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Understanding the franchise relationship and subsequent liquidation

Understanding the franchise relationship and subsequent liquidation

A franchise liquidation is a complex procedure, due to the nature of the franchise relationship. If either the franchisee or franchisor enters an insolvency procedure, it’s likely that it will affect the other. The current spate of restaurant and high street issues only highlights the problems many companies face. Therefore, Business Rescue Experts – leading insolvency practitioners in the UK – are sharing a guide to the process of franchise liquidation.

What is a franchise relationship?

The above term refers to a business concept where an established business allows a business to use their business model, and subsequent branding. There is a mutual benefit for each in the relationship. For instance, the franchisee enjoys the benefit from the experience and well-known reputation from the established business. The established business then enjoys the benefit of expanding their name and branding.

A franchise agreement will dictate the nature of the relationship. The agreement sets out certain terms for each business, such as the ability to use the established branding and model and the fees for doing so.

Franchise agreements are not specifically regulated in the UK, but there is some self-regulation from the British Franchise Association (BFA). The BFA outlines rules and codes of ethics for franchisees. However, if you enter a franchise relationship with a non-member of the BFA, you must err on the side of caution.

Similarly, the agreement will outline the interactions and assets. Generally, it will state that assets are owned by the franchisor, but leased to the franchisee. The ownership does not pass to the franchisee. Therefore, insolvency implications may be severe to the franchisor.

Franchisor insolvency

If a franchisor enters a formal insolvency procedure, it will likely be administration or company voluntary arrangement (CVA). These procedures are due to the complexity of business, and the necessity for orderly dealings with the franchisee.

Franchisor insolvency is a lot less common than a franchisee. However, in the event of the procedures, the franchisee must liaise with the administrator to:

  • Is there a buyer for the franchise building?
  • Will the stock previously provided by the franchisor continue to be supplied?
  • Will there be any other business interruptions?
  • Is it possible to buy the assets leased to the company?

If there is yet to be an overall purchaser of the company, it may be possible for the franchisee to purchase the assets they are already using. The franchisee is likely in the best place to put forth an offer, if they are available.

Pre-pack administration is also an available procedure, but it’s likely there will be a new owner before the franchisee is made aware. The administrators will then seek to transfer the franchise agreements to the new company, as an asset. The franchise fees are then due to the new owner.

Franchisee insolvency

Franchisee is a much more common procedure, and the insolvency process will likely by creditors voluntary liquidation. The below are reasons for this procedure:

  • The assets and stock the franchisee uses are likely to be the property of the franchisor. Therefore, there are likely no assets to sell, meaning administration is not suitable.
  • A company voluntary arrangement may not be possible if there is a break clause in insolvency. Therefore, the franchisor can terminate the agreement they held with the franchisee.

Of course, there is not a ‘one size fits all’. However, the above points will apply to most cases. A potential alternative is where a creditor may submit a winding up petition to the business if they have explored all other avenues in attempting to recoup losses.

There are several considerations should a franchisee face insolvency. A franchisee should attempt to take control of the situation and communicate with the franchisor. For instance, if the franchisee is attempting to start the business up again, the franchisor will have to be heavily involved from the beginning. They will have to either transfer the franchise agreement, or obtain an altogether new agreement.

Similarly, you may have to consider personal guarantees and the effects they may have on your position.

Ultimately, good communication is essential for the relationship. You must also seek immediate advice if you believe your company is facing a financial issue.