In July 2016, head franchisor Eagle Boys Dial-a-Pizza Ltd entered voluntary administration, leaving their 120 franchisees to continue to operate with the appointed administrator taking over head office duties. This month, private equity firm Allegro, who had earlier obtained the licence to Pizza Hut in Australia from YUM! Brands bought the Eagle Boys chain. Pizza Hut aims to convert 50 Eagle Boys stores to the Pizza Hut brand immediately, with the remaining stores to be rebranded in the coming months once ongoing negotiations with the franchisees conclude. This acquisition and rebranding will assist Pizza Hut to compete with Domino’s Pizza who are currently the market leader with a 50% share of the $3.7 billion pizza industry. Below, we look at what happens when there is a rebrand across the franchise network and a franchisee’s rights under the franchise agreement.
What Does the Franchising Code of Conduct Say?
The Franchising Code of Conduct (Code) provides the franchisor with the right to terminate a franchise agreement immediately if the franchisee becomes bankrupt or insolvent. The Code does not, however, grant a mutual right to the franchisee to terminate the franchise agreement where the franchisor enters into administration or liquidation.
Most franchise agreements will continue even where the franchisor goes into administration unless the agreement specifies otherwise. The administrator appointed to manage the franchisor entity can enforce the franchise agreement against franchisees and ensure their continuing compliance with the agreement including paying the relevant royalties and other fees.
A liquidator who has taken over a franchisor’s network may choose to sell the franchisor’s business and either:
- Assign each of the franchise agreements to the purchaser; or
- Terminate each of the franchise agreements and wind up the franchisor’s operations entirely.
Where the liquidator manages to find a buyer, the franchisee will usually be obligated to enter into an agreement assigning the franchise agreement to a third party purchaser. Most franchise agreements contain a clause to this effect.
Why is Due Diligence Important?
Before entering into a franchise agreement, a franchisee should do their due diligence in regards to the franchisor and their financial position.
The franchisor’s disclosure document must contain the previous two years’ financial statements or an independent auditor’s statement confirming the franchisor’s solvency (i.e. the franchise can pay its debts as and when they fall due). A qualified accountant should review these documents before the franchisee executes the franchise agreement.
The franchisee should also contact existing franchisees within the network to determine the franchisor’s performance of their obligations generally and meeting their financial requirements. Franchisees may request an annually updated disclosure document from the franchisor to maintain transparency of the franchisor’s financial position. Usually, this is provided within four months from the end of the franchisor’s financial year.
Research the Brand’s Reputation
Most franchisees invest in a franchise business because they have confidence in the strength and reputation of the brand and want to become part of the network to reap the benefits of the brand’s goodwill. Franchisees have invested both time and money into the business. Understandably, they will be reluctant to change unless they can be convinced of the benefits, or are obligated to do so under the franchise agreement and risk being in breach and terminated if they do not comply.
Alternatively, the franchisee may prefer to end the franchise agreement, provided there is no penalty to do so, de-brand and continue to operate independently from the franchisor and franchise network. Depending on the situation, the franchisor may attempt to enforce the restraint provisions of the franchise agreement to prevent the franchisee from continuing to trade.
The Franchise’s Intellectual Property
So far as a franchise agreement remains on foot, the franchisee has the right to continue to use the franchisor’s trade marks. If a new brand buys the franchisor, the assignment of the franchise agreement may also contain requirements to rebrand and refurbish the premises, stop using the existing trade marks, and begin using the new trade marks the purchaser provides.
A franchise agreement will typically contain a clause that states that the franchisee must use the Intellectual Property, including the trade marks the franchisor specifies from time to time. If widely drafted, this may allow the franchisor to change the trade marks the franchisee uses throughout the term, meaning that the franchisee will have to comply with any such requested changes.
Who Bears the Cost of Rebranding?
Franchisees should negotiate with the “new” franchisor whether they are willing to pay the costs of rebranding in consideration of the franchisee entering into a new franchise agreement. This would obviously help persuade franchisees as it limits or removes the risk associated with making the change. The franchisor would in turn also benefit as they could roll out the rebrand across the network without too much resistance or delay.
Clause 30 of the Code addresses capital expenditure and requires franchisors to provide franchisees with:
- A justification for the conversion;
- The desired outcome and benefit of the change;
- The amount of capital required; and
- Any foreseeable risks related to the change and the investment.
The new franchisor may introduce operational differences, and the franchisee must adhere to any changes made to the operations manual. The franchisee may also require some time to adjust to new systems and process, suppliers and products and services. Parties should negotiate these changes to allow for a smooth transition.
Ultimately the relationship between the franchisor and franchisee should remain mutually beneficial – the desired rebrand across the network for the franchisor and the continued goodwill associated with the brand for the franchisee.
If you are a franchisor facing liquidation or looking to implement a change in your brand, or a franchisee being requested to make changes to your franchised business, get in touch with our franchise team on 1300 544 755.