Many prospective Franchisees are aware of the much quoted mantra to “take independent legal advice” and many do take advice and embark on their franchise journey...
Time to go
As a franchise matures it is likely that from time to time a franchisee will want to leave the network for various reasons including retirement or because they wish to embark on a new business venture.
Ideally a departing franchisee will be immediately replaced, either by a new recruit to the network or by an existing franchisee wishing to expand their territory. In either case the departing franchisee will usually want to realise the value of the business he or she has created, so a business sale of some form will take place.
This is a transaction which should not take place in isolation from the franchisor. On the contrary, a well advised franchisor will take a hands-on approach to such transactions.
What then are the key issues for a franchisor in relation to franchise resales?
Make sure you have an organised process in place for your franchise resales. Inevitably both the outgoing and incoming franchisees will want everything to happen as quickly as possible.
As the franchisor you will also be keen to have the new franchisee signed up to a new franchise agreement, paying a licence fee and up and running in the business as soon as possible. However, the practical transfer of the business and any related premises ahead of the “legals” can result in an unholy mess.
Breach of franchise agreement
The signing of the new franchise agreement before formal completion of the transfer is likely to be a serious breach of the existing franchisee’s franchise agreement because it effectively grants a second franchise in the same territory.
Breach of lease
Allowing the new franchisee into occupation of the premises prematurely is likely to be a breach of the existing franchisee’s lease, exposing both old and new franchisee to the risk of eviction. Add to that the prospect of negotiations between the existing franchisee and the buyer breaking down before the legals are completed and it is easy to see that the franchisor can end up in a situation where it has two franchisees, appointed to the same territory,who are now refusing to speak to each other.
This scenario is likely to result in a thoroughly disgruntled seller who has not realised his or her desire to leave the network and has received nothing in respect of their business, the value of which may well have been reduced by the actions (or lack of them) on the part of the new franchisee after taking over the running of the operation. Throw a group of disenchanted employees into the melting pot and it is easy to envisage a resulting unpalatable stew of the kind that those of us with longer memories might remember being churned out by the school canteen.
The answer then is to get a process in place for the production, circulation, negotiation and completion of all documents required in the transaction and ensure that it is communicated at a very early stage to all of the parties and their lawyers. Then insist on everyone sticking to that process.
The existing franchise agreement should prohibit the seller from completing any sale without the consent of the franchisor. A well drafted franchise agreement will also require the seller to furnish the franchisor with full details of the potential buyer and any offer it has made for the business. In many cases of course the franchisor itself will have identified the potential buyer through its franchise recruitment process.
Template sale agreement
Ideally the franchisor will have instructed its solicitors to prepare a standard form template sale agreement to be used by the seller and buyer with any modifications to be approved by the franchisor. In this way the franchisor can ensure that the sale agreement contains provisions which preserve and protect its interests as well as those of the incoming franchisee.
Many franchisors also take control over the flow of money in the completion of the sale and purchase of the franchised business, insisting that the purchase price is paid to their solicitors so that the franchisor can deduct from the sale proceeds any sums of money owed to it by the outgoing franchisee before forwarding the balance.
BFA affiliated solicitors
While the franchisor cannot dictate which legal advisors are used by the seller and buyer it can make recommendations and if this is done at an early stage it provides an opportunity to direct the parties to solicitors affiliated to the BFA who are familiar with franchising and resale transactions. This can both speed up transactions and reduce costs.
Establish and recover debts
The sale of a franchisee’s business is perhaps the last occasion where a franchisor can relatively easily arrange matters to ensure that the outgoing franchisee’s outstanding debts and liabilities are paid. Typically this is achieved by the purchase price being paid to the franchisor’s solicitors and any outstanding debts and liabilities deducted from the sale proceeds, prior to transfer of the balance to the departing franchisee or its solicitors. The sale and purchase agreement can also provide for the payment on completion of the franchisor’s legal fees in connection with the transaction by either the seller, the buyer or a combination of the two.
Protecting the incoming franchisee
The franchisor will want to ensure that the new recruit to the network acquires all assets and any other interests necessary for the successful continuation of the business. This would include ensuring that appropriate warranties, in relation to the assets and business, are included in the sale and purchase agreement, together with appropriate restrictions on the post termination activities, of the outgoing franchisee. Such restrictions should in any event be included in the franchise agreement. They are commonly repeated and on some occasions enhanced in the sale and purchase agreement, specifically to protect the buyer as well as the franchisor.
Premises and landlords
If the franchise business is operated from commercial premises, it is essential to understand at an early stage what will be required to ensure that the incoming franchisee is in lawful occupation of those premises, on and from completion of the purchase of the business. Typically the existing franchisee will occupy the premises under the terms of a lease from a third party landlord. That landlord’s consent will be required to the assignment of the lease or to the surrender of the existing lease and the grant of a new one to the incoming franchisee.
Bank and other commercial references are likely to be required from the incoming franchisee, in order to obtain the landlord’s consent in principle to the assignment or grant of a new lease. Documents relating to an assignment or the surrender of the existing lease and grant of a new one will need to be agreed with the landlord, typically via its solicitors.
Repair and refurbishment
The landlord may require repair or refurbishment of the premises, as a condition of giving consent. All of these issues can cause serious delays in a franchise resale and should be identified and addressed at as early stage as possible.
No two franchise resales are ever the same so it is impossible to anticipate and cater for all eventualities in advance. However if the issues identified above are properly addressed at an early stage, well in advance of the proposed completion date, the chances of achieving a successful conclusion and avoiding unnecessary delays, stress and expense, can be greatly enhanced.
Owen White is one of the leading franchise specialists in the UK with over 35 years’ experience of providing legal advice to both franchisors and franchisees. If you would like further information please contact the Franchising team.