The prospect of franchisor insolvency can be an alarming thought for many franchisees, particularly as the franchisee is usually the last to know when the franchisor is in financial trouble. The Franchising Code of Conduct (the Code) contains provisions relating to the termination of a franchise agreement where the franchisee is bankrupt or insolvent, however it is silent on the issue of franchisor insolvency.

In practical terms there are a number of different outcomes which may result from a franchisor going broke, which will depend largely on the extent of the franchisor’s debt and the strength of the brand.

The possible outcomes could include external administration, the sale of the franchisor company (and the transfer of the franchise agreements) or the termination of all franchise agreements.

While the majority of the franchisor insolvency process is out of the franchisee’s control, there are several key things which can be done to protect a franchisee’s position and help prepare for any changes to the franchise system.

Research first! Preventative action is always better than reactive measures so as a starter franchisees need to be confident in the company they invest in. Franchisees should undertake thorough research before entering into a franchise agreement. In particular the disclosure document contains useful information about the franchisor company including its experience in operating franchises and its financial position.

The franchisor must attach to the disclosure document the financial statements for the franchisor company for the last two years or an independent audit to confirm the franchisor company is solvent. Franchisees should review this carefully and ask questions if anything is unclear.

Existing franchisees can request an updated disclosure document (including financial statements and audits) once every 12 months.

Act quickly: When a franchisee does become aware that the franchisor is in financial trouble it is important to act quickly to contact suppliers and, if the franchisor holds the lease for the premises, the landlord to ensure that all accounts and rent are up to date.

It is always beneficial for the franchisee to have a working relationship with the landlord and suppliers, even if these parties contract directly with the franchisor; it may help the franchisee continue the business in the event that the franchise agreement is terminated. The franchisee should also communicate with any external party (such as an administrator or liquidator) that is appointed to the franchisor company to confirm that its interest in the franchise is recognised.

Be co-operative: Franchisees should co-operate with any new purchaser appointed as franchisor. While franchisees may feel put out by a change in the franchisor the fact is that there are usually few limitations on the franchisor transferring its interest. There are significant risks for a franchisee who seeks to fight such a transfer or tries to walk away from the system all together.

On the other hand there are potential benefits to a new franchisor taking over from an insolvent franchisor who was most likely damaging the franchise system and brand. A new purchaser can revive a declining franchise and can improve the value of a franchisee’s business.

Franchisor insolvency can seem a scary prospect, particularly given recent high profile cases in which franchisees have been left high and dry following the insolvency of the franchisor. The potential risks for franchisees in this situation are significant, including loss of the goodwill in their franchise business and termination of their franchise agreement without compensation.

While there are significant risks involved, franchisees can take proactive steps to minimise the damage to their individual business. Where the franchise system is established and the brand is reputable there is a good chance that the franchise will continue and in some cases may prosper under a new owner.