One of the biggest misconceptions held by franchisees is in relation to the franchisor’s insolvency. Many franchisees believe that they will have the right to terminate their franchise agreement if the franchisor goes into liquidation or becomes externally administered, which, in most cases, is incorrect.

Unless the franchisee’s specific franchise agreement includes an express right for the franchisee to terminate the agreement should the franchisor become insolvent, the franchisee will have no right to end their franchise agreement. However such a clause is rare and very unlikely to be found in the franchise agreement.

Once the franchisor is in financial trouble, an administrator, receiver and manager or a liquidator is appointed to take control of the franchisor company and can enforce all rights of the franchisor under the franchise agreement against franchisees.

Franchisees must clearly understand that an appointment of a liquidator or an administrator does not relieve the franchisee from any of their obligations under the franchise agreement. The franchisee must continue to pay royalties and meet all their obligations under the franchise agreement because the liquidator can enforce the franchisor’s rights against the franchisee.

It is the role of the appointed party to take control of the franchisor’s entity and to try to either find a purchaser to acquire the franchisor’s system or to restructure the franchisor’s operations to trade the franchisor out of insolvency.

The franchisor’s financial troubles do not allow the franchisee the ability to transfer its rights under the franchise agreement to a third party or to sell the franchise business, as this can only be done with the consent of the franchisor (or in this instance, the liquidator or other similar entity).

It should be noted that franchisor’s insolvency is not covered by the Franchising Code of Conduct.

What the Code does cover is the franchisor’s ability to terminate the franchise agreement immediately if the franchisee becomes bankrupt or insolvent. 

Unfortunately, the termination right is not reciprocal to franchisees if the franchisor goes bust. Therefore, the prospect of the franchisor becoming insolvent is often of great concern for many franchisees.

What could happen to the franchisor's business?

Practically, there are three common outcomes from a franchisor’s financial distress, and these depend largely on the extent of the franchisor's debt and the strength of their brand:

1. external administration or liquidation

2. the sale of the franchisor’s business which would include transfer of the franchise agreements

3. termination of all franchise agreements

Although franchisor insolvency is outside the franchisee’s control, there are steps each potential franchisee can take to ensure the risk of their franchisor becoming bankrupt is small.

Before you buy a franchise

Prevention is better than cure. Research the franchisor, their financial position, where their system is vulnerable, what are the risks the franchisor is facing and whether the franchisor is equipped to deal with all such scenarios.

A disclosure document of the franchisor is a good start, as it should include the franchisor’s last two years’ worth of financials or an independent audit report to confirm the franchisor company is solvent

Speak with current franchisees within the system to find out if there are any ‘cracks’ in the franchisor’s overall performance, ability to meet their financial obligations and other obligations. 

Lastly, you will be entitled to request an updated disclosure document on annual basis from the franchisor and review their financial position.

What to do if your franchisor is insolvent

If you find yourself with an insolvent franchisor:

1. Cooperate

It is in the franchisee’s interests to cooperate with the liquidator or the new purchaser of the franchisor, as there is a high risk of loss of the goodwill in their franchise business and termination of their franchise agreement without any compensation.

2. Act immediately

As soon as you become aware that the franchisor is in financial trouble, get in touch with your suppliers and contact the landlord to ensure all the payments are up to date (if these payments go through the franchisor). 

It is also beneficial to contact the external party (such as an administrator or liquidator) who is appointed to the franchisor company to confirm your position and be kept up to date with what transpires in relation to the franchisor’s business.

It is highly recommended that before signing up to a franchise you seek legal and financial advice, including review of all financial figures by an accountant. It is also prudent to seek legal advice as soon as there is any hint of trouble.