The Code vs Ipso Facto
By Stone Group Lawyers on April 18, 2019
Can you really terminate a franchisee who goes bust?
Franchisors have traditionally operated with the comfort of being able to cut loose a franchisee who enters administration or insolvency. After all, this is a right conferred by the Franchising Code of Conduct (“Code”).
What does it mean to ‘go bust’?
No franchisor likes to see a franchisee go bust. Unfortunately, circumstances can arise where a franchisee is unable to pay their debts and the business cannot be salvaged. That can be detrimental to the reputation and goodwill of a franchise system. Franchisors will often prefer to get that franchisee out of the system, and sometimes operate that business as a corporate franchise until a more permanent solution can be found.
The term ‘goes bust’ can refer to bankruptcy, insolvency, entry into administration (whether voluntary or external) or appointment of a liquidator.
In basic terms, administration is stage one. An administrator is appointed to a company and tasked with evaluating whether the business can be salvaged by helping the company repay debts and escape insolvency. Many companies can successfully work through the administration and get back on their feet.
Liquidation is stage two, when it is determined that the company cannot be salvaged. A liquidator is appointed and tasked with selling the assets to pay creditors, and then dissolving the company.
Section 29 of the Code entitles a franchisor to immediately terminate a franchise agreement if a franchisee becomes bankrupt, insolvent under administration or a Chapter 5 body corporate (as that term is defined under the Corporations Act 2001). For a franchisor to rely on this, the franchise agreement must include a clause which says that the franchisor can immediately terminate on those grounds.
The Ipso Facto Regime
On 1 July 2018, the ‘ipso-facto’ regime of laws was introduced. The regime applies to certain types of contracts entered into on or after 1 July 2018 and certain types of insolvency events. It restricts a party to those contracts from terminating the contract if the reason for termination is because the other party is experiencing an insolvency event or restructuring procedure. Any attempt to terminate the contract will be ‘stayed’, meaning the termination is essentially suspended until a Court decides otherwise.
The purpose of ipso facto is to give struggling companies a lifeline, with the ability and flexibility to continue to trade while the company attempts to recover from the insolvency event. If the company can’t recover and enters formal liquidation, then the ipso facto regime generally ceases to apply, lifting the block on the ability to terminate the contract because of the insolvency event.
This is only a very basic and general overview of the ipso facto regime. The regime contains a very detailed process for determining whether or not it will apply. It will depend on the type of contract and the type of insolvency event.
The Code vs Ipso Facto
What we are now left with is a clash between the laws. Whether ipso facto will apply depends on whether the franchise agreement was entered into, renewed or varied on or after 1 July 2018. If the regime does apply, then the Code must be read subject to ipso facto, meaning that where there is a clash, then ipso facto takes priority. That means that despite the Code saying a franchisor can immediately terminate a franchise agreement for certain insolvency events, the franchisor can only exercise that right when ipso facto permits.
For our first example, let’s use the appointment of an external administrator to a franchisee’s company.
The Code says this entitles a franchisor to immediately terminate the franchise agreement. If the franchisor wanted to terminate, they would need to assess whether ipso facto prevented them from doing that. If ipso facto prevented it, then the franchisor cannot use that appointment of an external administrator as a reason to terminate during the administration event. However, if the administration eventually leads to the company being placed into liquidation, the franchisor must then assess again.
Most types of liquidation are generally not covered by the ipso facto regime, meaning ipso facto is unlikely to prevent the franchisor from terminating because of the liquidation.
For our second example, let’s use a franchisee’s company going straight into liquidation. Again, the Code says liquidation entitles a franchisor to immediately terminate the franchise agreement. The franchisor must still assess whether ipso facto would stand in the way because the regime will apply to some types of liquidation. If that type of liquidation wasn’t covered by ipso facto, then ipso facto wouldn’t prevent the franchisor from terminating because of the liquidation.
How to tackle a franchisee going bust
What is important to remember is that ipso facto prevents termination of a contract when the insolvency event is used as the reason for termination. It does not prevent a franchisor from terminating a franchise agreement if there are other valid grounds to do so (provided the franchisor does not rely on the insolvency event as well).
Section 29 of the Code gives franchisors the right to immediately terminate in circumstances other than insolvency events, such as abandonment and fraud. Again, for a franchisor to rely on this, the franchise agreement must include a clause which says that the franchisor can immediately terminate on those grounds. That means ipso facto is unlikely to stand in the way of the franchisor terminating in reliance on abandonment or fraud.
Section 28 of the Code also entitles a franchisor to terminate a franchise agreement if they have served a breach notice on the franchisee and the franchisee has failed to take the action required to remedy the breach within the required time.
Let’s use another example of a franchisee breaching their franchise agreement by falling behind in paying royalties, and also having an administrator appointed. Because the franchisee has failed to comply with their obligation to pay royalties on time, the franchisor is entitled to issue a breach notice and give a reasonable time to pay the arrears. If the fees then weren’t paid within the time given, then ipso facto is unlikely to prevent the franchisor terminating for failure to remedy the breach.
Franchisors must be very cautious about how they treat a franchisee who has gone bust or is on the track there. Perhaps once the ipso facto regime is tested further by the Courts, there will be better guidance on how the regime will interplay with the rights to terminate under the Code.
Care must be taken when terminating a franchise agreement in any situation, especially when a franchisee is experiencing an insolvency event. We cannot stress enough the importance of obtaining legal advice before terminating a franchise agreement. Failure to do so correctly can invalidate the termination and expose the franchisor to a claim by the franchisee.
The team at Stone Group Lawyers are experienced in acting for both franchisors and franchisees in all aspects of franchising law. Contact our office on 1300 088 440 to arrange a free 30 minute consultation with our franchise team.
This article is only meant to give you general information and should not be relied on as legal advice. Speak to one of our lawyers for more information.