Struggling Franchises

A survey carried out in 2017 by Franchising New Zealand identified the fact that New Zealand had, at that time, the highest proportion of franchises per capita in the world. With around 630 franchise brands, it was estimated that they made up about 7% of the small businesses in New Zealand, employed over 124,000 people and contributed $27.6 billion to the New Zealand economy, plus an additional $11.1 billion in motor vehicle sales and $7.4 billion in fuel sales.

We could not find any more recent figures, but which ever way you look at it, franchises make up a significant portion of businesses in New Zealand.

As with other business models, there have been individual franchisees fail before Covid-19 came to our attention, with a number of Mad Butcher outlets failing in the last couple of years being one high profile group.

Many of the franchises are in the types of business that cannot open and operate normally under Covid-19 levels 3 or 4, such as those involved in the food and hospitality, fitness, and health & beauty industries. Some involved in property care and maintenance might be able to operate under level 3 but will have suffered, along with practically every other business’ under level 4.

These same franchised businesses are also the type that provide goods and service which, in most cases, would fall into the category of discretionary spending for customers and therefore will be a bit further down the priority list for spending once the economy starts to get back to something approaching normal.

The appointment of receivers for the New Zealand owners of the Burger King franchise is the 1st high profile Covid-19 franchise victim but it is unlikely to be the last. Burger King is slightly different in that the vast majority of its outlets are owned by the New Zealand franchisor, as opposed to individual franchisees, but it still affects the lives of more than 2,600 staff across the country. Hopefully, for all those involved, a successful sale of the business will be achieved and mean that those outlets can all reopen for business.

We believe there is likely to be more franchised businesses to close in the coming months, or fail to re-open at all, and the effects on the individuals involved may be compounded by the fact that they are party to a franchise agreement.

The agreements will not all be the same, but most will include some, or all, of the following terms, which are there to protect the rights of the franchisor:

• The requirement to pay on-going franchise fees, licence fees and a contribution for advertising.
• The franchisee does not own the intellectual property.
• The franchisee cannot assign the rights under franchise agreement without franchisor’s agreement.
• The agreement can be terminated by notice in writing by franchisor on the occurrence of various events, including failure to pay amounts owed to the franchisor, failure to pay rent (where the franchisee is a sub-lessee of the franchisor), liquidation or receivership.
• On termination, there is a restraint of trade within specified areas for specified periods.
• Where the agreement is terminated as a result of one of the defaults (such as those listed above), the franchisee can be required to sell fixture and fittings and equipment etc to the franchisor, or nominee, at the lower of fair market value or book value as recorded in latest accounts.
• The franchisee will have given a personal guarantee to the franchisor.

The extra franchise expenses, on top of the normal business payments of rent, insurance, finance interest and payments etc, if not deferred or reduced by the franchisor, impose a further burden on the businesses concerned that have already faced 4 weeks without income.

The ability for the franchisee to sell and recover the maximum value from the business assets may also be limited by the terms of the agreement, as outlined above, and leave their personal assets exposed to claims under the personal guarantee.

Without question, franchisees in many categories of industry will have suffered under level 4 and many will continue to suffer under level 3.

If they have not already done so, they should be talking to their accountants and bankers in relation to the support packages that may be available to them.

When considering their options, franchisees should also be consulting their legal advisors on the effect the terms of their agreement with the franchisor will have on their ability to deal with the assets of the franchise, and on their personal liability, before making final decisions on what to do.

If a franchisee is looking to exit due to hardship then talking to the franchisor may be the first option. A new franchisee to take over the lease obligation, to continue to trade and to protect the brand may be a win-win for all concerned. The ceased business can then look at winding up options.

 

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