Managing Franchisee Debt – Update on new insolvency laws and tips for minimising franchisor financial exposure
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One such measure is 233B Insolvency Act 1986. Introduced by the Corporate Insolvency and Governance Act 2020, section 233B can have a significant impact on franchisors.
Set out below is a brief summary of section 233B, together with some of the key measures franchisors can employ to minimise financial exposure.
Brief summary
Subject only to certain limited exceptions (in particular relating to financial services), section 233B applies to all contracts for the supply of goods and services (including franchise agreements and any related terms of supply between a franchisor and its franchisees) and:
- renders ineffective any contract term that provides for the automatic termination of a supply contract, or allows a franchisor to terminate a supply contract, based on the franchisee entering into a defined insolvency procedures (a "relevant insolvency procedure");
- renders ineffective any other contractual consequence that is triggered by the franchisee entering into a relevant insolvency procedure;
- prohibits a franchisor from making the continued supply of products or services after the franchisee has become subject to a relevant insolvency procedure conditional upon the franchisee having made all outstanding payments in respect of such products or services; and
- prohibits a franchisor from exercising a contractual termination right that is triggered prior to the franchisee entering into a relevant insolvency procedure if that right is not exercised before the commencement of that procedure.
Practical tips for minimising financial exposure
There are a number of practical steps franchisors can take to minimise financial exposure under section 233B. Some of the key measures to consider include:
- Imposing strict financial reporting obligations on a franchisee. The provision of regular information on the financial status of a franchisee is vital to enable a franchisor to keep a franchisee's continuing solvency under close review so that, where section 233B does apply, it can act swiftly and exercise its rights to protect its position before the franchisee becomes subject to a relevant insolvency procedure.
- Tightening payment terms in the franchise agreement and supply contracts. Not only will this assist in maintaining cash flow, but it will also help to highlight at an early stage any franchisee solvency issues.
- Allowing termination of the franchise agreement for non-payment or a deterioration in the franchisee's financial position. Although a franchisor may not want to exercise such rights where the franchisee's finances are generally healthy, they will be very useful if it has concerns about the solvency of the franchisee.
- Granting to the franchisor a contractual right to revoke the franchisee's licence to sell any products supplied by the franchisor for which the franchisee has not yet paid on the occurrence of any event entitling the franchisor to terminate the franchise agreement. This will give the franchisor a contractual right to insist that the franchisee stop selling the products immediately upon the occurrence of a termination event. This could be useful leverage for pursing a retention of title of claim, and in any discussions with the franchisee's liquidator.
- Including in the franchise agreement an obligation requiring the franchisee on termination to (i) provide a complete inventory of all products held in stock, (ii) identify which products have not been paid for and the total value of such products, and (iii) return to the franchisor all products for which it has not paid.
Comment
Where it applies, section 233B has a significant effect on the action a franchisor can take against a franchisee whilst it is undergoing a relevant insolvency procedure. Franchisors should act now to review their franchise agreements and supply terms to ensure that they provide the maximum protection available in the event of a franchisee's insolvency.