Whether for issues of market share, possible shut down or reasons associated with efficiency, the acquisition of a competing brand represents an intellectual challenge for the management team charged with integration.
This is especially so when protected territories are contractually granted, often for significant periods of time post integration, which is often the case in franchising. There remains the distinct possibility that, notwithstanding common ownership and management structures, the brands will need to retain their identity in the market for a significant legacy period. This article addresses some of the issues facing management that require careful consideration to ensure that the benefits of acquisition or merger are realised.
The commercial decision to enter into negotiations is predicated on identifying the benefits that integration will pose. It is not however an unqualified assessment, as much of what underpins the decision will not be known until completion of an extensive due diligence. To the extent that a due diligence will range across financial, accounting, tax, human resources and legal issues, the essence of the initial reasoning will need to be sustained by these further enquiries as will the development of a growing understanding of the organisations’ culture and the consequences of bringing them within the common ownership/management structure.
Legal due diligence
It is the lawyer’s task to identify the contractual relationships and binding obligations that exist within the target company’s business. These need to be assessed as to their impact on settlement and the subsequent settling down of the post-settlement business.
The strength of contractual obligations permitting licensees to continue with brand and business methodologies (or models), should be assessed both at the acquirer and target level so that a grid of relationships and overlaps concerning the merged systems can be developed to allow commercial decisions to be made as to any resulting tensions. For example, there may be differences in fee structures or differences in Licensee/Licensor obligations.
Similarly, decisions will need to be made as to non-competition obligations where licensees choose not to stay within the system, either on expiration of rights and a failure to take up renewals, or should commercial proposals be put to them by management in order to ease issues of friction resulting from settlement.
In the absence of a commercial resolution devised and put forward by management to licensees of both systems, the legal conclusion may be that the continued conduct of brands and rights in parallel must continue for a time before conversion or relinquishment opportunities arise.
Relying in part on the legal conclusions arising from a due diligence and the cultural and other assessments made, management needs to develop a range of strategies including, importantly, a communication plan both as to ongoing licensees and the all important customer base.
The retention of parallel brands post settlement further gives rise to particular issues associated with ongoing accounting, customer service, technology and, of course, marketing.
Tensions with licensees
Not all licensees will respond positively to the merger of competing brands. Resistance may be found at a number of levels including:
- Passive resistance - This form of resistance simply involves a reliance on a pre-existing grant of rights. In the absence of commercial incentives from management or circumstances of breach or ultimate expiry of those rights, the new entity may simply have to honour and manage pre-existing obligations, even in the context of the subject brand diminishing in size and importance as time passes after settlement.
- Active resistance - If there are licensees who are unable to grasp the benefits of a merger, tensions will be created where the holder of rights to one brand is unhappy about the other brand being introduced into their area. While the original agreement may prevent the licensor from setting up similar branded stores within an exclusive territory, drafting may not be sufficiently broad to prevent the new merged entity from setting up the competing brand within the same area. The presence of the competing brand may not be well received. While this may not be a breach of the original agreement, as the original grantor is not running the same system, the licensee engaged in active resistance may either agitate within the system or seek specific legal advice on its rights.
This article does not permit a significant analysis of the unconscionable conduct provisions contained within section 51AC of the Trade Practices Act and their possible application. There is, however, potential for a licensee to argue that the licensor was under an obligation, albeit implied, to grow and develop the system to the benefit of the grantee and that the merger and possible quarantining in size and development of the acquired brand may breach this obligation. Without expressing a definitive answer, it is suggested that in the absence of an expansively drafted obligation within the original agreement there is unlikely to be an implied obligation that would cause the licensor any difficulty in this regard.
Strategy for dealing with active resistance
Legal advisors will confirm whether the original documentation permitted the licensor to mandate a brand conversion under the agreement, albeit with some financial assistance from the licensor. This may permit the adoption of the new and dominant system brand together with directed re-fits on shop premises, signage procedures and of course, new products.
Running hand in hand with a position on legal obligations is a necessity for the management team to demonstrate the benefits of conversion by reference to the resultant economic outcomes.
As a general observation, there is always a necessity to communicate clearly and strategically with concerned licensees. The benefits of action should be articulated in a manner designed to win over, if not all existing parties, then at least the majority.
The Australian Franchise Code of Conduct and the disclosure obligations under it will place an immediate obligation on management to re-draft and serve disclosure documents providing sufficient detail to disclose what is in fact a significant and material alteration to the conduct of both branded systems. This gives rise to a timing issue, namely what disclosure may be required during the possibly sensitive and in-confidence due diligence period when a final decision on acquisition/merger may be conditional. What consideration must a potential purchaser of licence rights to the system that is intended to be acquired and perhaps shut down/run down be given? Does that system treat it as business-as-usual or suspend grants pending a final decision or merely identify the trigger point at which new disclosure information will be provided?
An appropriate solution may be the suspension of further grants and negotiations with potential franchisees for at least the period of the due diligence and the satisfaction of any pre-conditions. This may carry some financial cost, but it will protect management against complaints of dissatisfied new franchisees who have learnt about the merger only after they have adopted the system and their cooling off rights have expired.
Conduct of multi-brand systems post-settlement
As indicated, this may be a necessary consequence of the merger. The key issues that likely arise are:
- Resistance from legacy franchisees who have brand loyalty and are trying to avoid competition within their markets.
- Necessity to support both systems ensuring that if a brand is intended to be shut down or run out, then the level of support is consistent across both brands and meets the obligations of the grantor notwithstanding that the system is not intended to grow and will ultimately be phased out.
- Keeping marketing initiatives and advertising funds separate (although in appropriate instances the dominant brand may need to contribute and support the legacy brand to ensure fair marketing support to legacy licensees where appropriate).
The views expressed in this article are derived in part from a paper delivered at the 39th International Franchise Association Annual Legal Symposium in Washington, 8 May 2006.
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.