What Happens When a Franchisor Goes Out of Business?

You did everything right. You followed advice and performed your due diligence before signing the franchise agreement. You entered the franchise contract feeling confident that the franchisor had developed a robust system and a trusted and recognisable brand name. But what happens if it all goes wrong?

Suddenly, the factors that had made this one of the best franchise opportunities out there are deemed worthless now the franchisor has gone out of business. There are so many questions to answer. Can you keep using the system? What about the brand? Is your territory still exclusive?

Unfortunately, it’s difficult to solve these questions, as the answers will depend on the reasons why the franchise is failing. The collapse of a business can be extremely worrying, and although it happens very rarely, it’s a risk that comes with buying into a franchise.

Here, we’ll take a look at the legal rights of an entrepreneur facing franchise liquidation and how your standard franchise agreement can be affected by it.

What if the franchisor goes into administration?

If the franchisor experiences severe financial difficulties, the first step will be to put the business into administration. At this point, the administrators take control of the franchise as they attempt to save the company from failing. As a franchisee, you're obliged to adhere to the terms of the franchise agreement and continue trading.

If you have adequate capital and want to buy out the business, this could be one of the franchise opportunities for sale that you’ve been waiting for. You could either do this alone or in collaboration with several other fellow franchisees.

A word of warning though; you must consider the pros and cons of taking over the business and consult professionals before you take any action. Having said that, you should let the administrators know your intentions as soon as possible before external buyers start to show an interest.

If an external buyer does purchase the business, you will have no say in what’s happening. The good news is that the business would be sold as a franchise and your contract would still be valid. For many franchisees, this is the best possible outcome, as they can continue to own and operate their franchise under the same terms as they did before the franchisor went bust.

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What if administration isn’t an option?

If administration isn't right for the business or it fails to find a buyer, the next step is liquidation. The main aim during the liquidation process is to sell off the franchise’s assets to the highest bidder. In this situation, your franchise agreement becomes invalid, as the franchisor is not able to continue their obligations. Therefore, the franchise contract ceases to continue.

Depending on how experienced you are as a business owner or franchisee, you will take different measures when your contract comes to an end. There are a couple of options for you:

• If you’re very experienced and confident in your abilities to run your own independent business, liquidation gives you the chance to continue trading without having to pay ongoing fees to the franchisor.
• However, at the other end of the scale, if you’re new to franchising, the thought of going it alone may be too daunting to turn it into a reality. You may also be in a difficult financial situation because you have recently invested in the franchise, but as yet have not reaped any of the rewards of being part of a franchise system. In this case, you may have to shut down your business.

What happens to the intellectual property?

Any intellectual property associated with the franchise will also be sold off as part of the liquidation process. But not every element of your agreement can be conserved. Here’s what’ll happen to different aspects of your business:

• Your brand – If you and some other franchisees choose to club together, you could potentially buy the franchisor’s brand and trademarks. If you are unable to do this and no one else steps forward to buy them, you will probably have to change your brand identity. The franchisor’s liquidator or administrator will want to get as much money as possible out of the brand in order to pay off the debts, so they’ll sell it if they can.
• Your territory – When the franchisor disappears, so do your territorial rights. This may or may not be an issue if you decide to continue trading – it all depends on the nature of your business and its location.
• Your suppliers – When a franchise system dissolves, suppliers are under no obligation to continue offering the benefits that former franchisees previously enjoyed. If you want to continue running your business, you may be able to negotiate favourable deals with your existing suppliers.

As you can see, it’s difficult to say exactly what will happen if your franchise does go into liquidation. Every situation is different and there’s no way of knowing whether you’ll be able to continue trading in a similar way after the process is completed. The best you can do is stay aware of any changes to the franchise and keep your options open as much as you can.

What will happen to the franchise system?

The value of the franchise system will depend on the type of business you run. In some franchises, there may be many elements that will continue to remain the property of the franchisor, such as operating procedures. Unlike a trademark that can be purchased or a supplier that can be negotiated with, the system is more difficult to sort out.

What if I’ve taken out a loan from the franchisor?

Sometimes, franchisees buy equipment or other assets from the franchisor through a loan rather than purchasing them outright at the start of their franchise agreement in order to keep costs down. If you haven’t finished repaying your franchisor back at the point they go into liquidation, your franchise unit may not be safe. In this scenario, the franchisor’s liquidator may recover those assets from you, stopping you from continuing to trade and turn a profit.

What do I need to bear in mind before becoming an independent business owner?

Before you start trading independently, you should try to work out which aspects of the business format are out of bounds and which you’ll be able to continue applying to your newly self-sufficient business. You don’t want to start your next venture with a cloud of legal issues hanging over your head because your former franchisor decides to take you to court.

What should I do if I’m faced with a franchisor who cannot pay their debts?

Here is our advice for franchisees who discover their franchisors are about to lose the business. This can be a difficult and confusing time, especially given you’ve invested a significant amount of money in a brand you trusted. But by following our guidance, you can ensure you put yourself in the best place for the future.

• Work with the professionals – It’s in your best interests to cooperate with the liquidator or the new buyer of the franchise. In circumstances like these, the future of your business is not secure, so working with the people in positions of authority may help to maintain goodwill at this crucial time. Also, if you build a relationship with them, you're more likely to be kept updated throughout the whole process. In turn, this should reduce your anxiety and give you the opportunity to get involved if you want to.
• Act fast – The sooner you touch base with key contacts within your business, the better. Speak with your suppliers and landlord to make sure that your payments are up to date. You don’t want your business to suffer as a result of the franchisor’s financial difficulties.

There are so many things to take into consideration if the franchise folds. It can be a tough time, not only professionally, but emotionally too. Sometimes, franchisors will want to exhaust every avenue before they admit defeat, so you may get less warning.

But, in an ideal world, the franchisor would want to help their franchisees as much as possible and let you know ahead of time if they are expecting to experience difficulties. Usually, this means providing notice of no less than five years before liquidation.

What if I want to buy the business?

This is a huge decision and shouldn’t be made lightly. You’ll need to do a significant amount of research to make sure you’ll be able to turn a profit without encountering the same issues the current franchisor faced. Find out more about this topic from the Business Rescue Expert by clicking here.

What next?

If your franchisor has announced they’re struggling financially, it’s natural you’ll be concerned about your franchisee rights and how you’ll be able to continue running your own business. The situation is different for each franchise, so we can’t tell you exactly how the process will be for you, but by staying in close contact with your franchisor, you’ll be able to make sure you’re always informed and in a great place to make any quick decisions if you need to.