Updated: 19th January 2021
It is commonly the case that franchise agreements terminate automatically when a franchisee enters insolvency. Agreements vary, but whatever the situation, the franchisor will want to recoup any arrears of fees and charges, or other payments due under the agreement.
The problem for a franchisor is that UK insolvency law often supersedes the terms of a franchise agreement. The Insolvency Act, 1986, states that in liquidation, the office-holder can terminate ‘onerous contracts,’ of which a franchise agreement may be one.
The office-holder’s main role in an insolvent liquidation is to collect in and realise assets, and assess the company’s liabilities. As a franchise agreement involves the payment of fees and other charges to a franchisor, the liquidator is within their rights to regard it as a liability rather than an asset, even though without the franchisor, the business would not exist.
If the liquidator decides that this is the case, the franchise agreement then becomes what is known as an ‘onerous contract’ which can be disclaimed under UK insolvency law.
Under Section 178 of the Insolvency Act, 1986, a liquidator has the right to terminate ‘onerous contracts.’ These can include franchise agreements, even if there is no clause within the agreement stating that termination will automatically take place in the event of franchisee insolvency.
The power for a liquidator to act in this way helps to facilitate the winding-up and closure of a company during liquidation. Where a contract is terminated by the liquidator, the franchisor becomes an unsecured creditor for any fees, charges, or other payments owed to them under the original agreement.
A franchisor usually holds the head lease for premises occupied by their franchisees. Premises are then sub-let, and when a franchisee becomes insolvent, the holder of the head lease is likely to become responsible for arrears of rent.
This allows the liquidator to reduce the insolvent company’s expenditure, and maximise creditor returns. Unfortunately, this situation can lead to the franchisor also experiencing financial problems, particularly if more than one franchisee has experienced financial difficulties.
So what if it is the franchisor that is facing liquidation?
There are several areas of concern for franchisees, when their franchisor enters insolvency and has to be liquidated. One of these involves the intellectual property, including trademarks, designs and other artistic works, around which the franchisee business has been built.
The liquidator will identify intellectual property as a major business asset, and subsequently sell it for the benefit of creditors, but the franchisees may decide to group together to buy the intellectual property themselves.
Other issues involve the ownership and use of hard assets, such as machinery and equipment. The insolvency and subsequent liquidation of a company in a franchise agreement can be a complex affair given the unique relationship between the two parties.
We can help you establish your company’s financial position, and make sure you take the most appropriate action. If you need further information about the liquidation of companies in a franchise agreement, Begbies Traynor will provide practical support and assistance.
We can examine the franchise agreement, establish where you stand, and provide professional guidance on the best way forward. Call one of the team for a free same-day consultation with a licensed insolvency practitioner.