One of the key reasons for franchisees to invest in a franchise is the power of the franchise brand. Financially stressed franchisees, suppliers and customers can make life difficult for franchisors, lenders and other stakeholders. In today’s economic climate many businesses will face financial distress at some stage – even in a franchise with sophisticated systems and support.
In this article we consider the impact of financial distress and insolvency on franchisees and practical steps that can be taken to identify and deal with financial distress to protect and preserve the franchise brand.
The financial distress of a franchisee (which sometimes may lead to the appointment of external administrators, for example voluntary administrators or liquidators) carries the risk of significant reputational damage for the franchise brand, and not just the particular business which is distressed.
Protecting the franchisor’s position prior to financial distress
It is important for a franchisor to manage relationships with franchisees in a way which will allow the franchisor some flexibility in circumstances where the franchisee becomes insolvent and, consequently, prevents the reputational damage associated with the financial distress of a franchisee.
As part of their documentation franchisors may have already taken security interests to protect loans to franchisees, goods delivered, or services provided. These security interests will give them added protection in the event of a franchisee insolvency. It is important for these securities to be perfected prior to financial distress and prior to the delivery of goods and services in accordance with the Personal Property Securities Act 2009.
In addition, specific controls could also be considered as part of the franchise agreement.
For example:
a) a requirement for the franchisee to lodge accounts with the franchisor regularly. This will enable the franchisor to monitor the financial position of the franchisee and serve as an early indicator of financial distress; and
b) preserve ‘step-in rights’, which enable the franchisor to ‘step into’ the business of the franchisee prior to it becoming distressed.
Alternatives to termination: protecting the brand
The impact of financial distress often has implications that extend beyond the franchisee’s individual business and can have an impact on the overall franchise brand. This is compounded in the event of the insolvency of a franchisee.
If inadequate protections are in place, the franchisor may lose control and the ability to protect the franchise brand. In those circumstances, the franchisor has a likely basis to terminate the franchise agreement completing the severance of the rights, control and interest in the franchised business.
This again has an impact on the franchise brand. With the implementation of the protection methods discussed above and strategic consideration, there are often other options that can be taken to provide better protection, control and most importantly outcomes to the franchisor on an insolvency.
For example:
- buying back the franchised business;
- temporary management of the franchised business by the franchisor, or other ‘step in’ rights;
- sale of the franchised business within an agreed period; and
- subsidising the franchised business and taking security for any loans provided.
These options may give the franchisor the basis to formulate a strategy that will lead to a better outcome, protecting the brand and providing a means of alleviating financial distress in the best interests of all stakeholders.
Contact : from left – Jonathan Kramersh (03) 8644 3584 or Tony Garrisson (03) 8644 3542 or Peter van Rompaey (03) 8644 3506 from HWL Ebsworth’s, Melbourne office.