What can a franchisee do to reduce loss when a franchisor collapses

05 May 2009 Topics: Franchising

Franchise systems are thought by many to be financially bullet proof and lower risk than one-off independent businesses.  However, the recent collapse of many big name franchisors, Traveland, Strathfield, Midas, Ezy DVD, Kleins and most recently, Queensland based appliance franchisor, Kleenmaid, clearly shows that they are not.

While the reasons behind each collapse may be different, the result for franchisees is usually the same. Franchisees need to be aware of the consequences for them of a collapse of the franchisor.

As with the collapse of Kleins, franchisees may be forced to cease operation and risk losing homes and other assets that have been put up as security for the ongoing operation of the franchise business.

In some instances, such as the collapse of Century 21 and Traveland, franchisees were able to continue operating as independent businesses or by joining a different franchise group operating under a similar franchise model, while others found refuge as a result of the purchase of the franchise system by a new franchisor. Other franchisees have acted proactively to save their livelihoods by joining forces and finances to buy out the franchisor. For Kleins franchisees however, the result of the collapse was that they were not able to continue to trade and had to close the doors.

The nature of franchising certainly has unique qualities and benefits that help businesses overcome tough financial times such as the current global economic crisis.  However, it is also true that with these good qualities come negatives, one of them being that the fate of franchisees is inextricably linked with that of the franchisor.

With franchise models where the franchisor owns the premises or holds the lease, as was the case with Kleins and is commonly seen in fast food franchise models, the collapse of the franchisor will most likely lead to a breach of the lease.  If the landlord takes action to end the lease without reference to the franchisee the business may find itself homeless.

There has been much debate about the benefits and consequences to the franchise parties as to who should hold the lease.  In some models it is better for the landlord to own the premises or hold the lease and grant occupancy rights to the franchisee, while for others it makes commercial sense for the franchisee to control the premises.  The risk and expense needs to be weighed against control and responsibility.  However, it is fair to say that not having control of the premises leaves the franchisee more vulnerable to lose the right to occupy it if the franchisor collapses.

So what can a franchisee do when a franchisor collapses? Don’t bother looking to the franchise agreement or the code for assistance.  The code is silent on the issue and most franchise agreements don’t deal with this issue. The answer is that the franchisee must look for a solution to best protect themselves, whether by shutting up shop to prevent further losses, re-branding, selling stock, plant and equipment and goodwill or going it alone.

There are some important considerations in these decisions. These include ownership and payment for remaining stock, re-packaging costs, costs to make good or re fit premises, changes to advertising, uniforms and signage, the requirement to continue paying franchise fees and payments to marketing funds under the franchise agreement, the recovery of funds already outlaid, including hefty initial franchise fees, marketing fund contributions or purchase costs and more.

Once in the franchise system, franchisees need to stay in regular contact with their franchisor and where applicable the landlord of the premises, be on the lookout for information and signs about the position of the franchisor and importantly establish a network with other franchisees in the system.  Information and relationship will be important for any recovery activity that needs to be taken.

Prior to entering into a franchise agreement or setting up any new business franchisees should have all documents reviewed by professionals experienced in this unique area. Proper advice on the franchise documentation is important to identify whether the franchisee may be restrained from operating in the premises at the end of the franchise agreement or after dissolution of the relationship with the franchisor and what rights the franchisee has to allow its escape from a failed or failing franchise system.

Franchisees should also seek advice on and implement asset protection strategies to ensure that assets owned by them but not connected to the franchise business are protected from a franchisor collapse.  Such asset protection measures are also vital in the event of a collapse of the franchisee’s business.

Franchisees should seek professional assistance to conduct financial due diligence on the franchisor.

The recent franchisor collapses prove that no business, even a long standing, seemingly successful franchise system is safe from financial failure. A sound knowledge of the financial position of the business is crucial and for franchised businesses, this includes the financial position of the franchisor.

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