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11 June 2019
Failures rates in franchising are typically much lower than non-franchised start-ups. However, the latest British Franchise Association/NatWest survey of the UK franchising sector cites franchisee underperformance as one of the three key concerns of franchisors, and franchise businesses are of course not immune from the economic headwinds and technological changes which are affecting various sectors.
Against the backdrop of a number of high-profile business failures in the UK retail sector, the government has issued a report on the insolvency regime, which will affect the operation of termination rights in supply agreements.
This article considers the proposals and provides a best practice recommendation for recovering goods in the possession of a franchisee once they have entered some form of insolvency protection.
The number of company voluntary arrangements (CVAs) is on the rise, driven by a number of factors, including increased costs and fierce competition from online sales. However, CVAs themselves are often not enough to save a failing business and this has led to the government stepping in and taking action. One of the proposed measures to support companies through a business rescue is the introduction of new rules to prevent suppliers terminating contracts solely by virtue of a company entering an insolvency process. This is relevant to franchisors, as most will also be the franchisee's principal supplier.
These measures are part of the government's wider response to its consultation on proposals to improve the corporate governance of companies that are in or are approaching insolvency.
Franchisors should take note of the following points contained in the government's response:
However, franchisors will retain the ability to terminate contracts on any other ground permitted by the contract such as:
It will be a few years before the measures become law (not least because of the distraction of Brexit). However, this development is relevant to any business entering into long-term supply agreements, as it is likely that the new laws, when passed, will apply to existing agreements.
These changes highlight the need for franchisors to assess their supply terms and ensure that the rights for termination are sufficiently detailed, clear and broad to enable the franchisor to take the necessary action when it is faced with an insolvent buyer.
Franchisors should ensure that they have comprehensive and robust terms of supply (ideally in a separate document from the franchise agreement) which have effective retention of title clauses so that they can take action to recover goods in an insolvency situation. However, franchisors often overlook terms of supply and do not give them enough attention.
Retention of title claims are a regular feature of claims made against insolvent businesses. Many suppliers of goods must have an all monies retention of title clause enabling them to recover the goods held by the retailer when they go into insolvency or alternatively payment for those goods in full to the value of the goods held at the date of the appointment of the insolvency practitioner.
It is well established in English Law that a buyer of goods has the right to sell goods once they are in possession, notwithstanding the supplier having retention of title and ownership in the goods. By selling the goods to a third party, title effectively passes, thereby negating the benefit of the retention of title clause. Recovering the proceeds of sale of any goods supplied is impossible unless the supplier has obtained a legal charge over the company's assets to the value of the goods, which is unusual in normal supply relationships.
In addition, credit insurers usually insist on their insured clients having an automatic termination of the licence to sell in the event of an insolvency of the buyer.
This type of clause will give a supplier a contractual right to insist that the buyer and the insolvency practitioner stop selling the supplier's goods immediately on the practitioner's appointment. To back this up, writing immediately on their appointment revoking the licence to sell and demanding an inventory showing the value of the goods held at the time of their appointment are recommended so that the value of the retention of title claim can be calculated as it crystallises at that point.
If the buyer continues selling the goods after receipt of such a letter, the supplier is entitled to claim the value of all goods sold following termination of the licence to sell, together with any goods that are retained by the buyer. This enables the full valuation of the retention of title claim to be pursued and hopefully payment made in full if the business carries on trading.
In most cases, the administrator will resolve the retention of title claim by paying the full value of the goods held once the inventory is agreed. Stock controls systems are usually available to provide a printout from the retailer's IT system showing the amount of goods held and their value. This is essential in deciding whether to pursue a retention of title claim.
If this clause is not contained in the terms and conditions, a letter should be sent immediately to the administrator, terminating the licence to sell in any event. If no such letter is sent or if there is no such clause in the terms and conditions, the value of the retention of title claim will diminish with each day of continued trading as the stock is depleted and sold.
It is therefore essential to terminate the licence to sell and preferably incorporate such a clause into the applicable terms and conditions to avoid these problems arising.
Most franchisors will act as suppliers of goods and services. As a franchise network grows, so does the systemic risk to the franchisor of franchisee default and failure. It is therefore important that franchisors invest in proper legal advice and legal contracts to ensure that they have the contractual rights to act quickly and effectively if the need arises.
It is recommended that franchisors review the interrelationship between the franchise agreement and the standard terms of supply, paying close attention to termination rights and developing a clear process for dealing with franchisees that are in financial distress.
For further information on this topic please contact Gordon Drakes at Fieldfisher LLP by telephone (+44 20 7861 4000) or email (firstname.lastname@example.org). The Fieldfisher LLP website can be accessed at www.fieldfisher.com.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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