Can I keep my business if the franchisor goes bust?

Purchasing a franchise is a big decision. For a franchisee, their success or failure depends in large part on the reputation and success of their adopted business. Unfortunately, it’s all too common for franchises to fall apart, leaving their franchisees in dire trouble. You might remember the saga of Pie Face, or the appointment of administrators to Eagle Boys Pizza.

So what happens when a franchise goes bankrupt or bust?

Who owns the Intellectual Property

Often, the intellectual property associated with a franchise will not actually be owned by it directly. Intellectual property comprises things like brand, trademarks, business names. In many cases, a separate company is usually set up for the sole purpose of owning the intellectual property. This company then ‘licences’ the use of the intellectual property to the franchisor. If problems arise with the business, then the IP holding company can sever the agreement. This protects the intellectual property itself, but can cause problems if franchisees want to continue to use it.

A good way to avoid this is to negotiate an agreement between the IP holding company which covers what happens if a franchise fails. This can allow the franchisee to continue trading under the brand name, even if the franchise fails.

What are the franchisee’s rights under the Franchise Agreement?

In the majority of cases, very little. Most Franchise Agreements don’t protect franchisees from problems arising with the franchisor. In fact, common practice dictates that only the franchisor will be able to sue for insolvency etc.

If the franchisor does fail, and there is no agreement between the franchisee and the IP holding company, things can get messy. In this case, a franchisee will have no choice but to ‘wait and see’.

If you are a franchisee, the most prudent thing to to is arrange for some protection under your Franchise Agreement. It is possible that such an agreement might be dismissed by an administrator, but nevertheless, it might help you get out of a tight spot.

If you purchase most of your products from the franchisor, you could also run into difficulty buying goods. In the event of a cataclysmic failure, you might be left trying to source goods and services through third parties. The same holds true for equipment,

If administrators and liquidators are appointed, they have the power to cancel some Franchise Agreements. Another possibility is that the liquidator or administrator may attempt to sell the whole of the franchise system. In that case, the franchisee will be effectively sold off to a new franchisor as part of the deal. During the sale process, the franchisee will be obliged to pay ongoing franchise and marketing fees to the liquidator.

If administrators and liquidators cannot find a purchaser, franchisees may be forced to close the doors and walk away from their businesses. The franchisee could continue operating their business under a new name, but without the goodwill attached to the franchise, this could be hard work.

Need advice about signing a lease for your business premises? Talk to the Franchising team at Rouse Lawyers. Contact us today!

How to minimise your risks as a franchisee

Entering into a Franchise Agreement is a long-term commitment, and making wrong decisions can affect your bank balance, health and your relationships.

Before you sign on the dotted line, here’s some important steps you can take to minimise your risk.

Don’t rush

It’s a good idea to think strongly about whether you want to run a franchised business. Remember that in a franchise, you must follow the rules laid down by the franchisor. These can be strict, and you might find yourself dealing with more red tape than expected.

If you are opening a franchised business at a greenfield site, you also need to ensure that you have sufficient capital to start a business. This includes the ability to survive any losses you may incur while you build your franchise. Make sure that you have the capability to raise finance, and decide whether you are prepared to put your assets at risk.

Choose the right franchise

Whilst you may have your heart set on a particular franchise, there are many great options to pick from. Ask yourself:

1. What is the franchisor’s business background and experience?
2. How long has the system been in operation?
3. How many franchisees are there?
4. How many franchisees have started, sold or ceased to operate within the past year?
5. How extensive is the training provided?
6. What are the fees, both upfront and ongoing?
7. What support does the franchisor provide in exchange for your fees?

Before you sign a franchise agreement, the franchisor is required to provide you with a disclosure document. In an ideal world, this will provide answers to many of the questions above. A key part of any disclosure document is the contact details for existing and former franchisees. It’s a good idea to should contact as many current franchisees as you can, and find out whether they are happy with their business. Be smart about this — don’t just contact franchisees recommended by the franchisor. Try contacting former franchisees, too. It can be instructive to find out why they left.

The more you investigate, the more comfortable you will feel. Don’t sign anything until you’re sure you’re going to be happy with your decision. The worst thing you can do is rush headlong into a dodgy deal.

Choose the right structure

A lawyer and an accountant will help you choose the right structure for your business. Whether you enter into the franchise as a sole trader, partnership, company or trust, making the right decision from the outset is essential. Each structure is different, and the most suitable structure will depend on your circumstances.

Expect the best but plan for the worst. Investing in the right structure can limit your liability and help protect your personal assets if the business goes belly-up. The right structure can also help with tax minimisation if your business becomes a roaring success.

Take detailed notes

Never rely on a promise or representation regarding the potential for the business without doing your own research and investigations. If a franchisor makes a promise about something which is not specified in the franchise agreement or disclosure document, make sure this is recorded in writing. A common way of dealing with promises is to sign something called a “prior representation deed”, which details exactly what promises are going to be relied upon.

Communicate

Remember that franchising is not a business – it is a way of doing business. The franchisor has a proven system for success and has opted to duplicate that system by creating franchises. Don’t assume that because a franchise is your business, you can run it any way you want. If the franchise agreement restricts your products, for example, you must comply with those restrictions. Making changes to your business can also require getting the franchisor’s prior approval in writing.

Adhere to time limits

If your franchise agreement allows you to renew for a further term, diarise the time limits. The timeframes given to you are probably strict. If you miss the timeframe, then the franchisor has no obligation to grant you a renewal. It’s also important to remember to renew your lease. After all, you don’t want to renew your franchise agreement only to find that you don’t have a store to operate from!

If you receive a notice from your franchisor claiming that you’re in breach of your agreement, act on it immediately. Breach notices almost always come along with a timeframe. Whether it is paying your outstanding fees or speaking to your lawyer about your options, if you don’t comply, your franchisor could terminate the franchise agreement.

Need advice about signing a lease for your business premises? Talk to the Franchising team at Rouse Lawyers. Contact us today!

 

 

 

 

 

 

Foreign Resident Withholding Tax – The Facts

Foreign Resident Withholding Tax – Practical Effects

The general thrust of the new foreign resident withholding tax regime is to require a purchaser to withhold 10% of the purchase price on acquisitions from foreign vendors of real property (real estate), or shares in a company that holds real estate.
However, the rules apply to all transactions involving real property and shares in companies, even if between two residents, unless steps are taken to fit within an exclusion.

Key elements of the new regime

Direct interests

- The regime applies to all transactions involving taxable Australian real property (including a mining, quarrying or prospecting right) exceeding a market value of $2million just after the transaction, even if the vendor is a resident.
- Company title is also treated as a direct interest.
- The obligation is to withhold 10% of the 1st element of the cost base, usually the purchase price or the varied amount if the ATO provides a variation (even if the transaction would not be liable for CGT e.g. deceased estates, CGT rollover). Note: On 6 September 2016 an ATO Legislative Instrument was registered that varied the payment to nil for assets passing under a deceased estate. The instrument also applies to assets passing under a joint tenancy.
- The $2 million threshold is based on market value, not the purchase price. If only a partial interest is being sold, the $2 million threshold applies to the value of the whole property.
- For transactions with related party or at an undervalue, the obligation to withhold is based on market value rather than purchase price
- All vendors must obtain a Clearance Certificate for a period covering the time the transaction is entered into.
- Declaration by the vendor (see below) will not be sufficient.

Indirect interests

- Withholding is only required if you know or reasonably believe that any vendor is a foreign resident; the entity has an address outside Australia (according to any record about the transaction) or an amount or financial benefit is payable to a place outside Australia (and you do not reasonably believe that the entity is an Australian resident), the entity has a connection outside Australia of a kind specified in the regulations; or the interest is a company title interest.
- Clearance Certificate is not relevant.
- No monetary exclusion – applies to shares with a value greater than nil.
- Shares are only covered if they fall within the concept of indirect Australian real property interest, which does not cover all companies or trusts that own real estate. The company or trust must pass a non-portfolio interest test and a principal asset test.
- Also applies to options and rights to acquire TARP or indirect Australian real property interests (para 1.72 of EM).
- Excluded if listed on an approved stock exchange; or conducted using a crossing system.
- Withholding is not required if, before you pay the ATO, the entity gives you a declaration that the entity is an Australian resident or the shares are not an indirect Australian real property interest for a period covering the time the transaction is entered into, and you do not know the declaration to be false.
- The declaration is of no effect if given more than 6 months before the time payment would otherwise be due to the ATO.
- Penalties for declarations that are false or misleading in a material particular: 120 penalty units if you know it is false or misleading, 80 penalty units if you were reckless in making the declaration and 40 penalty units if you did not take reasonable care in making of the declaration.

Variations

- Variation if 10% exceeds tax on profit.
- Variations at discretion of ATO, but the Commissioner must have regard to the need to protect a creditor’s right to recover a debt.
- Applications for variations may be made by the vendor, the purchaser or creditors of the purchaser.

Other exclusions

- Applies to acquisitions on or after 1 July 2016; that is, only to contracts entered into after that date.
- An amount is already required to be withheld from a withholding payment relating to the transaction.
- Certain securities lending arrangements (s 26BC(3) (a)(ii) of the Income Tax Assessment Act 1936 (Cth))
- Insolvency: The vendor is a company subject to certain arrangements for insolvency and external administration (paragraph 161A(1)(a) of the Corporations Act 2001(Cth)).
- Bankruptcy: Transaction occurs in administration of a bankrupt estate or other bankruptcy arrangements.
- Circumstances that are, under a foreign law, the same or similar to those in any of the above subparagraphs.
A purchaser is discharged from any liability to pay to the vendor, a creditor or any other person, the amount it pays to the Commissioner under the regime.
A purchaser paying an amount to the Commissioner must apply to register as a withholder.

Practical implementation

Does the foreign resident withholding tax involve taxable Australian real property or interests in entities with taxable Australian real property?

Direct interests

- Includes Company title.
- Market value of the whole property exceeds $2 million (irrespective of purchase price, and includes transactions not liable for CGT).
- If the vendor is an Australian resident, they must obtain a Clearance Certificate.
- If any vendor is a foreign resident, they must obtain a variation if amount withheld will exceed tax liability or some vendors are Australian residents.

Indirect interests

- No monetary exclusion – applies to shares with a value greater than nil.
- If the vendor is an Australian resident, they must include a Declaration in the agreement for sale of shares, units or other equity interest.
- If any vendor is a foreign resident, consider exclusions. If the interest is not an indirect Australian real property interest, include declaration in agreement.
- If any vendor is a foreign resident, obtain a variation if amount withheld will exceed tax liability or some vendors are Australian residents.
- Additional declaration required if declaration given more than 6 months before the required time.

Need expert advice about selling real property and the foreign resident withholding tax? Speak to the Taxation team at Rouse Lawyers. Contact us