating your obligations cease if the franchisor is insolvent.

2. Fees

If the administrator continues operating the franchise business, the franchisee must still pay franchise fees to the franchisor, including royalty and marketing fees. as well as any outstanding debts.

3. Premises

The impact on franchisees that operate their franchises from a fixed premises depends on who entered into the lease agreement. If the franchisee holds the lease agreement, their rights to occupy the property don’t depend on the franchisor’s financial situation. 

But if the franchisor holds the lease agreement, the franchisee may no longer be able to occupy the premises — especially if the terms of the lease allow the landlord to terminate the lease for insolvency, or the franchisor has failed to make rental payments. 

The appointment of an administrator could have terrible consequences for franchisees sub-leasing from their franchisor. We then recommend franchisees secure a lease directly with the landlord at the outset if possible.

4. Suppliers

Your relationship with a supplier may be affected if a franchisor directly entered into supplier agreements and sold you supplies. This is because the supplier may no longer be committed to fulfilling orders until debts have been paid.

5. Intellectual Property

If the franchisor does not directly own the franchise’s intellectual property (IP), the franchisor’s insolvency may affect their rights to license the IP to other parties, for instance, franchisees. Unless the franchisee obtains the rights to use the IP from the IP owner, the franchisee may no longer be able to operate using the franchise’s business name or logo. 

What About the Money Owed to the Franchisee?

The appointed administrator may choose to terminate your franchise agreement. If so, you become an unsecured creditor. This means that a secured creditor will have their debts repaid first.

Can a Franchisee Terminate the Franchise Agreement if the Franchisor is Insolvent?

As mentioned above, unless there is a specific clause the franchise agreement, the franchisee can’t terminate the franchise if the franchisor is insolvent. A franchisee can terminate, however, if it can establish that the franchisor breached the franchise agreement. Although you can argue that the franchisor’s inability to perform their obligations under the franchise agreement constitutes a breach, you should speak with a franchise lawyer first about collecting evidence of the breach.

How Can a Franchisee Protect Their Business?

A franchisee can protect their franchise by following these steps. 

1. Due Diligence

You should undertake thorough due diligence of the franchisor to determine whether they are at risk of being solvent or likely to remain solvent throughout the term of the franchise agreement. If the franchisor entity exists within a corporate group, it may also be worthwhile to determine the solvency or the other entities to ensure all aspects of the business are financially stable.

2. Negotiate

Although it may be difficult to negotiate the terms of the franchise agreement, there are useful clauses that may be inserted to provide franchisees with protection, including: 

  • A clause that allows the franchisee to terminate the franchise agreement if the franchisor is insolvent. 
  • A clause requiring the intellectual property owner to take over the rights of the franchisor in the case of insolvency.
  • A warranty that the franchisee will continue to have rights to use the intellectual property for the remainder of the term by obtaining the rights through the intellectual property owner. 
  • A clause allowing the franchisee to de-brand and terminate the franchise agreement if the franchisor entity goes into administration for any reason.  
  • A clause requiring the franchisor to ensure that they remain solvent.

***

Franchisees are in a vulnerable position when it comes to the insolvency of the franchisor, and the Franchising Code of Conduct does not provide protections in this regard. To manage your risk, it is important to thoroughly undertake due diligence of the franchisor and negotiate protective clauses in the franchise agreement. If you have any questions or need advice about next steps if your franchisor is insolvent, get in touch with LegalVision’s franchise team on 1300 544 755.

Webinars

Redundancies and Restructuring: Understanding Your Employer Obligations

Thursday 7 July | 11:00 - 11:45am

Online
If you plan on making a role redundant, it is crucial that you understand your employer obligations. Our free webinar will explain.
Register Now

How to Sponsor Foreign Workers For Your Tech Business

Wednesday 13 July | 11:00 - 11:45am

Online
Need web3 talent for your tech business? Consider sponsoring workers from overseas. Join our free webinar to learn more.
Register Now

Advertising 101: Social Media, Influencers and the Law

Thursday 21 July | 11:00 - 11:45am

Online
Learn how to promote your business on social media without breaking the law. Register for our free webinar today.
Register Now

Structuring for Certainty in Uncertain Times

Tuesday 26 July | 12:00 - 12:45pm

Online
Learn how to structure to weather storm and ensure you can take advantage of the “green shoots” opportunities arising on the other side of a recession.
Register Now

Playing for the Prize: How to Run Trade Promotions

Thursday 28 July | 11:00 - 11:45am

Online
Running a promotion with a prize? Your business has specific trade promotion obligations. Join our free webinar to learn more.
Register Now

Web3 Essentials: Understanding SAFT Agreements

Tuesday 2 August | 11:00 - 11:45am

Online
Learn how SAFT Agreements can help your Web3 business when raising capital. Register today for our free webinar.
Register Now

Understanding Your Annual Franchise Update Obligations

Wednesday 3 August | 11:00 - 11:45am

Online
Franchisors must meet annual reporting obligations each October. Understand your legal requirements by registering for our free webinar today.
Register Now

Legal Essentials for Product Manufacturers

Thursday 11 August | 11:00 - 11:45am

Online
As a product manufacturer, do you know your legal obligations if there is a product recall? Join our free webinar to learn more.
Register Now

About LegalVision: LegalVision is a commercial law firm that provides businesses with affordable and ongoing legal assistance through our industry-first membership.

By becoming a member, you'll have an experienced legal team ready to answer your questions, draft and review your contracts, and resolve your disputes. All the legal assistance your business needs, for a low monthly fee.

Learn more about our membership

Need Legal Help? Submit an Enquiry

If you would like to get in touch with our team and learn more about how our membership can help your business, fill out the form below.

Our Awards

  • 2020 Innovation Award 2020 Excellence in Technology & Innovation Finalist – Australasian Law Awards
  • 2020 Employer of Choice Award 2020 Employer of Choice Winner – Australasian Lawyer
  • 2020 Financial Times Award 2021 Fastest Growing Law Firm - Financial Times APAC 500
  • 2020 AFR Fast 100 List - Australian Financial Review
  • 2021 Law Firm of the Year Award 2021 Law Firm of the Year - Australasian Law Awards
  • 2022 Law Firm of the Year Winner 2022 Law Firm of the Year - Australasian Law Awards