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Michael Murray is an Australian author and commentator on corporate and personal insolvency law and related policy and law reform, in Australia and internationally. No legal advice is offered or given.

A not so simple fix for franchise insolvency?

The financial collapse of a franchisor can have a severe impact on its franchisees but a “simple fix” proposed to address that impact may not be simple at all.

Those academics and policy makers concerned about the business model of franchises, and its lack of legal protection in such cases, often seek to offer protection by way of amending the corporate insolvency process. One difficulty, the least of them, is that franchisees are usually not creditors in the insolvency of the franchisor. This may be because franchise law comes not out of the Corporations Act model, but from consumer law, with franchisees seen as consumers rather than investors.

A recent article offers what is marketed as a “simple fix” – to bring franchise arrangements under the Corporations Act in Australia, and in that process define the rights and responsibilities of both parties. An alternative is stand-alone legislation which the article says is not a model adopted in many other countries.

Bringing franchise arrangements under the Corporations Act?

“Bringing franchise arrangements under the Corporations Act” involves, according to the authors, these suggested corporate and insolvency related reforms:[1]

  1. Oblige insolvency practitioners to keep franchisees informed;
  2. Require franchisors to inform franchisees if any of its decisions may adversely impact the solvency of (a) the franchise network, (b) the individual franchisor or (c) the franchisee;
  3. Require any information about decisions that relate to (a) debt restructuring of the franchisor or any entity whose failure would adversely affect it, (b) organisational change or restructuring of the franchise or franchisor and/or (c) the insolvency or imminent insolvency of the franchise or franchisor, be given to the franchisee no longer than 14 days after the decision is made;
  4. Provide that in any of the above situations the franchisee can require the franchisor (or the buyer) to buy back the franchisee’s unit(s) if the change results in the franchisee being materially disadvantaged;
  5. Adopt a variation of the EU ‘works council’ model and include franchisees on the board of any corporation that owns or operates a franchise network;
  6. Expand the corporate franchisor’s directors’ duties to oblige directors to owe to franchisees the same duties as they currently have to their company’s shareholders, employees and creditors;
  7. Require that corporate governance includes a duty for directors to take decisions that factor in the well-being of the corporation’s franchisees;
  8. Remove Australia’s ‘Exempt Proprietary Company’ exemption under the Corporations Act from any company that is issuing franchise agreements;
  9. Amend corporate law to give franchisees the right, during the Part 5.3A voluntary administration period, to collective representation at committees of creditors. An issue to resolve would be whether to allocate them voting rights ‘for a dollar’ per franchisee or for an amount that more nearly equates to the size of their investment; and
  10. Require franchisors to inform the state and/or private institution governing or regulating franchises in advance if a decision may adversely impact the solvency of (a) the franchise network, (b) the individual franchisor or (c) the franchisee. Such information should be made publicly available to potential franchisees.

Comment

Others may comment on the details of these but from an insolvency perspective, some are quite problematic, for example to require a franchisor to publicly announce any decision it makes that may adversely impact its solvency.

Other approaches?

There are various types of business entities that are not suited to the strict levelling of insolvency law and a policy response is often to create their own regime.

Banks, insurance companies have theirs, for economic policy reasons; Aboriginal corporations have theirs, for social policy reasons. There are those, like managed investment schemes, that have been caught out, like franchisees, in finding that there are no laws available to address the impact of insolvency, except for the unsuitable and inflexible Corporations Act. Then there are those – employees – who for more policy reasons – are given some particular protection, not only in the Corporations Act, but also under the Fair Entitlements Guarantee Act. While there are some parallels to be drawn between franchisees and employees, it is a long stretch, for legal and policy reasons, to equate them.

The issue seems to do less with giving franchisees protection and rights to information in an insolvency, than the franchise system itself needing its own better legal structure – one that creates legal relationships and responsibilities and otherwise addresses the numerous difficulties with the present laws described in the article. If that structure creates a creditor status for the franchisee, well and good – that franchisee can stand in line like other creditors in the franchisor insolvency, usually an unproductive task, but they are welcome to it.

Whatever ways may better support the franchise structure, and enhance its merits, no such structure could or should eliminate risk. As Goode says, ‘risk can only be eliminated by not doing business at all’. 

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[1] Moral Hazard, Path Dependency and Failing Franchisors: Mitigating Franchisee Risk Through Participation, Jennifer L L Gant and Jenny Buchan, (2019) 47(2) FLR 261-287. As edited.  See BusinessThink UNSW.

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