Managing franchisee debt – new insolvency laws update and tips for minimising franchisor financial exposure

Introduction
Brief summary
Practical tips for minimising financial exposure
Comment

Introduction

As businesses begin to feel the benefits from lockdown easing, it is important to remember that a number of businesses are now saddled with eye-watering levels of debt and some may not return to financial health. At the same time, some of the economic measures put in place by the UK government to reduce the impact of the covid-19 pandemic are here to stay.

One such measure is section 233B of the Insolvency Act 1986. Introduced by the Corporate Insolvency and Governance Act 2020, section 233B can have a significant impact on franchisors.

This article summarises section 233B and some of the key measures that franchisors can employ to minimise financial exposure.

Brief summary

Subject to only certain limited exceptions (in particular, those 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 procedure (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 a 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 numerous practical steps that franchisors can take to minimise financial exposure under section 233B. Some of the key measures to consider include the following:

• 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 cashflow, 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 useful if it has concerns about the solvency of the franchisee's solvency;
• granting 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 if any event entitling the franchisor to terminate the franchise agreement occurs. 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 pursuing a retention of title of claim and in any discussions with the franchisee's liquidator; and
• including an obligation in the franchise agreement that, upon termination, requires the franchisee to:
  • provide a complete inventory of all products held in stock;
  • identify which products have not been paid for and the total value of such products; and
  • return all products for which they have not paid to the franchisor.

Comment

Where section 233B applies, 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.

For further information on this topic please contact Gordon Drakes at Fieldfisher LLP by telephone (+44 20 7861 4000) or email ([email protected]). The Fieldfisher LLP website can be accessed at www.fieldfisher.com.