Deacons Lawyers explain franchisee insolvency

Although franchised businesses have a far stronger track record of riding through the tough times, the reality is that perhaps for the first time in many years franchisors will need to consider the solvency of some of their franchisees. The health of the whole franchise network requires franchisors to put strategies in place to detect signs of financial stress at the earliest possible stage, and to act quickly to minimise losses should a franchisee be unable to pay its debts as and when they fall due. If they do not do so, the impact can spread beyond the franchisee to supplier relations, consumer perceptions of the network and the financial position of the franchisor.

If a franchisee cannot pay its debts "as and when they fall due", the franchisee will be deemed to be insolvent under law. This has various consequences, including that any moneys paid to a supplier or the franchisor after this time may be characterised as "preference payments", clawed back by a liquidator and distributed evenly among all of the franchisee's unsecured creditors.

An early intervention strategy requires franchisors to monitor stock levels, watch late royalty payments and stay in close contact with third parties such as landlords and suppliers, who are often the first to receive late or short payments from franchisees. It would be prudent for franchisors to review the terms of their franchise agreements to ensure that they offer the franchisor the maximum protection. The following questions provide a good "checklist" of the types of things that a franchise agreement should cover:

• Do the inspection and audit provisions provide sufficient power to investigate the situation and obtain an accurate picture of the franchisee's financial position?
• Can the franchisor require evidence of a franchisee's solvency on demand?
• Does the franchisor have the power to take a charge over a franchisee's business and personal assets to secure moneys owed to it?
• In the case of a corporate franchisee, are there personal guarantees in place to cover debts owed by the franchisee not only to the franchisor, but to its related entities?
• Does the franchise agreement clearly set out a process for the franchisor to purchase the franchisee's business assets at fair market value at the end of the franchise?
• Can the franchisor offset moneys owed by it to the franchisee (for example, the purchase price for the business assets) against moneys owed by the franchisee to it?

By Jessica Rowe - Deacons Lawyers

Deacons Lawyers offer franchise advisory services to franchisees and franchisors.