Recession proofing for Franchisors

Recession proofing for Franchisors

 

Recession proofing for Franchisors

by Mark O’Shea, Partner and Head of Franchising at Rawlison Butler LLP and Alexandra Lloyd-Foster, Associate at Rawlison Butler LLP

Although the current economic downturn is taking its toll on businesses large and small, there are many entrepreneurs who remain optimistic and, indeed, who believe that their business will flourish during these difficult times.

Recent experience demonstrates that a downturn in the economy actually encourages people to seriously consider their options and franchising is, for many franchisors, considered the safest route for business expansion.  However, there are a number of controls that need to be in place, especially for franchisors, to ensure that existing franchise businesses survive and thrive during a recession.

Warning Signs

The warning signs of businesses in financial difficulty are many and varied but it goes without saying that close monitoring of franchises in obvious or suspected difficulty is essential. Slow or non-payment for stock, late or non-reporting in accordance with the terms of the Franchise Agreement and failure or delays in attending regular meetings with the franchisor can be indicators that all is not well.

Protecting your reputation

Franchisors should re-visit the terms of their Franchise Agreements, particularly the application of 'step-in' rights that the franchisor can exercise should problems arise, as well as termination rights applying on the franchisee's insolvency. A well-drafted provision will enable the franchisor to terminate if the franchisee is unable to pay its debts as they fall due and where the franchisee ceases or threatens to cease trading. Late or non-payment of debts by the franchisee, such as those owed to third party suppliers, can seriously harm the franchisor's name and reputation, and so the prompt recognition of any problem and implementation of any remedial action is vital.

Where the franchisee is a limited company or limited liability partnership, it is always prudent for the franchisor to require personal guarantees from those standing behind the franchisee trading entity at the time the franchise agreement is entered into, especially if the franchisor is providing a financial contribution or support package, but it should always be borne in mind that a personal guarantee is only as good as the individual standing behind it. If in doubt, a bank guarantee should be considered.

Any retention of title (RoT) provisions for stock supplied by or through the franchisor should also be scrutinised. Ideally, a good RoT clause should oblige the franchisee to keep all goods separate and identifiable from the franchisee's own goods or those of any third party, and whilst it is not possible to prevent the franchisee from selling goods in the ordinary course of business, the clause should ensure that the franchisor's rights transfer to any sale proceeds of those goods. Though not always practical, it is a good idea to require those funds to be maintained in a separate, designated bank account in the franchisor's favour in order to avoid those funds being mixed with the franchisee's other funds available to its creditors generally.

Property issues

Where a franchise network involves property, a franchisor can consider requiring their franchisees to take on direct liability for the leases and the lease/rental payments.  Where franchisors take the lease of premises themselves and grant a sublease to the franchisee, the franchisee will already have these liabilities.  However, by requiring the franchisee to take the lease directly, it will enable the franchisor to avoid the franchisor having to make the lease/rental payments and then being out of pocket if the franchisee does not make the payments due to the franchisor under the sublease.

Where the franchisor requires a franchisee to take the lease direct it will need to ensure the following:-

1. The lease contains a right of first refusal in favour of the franchisor in the event of the franchisee wishing/needing to assign the lease
2. The franchisor has an option to take the lease from the franchisee should the franchisee default, be in arrears, breach the franchise agreement or become insolvent
3. The term of the lease coincides with the length of the term of the franchise agreement; or, if the lease term is longer, the lease contains an option to break in favour of the franchisee permitting the franchisee to terminate the lease in the event of the franchise agreement not being renewed.  The franchise agreement will need to contain a provision requiring the franchisee to ensure the lease contains such an option to break; and, that the franchisee exercises this break in the event of the franchise agreement not being renewed.
   

Where the franchisor wants to continue taking leases itself and granting subleases to its franchisee, it may want to consider taking personal guarantees from the franchisee principals, where the franchisee is a limited company or a limited liability partnership.  As personal guarantees are only as good as the individuals behind them, a franchisor should also consider taking a rent deposit to cover rent arrears and breaches of covenant in the sublease by the franchisee.

Room for optimism

Undoubtedly, and for a variety of reasons, an economic downturn can be a good time to develop a franchise business.

Existing or prospective franchisors can often:

• Negotiate improved terms and/or lower prices for the purchase of stock, equipment and/or advertising
• Take advantage of lower market values and reductions in property prices or rents; and
• Benefit from a potentially greater pool of prospective, skilled franchisees.
  

For many prospective franchisees, redundancy can and often does prove to be the catalyst for a lifestyle change and the opportunity to run your own business, with franchising representing a relatively low risk means of doing so.

The fact remains that business is cyclical – there are always booms and busts, and if the right controls are in place, franchisors and franchisees should remain optimistic!

For further information visit www.rawlisonbutler.com or email Mark at moshea@rawlisonbutler.com