Franchisor in trouble, what to do?

It seems inevitable that the world is heading for a recession. No one can predict how deep or long-lasting it will be, but there is no doubt that it will be an economic downturn. This circumstance also has an effect on the franchise industry. In practice, it appears that franchisees are feeling the consequences of the economic downturn, but so are franchisors. The latter in particular, franchisors in difficulty, often leads to difficult situations that can affect many parties. Examples include the financing banks, with whom the franchisor often has an arrangement, suppliers, landlords and, last but not least, the franchisees. After all, in the case of credit arrangements, sublease relationships and supplier relationships, the franchisee in his business operations, despite the fact that he is an independent entrepreneur, is still highly dependent on the fortunes of his franchisor.

In popular terms, if a franchisor goes bankrupt, this can, in the light of the above, have major consequences for the bank financing of the franchisees. Furthermore, the fate of the franchisee’s lease may at the very least become uncertain and may lead to a halt in deliveries on the part of the contract suppliers and significantly less favorable purchasing conditions for the franchisee when purchasing elsewhere. It is therefore important for the franchisee to be extremely aware of his position in all these areas. In general this is of course true, but especially when things rumble on the horizon. Under certain circumstances, it may be worth considering prematurely terminating the franchise agreement in order to try to avoid the most drastic consequences of a possible bankruptcy of the franchisor. In any case, it is important to obtain timely external advice in such situations, if possible in a collective context, thus together with the other franchisees of the franchisor concerned.

More concretely, it is particularly useful to consider the termination provisions in the franchise agreement and what these stipulate regarding the possibility of (premature) termination in the event of bankruptcy or cessation of the franchisor’s business activities. The same should be checked with the sublease agreement, if there is one. Also of great importance in that context is any non-compete clause included in the franchise agreement and the question to what extent this remains applicable after the bankruptcy or liquidation of the franchisor. It is of great importance in this respect that the non-competition clause does not automatically lapse after bankruptcy and that a trustee of a bankrupt franchisor can still derive rights or claims from it in the aforementioned cases.

In addition, in the event of dire weather at the franchisor, it is important to consult the financing bank in good time and, if possible, to make alternative financing arrangements. The latter also applies to deliveries: although foreign purchases are generally not permitted during the term of the franchise agreement, and this prohibition should of course not be challenged, a breakdown by the franchisor may necessitate at least the investigation of alternative channels.

Finally, it should be noted that in practice it often happens that when a franchisor is in difficulties, the reaction of (some of) the franchisees is to reverse automatic payments and also suspend other financial obligations. In general, this is not a recommendable course of action: such actions precipitate the bankruptcy of a franchisor rather than bring about an improvement in cooperation. If a franchisor were to go bankrupt (partly) as a result of such a course of action on the part of the franchisees, the franchisees would also run the risk that the bankruptcy trustee would attribute the responsibility for the bankruptcy to the franchisees, resulting in all kinds of difficult liability discussions and risks.

The bottom line of all this: know your position.

Ludwig & Van Dam franchise attorneys, franchise legal advice