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Franchisees at a loss when franchisor fails

STARTING a new business can be daunting. Many business fail as a result of poor management or lack of initial funding. But what if you could rely on a well-known successful brand, tried and tested systems and processes, established suppliers and customers, and support from a large buying group? Today, more than half a million Australians are employed in franchises and there are more than 850 franchise systems in Australia. And while most franchise operations are successful, a study commissioned by Australia’s largest accounting body, CPA Australia, has found there is little protection for franchisees under insolvency laws when their franchisor fails. The exploratory study, When the Franchisor Fails, conducted by the University of New South Wales, was undertaken to determine the effect of franchisor failure on franchisees. Bottom line: “Franchisees have no control over their future when a franchisor fails,” according to CPA Australia business policy adviser Judy Hartcher. “They are often at the mercy of liquidators and administrators whose primary responsibility is to find the best outcome for creditors. The best price, not the best buyer, is the liquidator’s main concern when selling the business. Little consideration is given to the buyers’ ability to run a franchise system.” Franchisees are also vulnerable to the decisions made by liquidators that could affect their business viability. For example, liquidators have the right to terminate any onerous contract to which the franchisor was a party, including franchise agreements and leases for franchise premises. The study also found that franchisees of failed systems had no statutory voting rights at the franchisor’s creditors meeting as they were not usually recognised as creditors by law. “The exposed position of franchisees when a franchisor fails supports the view that they have limited legal redress under Australian insolvency laws and there may be an opportunity for review,” Ms Hartcher said. The situations that franchisees find themselves in when a franchisor failed also demonstrated their unique position and how different they were to other small businesses. The challenges that they face during a franchisor insolvency stem from the complex nature of the modern franchise model and the dependent nature of their relationship with their franchisor. “For example, franchisees often have difficulty trading when the franchisor is in trouble as customers do not distinguish between the franchisee and franchisor’s business,” Ms Hartcher said. “This can be particularly so if the franchise system has a high profile and receives a lot of media attention. “Traveland, which became insolvent in 2001 as a result of the collapse of its parent company Ansett Airlines, is a case in point.” While most franchise systems in Australia were healthy and profitable, the study identified 40 failed franchisors in the past 15 years, affecting 1,090 franchisees. Overall, franchising contributes about 10 per cent of Australia’s GDP and in 2004, there were about 850 franchisors in Australia. According to the study, franchisees that are hardest hit by franchisor insolvency were those that: • were new to the system; • did not have specific qualifications but were attracted to the franchise; • had high sunk costs (debt-servicing needs) from paying a high franchise fee and had paid for an expensive fit out in a major shopping centre; • had many employees; • did not have the lease in their own name and lost the right to the site when the franchisor’s failure constituted a breach of the lease; and • did have the lease in their own name and were not able to trade profitably once the franchisor failed. “When a franchisor fails, franchisees may be able to negotiate a better outcome for themselves by grouping together and taking necessary and timely action. However, this solution is difficult to achieve as they often have no contact with each other, except through the franchisor,” Ms Hartcher said. “The possibility of finding each other through phone directories can be near impossible if they do not know each others’ names. ‘Without adequate legal protection, a franchisee’s best defence lies in prevention. “When the franchisor and the franchisee have their initial discussions, the franchisee should consider how the franchisor’s failure would affect him or her and take it into account when negotiating the franchise agreement.” The research contained in When the Franchisor Fails, was commissioned by CPA Australia because of the leading role played by the accounting profession when franchisors failed. The research was conducted by Jenny Buchan, of the School of Business Law and Taxation at the University of New South Wales. Formerly a commercial lawyer in private practice for 19 years, Ms Buchan’s focus as a lawyer and academic has been on franchising and the challenges it poses for insolvency law. A copy of the report can be downloaded from www.cpaaustralia.com.au.

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