What should you do if your franchisor goes broke? This is a very real fear for some franchisees, especially since the franchisee is typically the last person to be informed of any financial difficulties of the franchisor.

There are certain clauses in the Franchising Code of Conduct (the Code) that allow for a franchise agreement to be terminated based on the insolvency of a franchisee. However, the Code does not reciprocate this ground for termination to account for franchisors that have gone bankrupt.

If a franchisor does become insolvent, there can be various consequences. These consequences will vary depending on the franchisor’s level of debt and the resilience of the company.

There are three things that can happen once a franchisor goes broke:

1. External administration of the franchisor company;

2. Sale of the company and having all franchise agreement transferred; or

3. Termination of the franchise agreements.

Although franchisees have very little influence over how a franchisor runs an insolvent franchise, they may protect themselves by anticipating possible variations to the franchise system.

Conduct a thorough investigation

Before you enter in a 5 or 10-year franchise agreement, make sure that you have become completely familiar with the disclosure document. This document will give you valuable insight into the franchisor company, such as its knowledge in running a franchise and a financial overview of the company.

It is the responsibility of the franchisor to provide at least two of the company’s most recent financial statements or an independent audit confirming the solvency of the company. Make sure you and a franchise solicitor review these documents and clarify anything that may be unclear.

As a franchisee, you’re entitled to an up-to-date disclosure document every year, which includes the financial statements and audits.

Take action

Get in touch with your suppliers as soon as you discover that the franchisor is going broke. Also, if the lease is kept with the franchisor, contact the landlord to check that there is no rent in arrears. Legal advice is worth considering at this stage as well.

Once you have a franchise lawyer advising you, try to establish some communication with the administrator or liquidator assigned to the franchise to get some acknowledgment of your interest in the company.

Co-operate

If the Franchisor business is sold, it’s in your best interests to establish a good working relationship with the new franchisor (once appointed). Despite the inconvenience of having to adapt to this change in management, the truth of the matter is that franchisors sustain few restraints when it comes to transferring their interest. It is extremely risky to attempt to abandon the franchise entirely or try to challenge the transfer. In a positive sense, the new franchisor will take over from a failing franchisor and strengthen the brand identity that has suffered as a result. The new franchisor may very well revive the dying franchise and resuscitate the overall value of your business.

Dealing with an insolvent franchisor can be a daunting task, especially considering the significant legal and financial risks involved. These risks include things like a damaged reputation and the termination of the franchise agreement without being compensated for your loss.

Conclusion

In light of these risks, legal advice can make a huge difference and is highly recommended before you sign any sort of legally binding agreement or when the legal situation governing your business changes. On top of this, franchisees can take steps to minimize the harm to their franchised outlet. As a franchise owner, you should be considering legal advice at nearly every stage. For more information on how to protect your franchise, contact LegalVision and speak with one of our franchise solicitors.

Emma Jervis

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