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Selling your franchised business

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A franchised business may be transferred in a number of ways.  This article deals only with the situation where the transfer occurs by means of an ordinary sale of the franchised business and its assets as a going concern.

The key issues that a franchisee must consider when selling their business include the following:

Franchisor’s Consent

The rights granted to operate the franchised business are personal to the franchisee and the franchisee cannot ordinarily transfer those rights without the franchisor’s prior approval.   The Franchising Code states that a request for the franchisor’s consent to a transfer must be in writing and the franchisor must not unreasonably withhold its approval.  The franchise agreement often also sets out a procedure that must be followed by the franchisee and the conditions that must be satisfied to obtain the franchisor’s approval.

The purchaser franchisee may be required to sign the franchisor’s standard franchise agreement at the time of the sale, which may only be for the balance of the term of the existing franchise agreement and may contain different fees which could impact on the sale price sought by the vendor franchisee.

Franchisor’s First Right of Refusal

Often the franchise agreement will grant the franchisor the first option to buy the business before the franchisee can offer it for sale to third parties.  The franchisor is usually given a period of time to consider and respond to the offer, which can delay the sale process.   If a franchisee fails to comply with its obligations in this regard, the franchisor can withhold its consent to the sale.

Transfer Fee

Many franchise agreements impose a transfer or assignment fee to be paid by the franchisee upon the sale of the business.  Such fees can be a fixed amount, a percentage of the purchase price or a proportion of any franchise fee payable under the franchisor’s standard franchise agreement which is current at the time of sale.  Sometimes the fee is higher if the business is being sold within the first few years of operation.  Franchisees should consider factoring such fee into the purchase price for the business or negotiating to pass on the fee to the purchaser franchisee.

Sale Contract

The franchisee’s lawyer should prepare a Sale Contract dealing with all relevant aspects of the transfer.  The finalisation of the terms of the Sale Contract can be a time consuming and costly process, especially if the terms are extensively contested or negotiated with the purchaser franchisee and/or the franchisor.

In some jurisdictions, by virtue of state specific legislation, the franchisee may be required to provide other documents to the purchaser franchisee before the Sale Contract can be executed (eg in Victoria a Section 52 Vendors Statement will be required to be provided to the purchaser franchisee where the sale price is $350,000 or less).

Lease

If the business operates from premises and the franchisee holds a lease or sublease of the premises, it may be necessary to transfer the lease or sublease along with the business.  This can involve not only the cost of drafting the necessary transfer documentation, but also the costs of procuring the consent of the landlord and any mortgagee on title to the premises.

If the franchisor holds the lease and the franchisee is granted a licence to occupy, the purchaser franchisee may be required to enter into a new occupancy licence and the landlord’s consent may also need to be obtained for such licence.

Transfer of Employees

If the franchisee has any staff, it must consider whether any of them are to be employed by the purchaser franchisee.  If so, the parties will need to reach agreement as to how to deal with any accrued entitlements due to the employees (e.g. annual, personal and long service leave).  This may involve adjustments to the purchase price.  If the employees are not to be employed by the purchaser franchisee, the franchisee will be required to terminate their employment and pay out any accrued entitlements and possibly redundancy payments.

Tax Considerations

It is critical for the franchisee to think about the tax consequences of the transfer.  Potential tax benefits could dictate whether the transfer is effected by way of a sale of the business assets or a sale of the shares in the franchisee company.  The franchisee should consider any Capital Gains Tax liabilities which may be triggered by the sale and, if the business is not being sold as a going concern, any GST payable.

Restraint

Franchisees are often bound by a restraint of trade for a period of time after the transfer of the franchised business.  Such restraints can involve the franchisee being prohibited from operating or being involved in a similar or competing business, or from canvassing any customers, suppliers or employees of the franchised business.  The purchaser franchisee may also seek to impose additional restraints in the Sale Contract. Before selling, a franchisee should have a clear plan for any employment or business ventures it intends to undertake and should make contingency arrangements for deriving income without breaching any enforceable restraints.

Ongoing Obligations

Some obligations imposed under a franchise agreement do not end when the franchise agreement ends.  The franchisee may continue to be bound by certain provisions, for instance those dealing with the use of confidential information or intellectual property, even after selling the business.

In addition to the key points above, there are a plethora of other issues arising from the sale of a franchised business.  Franchisees should take care to ensure they comply with all relevant obligations and seek appropriate accounting and legal advice.

Franchisees should conduct their own internal due diligence and spend time getting their “house in order” before embarking upon selling their franchised business (eg ensure permits, licences and leases are in place and valid; communicate with the franchisor and ascertain what their internal process and requirements will be).  Early preparation for the sale of a franchised business is recommended and will only serve to maximise the sale price and ensure the transaction runs smoothly.

MST has extensive experience in assisting its clients to comply with franchise agreements and to buy and sell franchised businesses.  Please contact one of our Franchising Team lawyers for further information.

Author: Esther Gutnick