What if your franchisor fails?

In Manzoor Ishani’s second instalment, he reveals what can be done if your franchisor’s business goes into liquidation

 

If the primary object of a liquidator is to gather in the franchisor’s assets and then dispose of them for the best price obtainable, who, you may ask, would be interested in buying them?

A competitor or someone in a very similar line of business could be interested in buying the franchisor’s business. If the prospective buyer is already a franchisor, they may be reluctant to do so because of the complications that may ensue. For one thing, it’s quite likely that there will be a degree of duplication of sites or territories with the result that it may now have two franchisees competing with each other, whereas previously they were different outlets. Secondly, if the failed franchisor’s decline has been slow, the purchaser will have the problem of integrating the failed franchisor’s franchisees into its own network, a particularly difficult task when the existing franchisees may not be in the mood to deal with another franchisor!

Most purchasers will insist on having at least one meeting with the failed franchisor’s franchisees to gauge opinion for whether there is potential for a successful long-term relationship.

Alternatively, one or more of the franchisees could club together and buy the assets from the failed franchisor. This has worked best where franchisees have been quick off the mark to take legal advice when the first signs of trouble appeared. In one particular case, I was consulted by a group of franchisees who had noticed a deterioration in the services provided by their franchisor. This, together with other signs, such as the shedding of some staff on the franchisor’s payroll, led my clients to believe that all was not well. A contingency plan was drawn up to ensure a seamless transfer of ownership if necessary. The formation of such a plan need not be expensive. However, its implementation may be, depending on the reaction of the franchisor and or its receiver/liquidator. Even then, it may still be a relatively low price to pay, particularly if it is shared out amongst the network, rather than losing one’s business or finding oneself as a franchisee of a strange franchisor.

If a franchisor, in their death throes, has reached the point where it is in breach of their obligations under the franchise agreement, it is always open to a franchisee to terminate the agreement and make a claim against the franchisor for damages. The problem with this course of action is that it may precipitate the liquidation of the franchisor! It all presupposes that the franchisor is worth suing, which it may be if the difficulties are something other than financial. Furthermore, termination by a franchisee would, in all probability, mean that the franchisee will no longer be able to use the franchisor’s system; know-how; trade secrets; trade name; trade mark; trade service mark; goodwill and copyright material etc.

 The main advantage of having a strategy before the proverbial fertiliser has hit the fan is that it enables franchisees to plan things in a rational manner. Franchisees will realise that amongst them there are people with varying degrees of ability and different views. Given this, they are more likely to succeed in organising themselves at an earlier stage. Not all franchisees will wish to be involved and there is no reason why only a handful of franchisees should not take over the mantle of the franchisor.

The vehicle used by franchisees in these circumstances would normally be a limited liability company structured in such a way that the franchisees become shareholders, and those who have agreed to take an active part become its directors.

Once franchisees have decided their own internal structure, they can concentrate on the best means of acquiring the franchisor’s assets.
They will need to be a good negotiator because when it comes to negotiating with a receiver or liquidator, there may be more than one purchaser in the frame.

However, it is always possible that there will be no buyer for such assets. If that is the case, Christmas may have come early for the franchisees! In these circumstances they should, at the very least, be able to purchase some of the essential features of the franchise, such as copyright in the manual, trademark, trade name, etc, at a relatively low price. The cost, if shared out amongst the whole franchise network would be negligible and franchisees would thereafter be free to carry on the business as before, but without having to pay any franchise fees. Of course, previously they may have relied on the franchisor’s support, now they will have to swim for themselves. Here again, experience has shown that franchisees do see the merit in co-operating with each other because they appreciate the benefits to be derived from a uniform marketing image, communal advertising, bulk purchasing, etc.

I think it is true to say that very few franchisees have lost out in circumstances where a franchisor has gone bust. If they have lost out, it is because they have failed to take the right advice and appropriate action at the critical time. A well prepared and organised group of franchisees can drive a very hard bargain with a liquidator. After all, who would buy the assets of a failed franchisor from a liquidator in the face of organised opposition from franchisees? That such a person is going to look for their future income from the very same franchisees!

In the final analysis, whether or not franchisees are organised, it seems to me that when a franchisor goes bust it is not always bad news for franchisees. They may end up owning their own franchisor company or becoming franchisees of another franchisor, who having made a recent purchase is more likely to take its investment more seriously and show greater enthusiasm towards its franchisees. Or franchisees may end up going it alone, albeit (if necessary) by changing the name and the style of the business, but carrying on more or less as previously, but without having to pay any fees on an ongoing basis.