Australia: Franchisee Insolvency

Last Updated: 4 August 2009
Article by Chris Nikou

Originally Published 1st July 2009

Do you:

  • receive monthly income reports from franchisees?
  • receive annual profit and loss, balance sheet and cash flow statements?
  • track each franchisee's debtor and creditor lists, amounts and time outstanding?
  • have set trade terms for all franchisees to use?
  • provide updates to your franchisees regarding the danger of bad debts?
  • look for opportunities to improve lagging franchised businesses before the negative image and impact associated with a franchise closure?
  • proactively work with franchisees to improve their business structure and strategically plan exits from the system with your franchisees?

The global economic crisis has prompted a number of franchisors to implement more stringent risk identification and reduction schemes. Franchisors must be vigilant to ensure that their franchisees experiencing financial uncertainty are identified early and dealt with appropriately. The collapse of a franchisee may affect the public perception of strength in a franchise system and in extreme circumstances can affect the franchisors market position and financial stability. Closely monitoring franchisees (particularly multi-unit operators) becomes more important where the affect of franchisee collapse on a franchise system is significant.

In most circumstances the collapse of a franchisee will require the franchisor to work together with the franchisee and other stakeholders (particularly the landlord and the franchisee's bank, which often has a charge over the fitout) to reach a commercial resolution of the matter. This can result in the franchised business being sold as a going concern to enable the stakeholders and franchisor to realise as much value as possible from the sale to minimise the outstanding debt.

The Franchising Code of Conduct (the Code) allows franchisors to immediately terminate (upon giving notice in accordance with the Code) a franchise agreement if a franchisee becomes bankrupt, insolvent, under administration or under an externally administered body corporate. Despite this provision, insolvency can be difficult to substantiate in practice which leads franchisors to terminate on other grounds (such as abandonment).

Checking regular financial reports and monitoring the payment of creditors (particularly landlords and key suppliers) can be vital in the early detection of franchisee insolvency. Early detection can leave both parties with more options, such as restructuring, temporary royalty relief, or providing additional support to the franchisee. It can minimise any damage to the brand by giving franchisors time to ensure the franchisee's customers are not affected and the goods or services provided by the franchisee continue seamlessly.

There are some tools that are drafted into franchisee agreements, such as the franchisor's right to:

  • inspect and audit the franchisees records
  • take security over the franchisee's assets
  • require adherence to a minimum performance criteria (with consequences for failing to comply)
  • purchase the franchisee's business (including its assets) upon termination of the franchise agreement
  • use the franchisee's assets prior to any purchase
  • transfer to itself phone numbers, business names and services associated with the business.

These tools can assist franchisors to detect issues early, minimise their risk and take practical steps to protect the franchise system by ensuring that the franchised business continues to operate.

In most cases it is not enough for franchisors to simply monitor the performance of their franchisees. Franchisors should review their business model to ensure that it is able to withstand the coming financial challenges. It is a time to ensure that local area marketing, training and morale are considered and business expenditure is adjusted proportionately.

It is both unfortunate and unavoidable that a percentage of franchisees across the industry will experience financial uncertainty during the global financial crisis. To minimise the impact of distress on franchise systems it is crucial that franchisors develop a range of responses that can be readily adapted to a franchisee's individual circumstances as soon as signs of distress are detected. Franchisors must collaborate with their franchisees to identify the cause of distress and address the problem. It is important to identify whether franchisees struggling with solvency issues are best served by exiting the franchise system on mutually agreeable terms suited to preserve the franchisee's assets and the integrity of the brand or by continuing to operate their business.

Despite recent growth and development in the franchising sector and its reputation for weathering turbulent economic times, it is essential that franchisors do not become complacent in monitoring and risk minimisation and encourage their franchisees to recession proof their businesses where possible.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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