Boom and bust

What happens if your franchisor goes bust? Franchise solicitor Robert Bedford offers his legal advice

Most franchise contracts will deal with the situation where a franchisee cannot pay its way (generally the franchisor has the option to terminate), but very few deal with the effect on the relationship if the franchisor finds itself in similar circumstances. In the current economic climate and, with established brands such as Coffee Republic and O'Brien's Sandwich Bars having entered into administration in recent years, this is no idle question.

Franchisors are unlikely to simply disappear overnight and there is every chance that, as with the companies mentioned above, they will initially be placed into administration. During this phase, an administrator will be appointed to take over management of the business and attempt to turn its fortunes around. Franchisees will continue to be bound by the terms of their agreements, including their basic obligation to continue trading. While it is possible that an administrator will not have the resources or inclination to pursue franchisees that cease paying royalties or attempt to leave, there is no guarantee that this will be the case.

If franchisees with sufficient capital are on hand, there may be an opportunity to buy out the business and step into the shoes of the franchisor, but action must be taken urgently before the company starts to break up or external buyers take an interest. Franchisees considering this course of action must carefully assess the liabilities being taken on and will require experienced advisers.

If an outside party is interested in picking up the franchisor's business, they would be reckless to do so without gauging the likely response of the existing franchisees, but in general, franchisees will not be able to stop a sale going ahead.

If administration is unsuccessful, or if the franchisor's situation was not appropriate for administration in the first place, the business may be placed into liquidation. Whereas an administrator's remit is to attempt to rescue the company as a going concern, a liquidator's primary goal is to wind down the business and sell off the assets to the highest bidder.

Those assets will include the intellectual property (trademarks and copyright) used in connection with the business and if any of the franchisees wish to continue trading under the same brand, there may be an opportunity to acquire the relevant intellectual property.

If no party is willing and able to take on the business as a going concern, the franchisor company will ultimately be dissolved and the franchisees will no longer be under any ongoing liabilities to a parent organisation. Experienced franchisees may see this is a chance to carry on without the burden of ongoing fees but more junior members will have received little in return for their substantial outlay when joining. In addition, if the model is heavily reliant on the franchisor's ongoing involvement (for example, as the chief supplier) it may be difficult for any franchisees to continue.

Franchisees who have taken an underlease for premises from their franchisor will also need to consider their position carefully and may be able to negotiate improved terms directly with the landlord.

There is no one answer as to how a franchisee should react in these circumstances, but the risks and opportunities will likely be substantial and franchisees concerned about the financial health of their franchisor are strongly recommended to seek appropriate legal advice at an early stage.

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