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Proposed changes to the UK insolvency regime, and what that means for franchisors and suppliers

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United Kingdom

In response to the Coronavirus crisis, the UK Government has stated “The UK’s Insolvency Framework will add new restructuring tools including a moratorium for companies giving them breathing space from creditors enforcing their debts while they seek a rescue or restructure.
 
Whilst there is a lack detail at present about what exactly this will mean, we expect the UK Government to do the following:
 
  1. Introduce a moratorium provision that has been discussed and consulted on by the government for a few years. The moratorium is supervised by an insolvency practitioner, but the debtor company remains under the control of the directors. However, the company needs sufficient cash to keep trading through this period. The length of the potential moratorium is likely to last between one to three months. The moratorium is likely to be obtained by e-filing documents at court, with some qualifying criteria that the insolvency practitioner will have to agree are present (such as the company having sufficient cash to trade for the moratorium period). The moratorium is likely to be the same as an administration moratorium, so will prevent the enforcement of security or presentation of a winding up petition (unless the court gives permission).
  2. Introduce an exclusion of “ipso facto” clauses, such as clauses that allow a supplier to stop the further provision of supply of goods (and licences of IP) because of the debtor company entering an insolvency process. It remains to be seen what supplies will be caught by these provisions. Again, it is most likely to require the company to have sufficient funds to pay for new supplies.
  3. Suspend temporarily wrongful trading provisions from 1 March until 1 June 2020.  Presumably, this means the additional debts incurred during that period would not form part of any award against the directors for wrongful trading, but the directors could still (separately) be sued for breach of duty. 

We are already seeing high profile brands in the leisure and hospitality sectors enter into a formal insolvency process, and more will follow over the coming months. Although failures rates within franchising are typically much lower than non-franchised businesses, franchising will not be immune from this trend.

This announcement is good news for any business, which is coming under pressure from its creditors, including both franchisors and suppliers and their franchisees and distributors. 

However, on the basis that the number of potential insolvencies will be greater among franchisees and distributors, franchisors and suppliers should consider how best to mitigate against the risk of widespread failure within their networks. Of course, part of the solution is to work closely with franchisees and distributors to try and preserve these relationships – and many are busy doing this right now. However, this article considers the legal levers, which a franchisor or supplier may need to consider pulling at a later stage. 


Terminating the right to terminate

Most franchise agreements and supply contracts contain either an automatic termination clause, or a right to terminate on notice, once a franchisee or distributor enters into formal insolvency (such as administration, liquidation or a creditors voluntary administration ("CVA")). It seems likely that the UK Government will legislate to prohibit the enforcement of these ‘termination clauses’.

It is not clear whether such prohibition will extend to cover a termination where a party has not entered into a formal insolvency, but is unable to pay debts, or the terminating party anticipates that it will enter into a formal insolvency.

Will there be other ways to terminate contracts with a company in formal insolvency?

It is likely that franchisors and suppliers will retain the ability to terminate contracts on any other ground permitted by the contract such as:

(a)    non-payment of liabilities (e.g. invoices) incurred following entry into a moratorium, restructuring plan, or insolvency procedure;
(b)    giving notice in accordance with other terms of the contract (e.g. a right to terminate upon giving fixed notice); or
(c)    any other ground that gives rise to termination, save for those connected with the financial position of the debtor company, or it entering into a moratorium, restructuring plan, or insolvency procedure.

If termination is not an option, will there be an obligation to supply a company in a formal insolvency?

It is likely that franchisors and suppliers will have to continue to fulfil their commitments under their contract with the debtor company. This will help businesses trade through the rescue and restructuring process, permitting a degree of stability in their operations so that rescue will be more likely.

A franchisor or supplier will need to seek permission from the court in order to terminate supplies. In rare cases where a supplier will be significantly and adversely affected by not being able to rely on a contractual termination clause, the supplier will be allowed to exercise such a right on the grounds of undue financial hardship. Only if a supplier's own solvency is threatened will the right be granted. 

It is not clear whether a franchisor or supplier can request pre-payment as a condition of continuing to supply. If the legislation is silent on this, the position will be subject to the express terms of the contract. 

These changes highlight the need for franchisors and suppliers to assess their supply terms and ensure that the rights for termination are sufficiently detailed, clear and broad to enable the franchisor or supplier to take the necessary action when it is faced with an insolvent buyer.

It remains to be seen how helpful the proposed moratorium will be for most companies. If a company does not have sufficient funds to trade through the moratorium, these proposal will be of little benefit. If the UK Government is able to deliver its other financial assistance packages within the same timeframe, then companies may have a fighting chance, but it is a big "if".


Recommendations

Most franchisors, or their affiliates, will act as suppliers of goods and services. As a franchise or distribution network grows, so does the systemic risk to the franchisor or supplier of default and failure within the network. It is therefore important that franchisors and suppliers invest in proper legal advice and legal contracts to ensure that they have the contractual rights to act quickly and effectively if the need arises.

Key takeaways include:
 
  • review the inter-relationship between the franchise agreement or supply agreement and the standard terms of supply, paying close attention to termination rights and developing a clear process for dealing with franchisees or distributors who are in financial distress.
  • Look at the wording of termination clauses, which are linked to insolvency. Do they include anticipatory terminations? Are they specific enough to cover rights to terminate for other breaches unconnected with entering into informal insolvency?
  • Ensure that personal guarantees extend to the supply of goods.
  • Ensure supply terms have the flexibility to switch to pre-payment.
  • Include an automatic revocation of a licence to sell the products once a debtor company enters into informal insolvency, with an obligation to provide an inventory.


If you would like more information on this issue, please contact Gordon Drakes, or contact a member of our restructuring and insolvency team.
 

We are all navigating uncharted waters as business and society faces up to the impact of COVID-19.  We very much hope you and your loved ones remain in good health. 

 Please be assured that Fieldfisher is continuing to work with clients to navigate COVID-19 related issues and on business as usual needs.  Do get in touch with us if you would like to chat anything through.


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