Franchisees struggle when franchisor fails: study

The situations that franchisees find themselves in when a franchisor fails also demonstrate their unique position and how different they are to other small businesses. The challenges that they face during a franchisor insolvency stem from the complex nature of the modern franchise model and the dependent nature of their relationship with their franchisor.

Queensland Business Review
March 6, 2006

Franchisees struggle when franchisor fails: study

Franchisees find little protection under insolvency laws when their franchisor fails, according to a study commissioned by Australia's largest accounting body, CPA Australia.

The exploratory study, When the Franchisor Fails, conducted by the University of New South Wales, aims to determine the effect of franchisor failure on franchisees.

CPA Australia's Business Policy Adviser Judy Hartcher says, "Franchisees have no control over their future when a franchisor fails."

"They are often at the mercy of liquidators and administrators whose primary responsibility is to find the best outcome for creditors. The best price, not the best buyer, is the liquidators' main concern when selling the business. Little consideration is given to the buyers' ability to run a franchise system."

"Franchisees are also vulnerable to the decisions made by liquidators that could affect their business viability.

"For example, liquidators have the right to terminate any onerous contract to which the franchisor was a party to, including franchise agreements and leases for franchises' premises."

The study also found that franchisees of failed systems had no statutory voting rights at the franchisor's creditors meeting as they are not usually recognised as creditors by law.

Hartcher adds, "The exposed position of franchisees when a franchisor fails supports the view that they have limited legal redress under Australian insolvency laws and there may be an opportunity for review".

The situations that franchisees find themselves in when a franchisor fails also demonstrate their unique position and how different they are to other small businesses.

The challenges that they face during a franchisor insolvency stem from the complex nature of the modern franchise model and the dependent nature of their relationship with their franchisor.

Hartcher explains "For example, franchisees often have difficulty trading when the franchisor is in trouble as customers do not distinguish between the franchisee and franchisor's business".

"This can be particularly so if the franchise system has a high profile and receives a lot of media attention. Traveland which became insolvent in 2001 as a result of the collapse of its parent company Ansett Airlines is a case in point."

While most franchise systems in Australia are healthy and profitable, the study identified 40 failed franchisors in the last 15 years, affecting 1090 franchisees.

Overall, franchising contributes about 10% of Australia's GDP and in 2004, there were about 850 franchisors in Australia.

According to the study, franchisees that are hardest hit by franchisor insolvency were those that:

  • Were new to the system
  • Did not have specific qualifications but were attracted to the franchise
  • Had high sunk costs (debt-servicing needs) from paying a high franchise fee and had paid for an expensive fit out in a major shopping centre
  • Had many employees
  • Did not have the lease in their own name and lost the right to the site when the franchisor's failure constituted a breach of lease
  • Did have the lease in their own name and were not able to trade profitably once the franchisor failed

Risks: Sunk costs: franchisee's trapped capital keeps them chained to treadmill, When the franchisor tanks, so does the franchisee, Insolvency, Franchisees are pawns in insolvency flip, Risk much higher for franchisee than independent business, Franchisor insolvency, Academic research, No real penalties for abuse of federal insolvency laws, Lease controlled by franchisor, Australia, 20060306 Franchisees struggle

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