Franchisee insolvency: Navigating the complexities

I recently guided two Domino’s Pizza franchises through a Small Business Restructuring (SBR) process, which inspired me to write about franchising and insolvency. It was a complex yet insightful experience, shedding light on the unique challenges of working with franchised businesses. Over the years, my colleagues and I have worked with a diverse range of franchise models across various industries – from Pie Face to Miniso, Little Caesars to Soul Origin, Complete Garden Centre to United Service Stations, Salsas Fresh Mex to Kwik Copy, and many more well-known brands.

Franchised business operations are symbiotic – they thrive when there’s a balance between franchisor and franchisee. However, this interdependence also introduces an extra layer of complexity, which can pose significant challenges if the relationship falls out of balance. This can happen for several reasons, such as the franchisor struggling to meet its obligations around brand development, marketing, or supply consistency, or the franchisee facing challenges in maintaining systems and standards, meeting financial targets, or handling external pressures like rising labour costs, increased operating expenses, or declining customer demand.

In cases where either party requires an insolvency procedure, this interconnectedness makes the process more challenging and the outcome for creditors more uncertain. Unlike standard insolvency cases, the insolvency practitioner must navigate not only the usual employee, financial creditor, and trade supplier interests but also the specific obligations set out in the franchise agreement. These agreements often introduce additional obligations that can complicate issues like premises leases, branded stock, and other asset realisation restrictions.

Taking the time to understand how all these jigsaw pieces fit together is crucial to achieving the best possible outcome in a franchised business insolvency. This is what makes these cases particularly interesting – and why I felt compelled to explore the topic further. Insolvency of a franchisee business can indeed be more complicated than handling a standard independent business. Some of the key challenges include:

1. Franchise Agreements: Franchisee businesses are bound by specific franchise agreements that outline the relationship with the franchisor. These agreements often contain clauses that affect the insolvency process, such as how the franchise’s brand, intellectual property, and business model will be handled. For instance, during the recent liquidation of a franchised gym, a significant portion of the equipment was branded, which added complexity to the realisation process.

2. Brand Control: The franchisor usually has significant control over the brand and operations. If the franchisee becomes insolvent, the franchisor may wish to terminate the agreement, which could affect the ongoing value and operations of the business during the insolvency process.

3. Franchise Fees and Royalties: Franchisees are required to pay ongoing fees or royalties to the franchisor. These obligations may still be due even during insolvency proceedings, complicating the resolution.

4. Supplier Relationships: Franchisees typically rely on specific suppliers or networks tied to the franchisor. These relationships may have to be renegotiated or disentangled during insolvency, which can be difficult if the franchisor insists on exclusive supplier arrangements.

5. Franchisee Obligations: If the franchisee owes money to the franchisor, or if the franchisor’s brand and reputation are at risk, the insolvency could require a more delicate negotiation to balance all stakeholders’ interests.

In general, managing a franchisee insolvency requires more careful management of the legal, contractual, and operational aspects than a standard business insolvency. However, as demonstrated by our successful restructuring of the two Domino’s stores recently, it is entirely achievable through clear communication with all stakeholders and a well-structured rescue proposal.

Andrew Spring
Partner
Jirsch Sutherland