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When a franchisee becomes insolvent

Insolvent franchisee

Where an insolvent corporate franchisee is about to close its business, franchisors may look for a potential solution to try to retain goodwill in the brand in that particular territory.  This may include appointing a new franchisee under different ownership to acquire the assets and to trade under a new franchise agreement.  Sometimes, the franchisor may themselves step in, under rights reserved to them in the franchise agreement, to take over premises and acquire assets.

Franchisee’s bad debt

Occasionally, the corporate franchisee becomes insolvent for reasons not usually associated with failure or poor performance.  It may suffer a catastrophic bad debt if a key customer goes bust; it may face a substantial dilapidations bill on expiry of a lease.  In some circumstances, the franchisor may have confidence in the owners continuing to operate a franchised business in the territory through a new limited company.  However, this does present the franchisee’s owners with considerable personal risk.

The Insolvency Act 1986

Section 216 of the Insolvency Act 1986 restricts a director of an insolvent company from being involved in another company with the same or similar name.  Such a director risks criminal liability that can include a fine and/or imprisonment and be personally responsible for all debts of the new company.

In order to circumvent the application of Section 216, a director would ordinarily need to make an application to seek the court’s permission to be involved in the new company under the same franchised brand name.

London Gazette notice

There are a few exceptions to that rule, one of which is that the director gives notice in the correct form to all creditors of the insolvent company and their wish to be involved in the new company and publishes that notice in the London Gazette, all within 28 days of completion of the sale of assets.

Franchisor’s support

Corporate franchise owners need to be aware that they cannot simply rely upon the goodwill of the franchisor to enable them to use the brand name in their new company.  Franchisors must ensure that the franchisee owners take the correct steps, failing which they may find that on a successful Section 216 prosecution, the ability to operate the successor franchisee business may be severely curtailed.  Franchisees in such a situation must take specific advice from an insolvency practitioner or insolvency lawyer.

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