PUBLISHED ON 22nd OF FEBruary 2011 ONLINE & in Print – FRANCHISING MAGAZINE
A partnership in a franchise business is usually between two or more people who may operate as a partnership in the true sense or they may operate through a corporate or trust structure. Usually, all partners are actively involved in the business, have made a financial investment and rely on the business’s performance for a financial return.
A partnership or shareholder dispute really only has four outcomes: the parties reconcile and business goes on; the franchise is sold to a third party; one party buys out the other party; or the franchise is shut down. The last three have implications for the partners, which are discussed in this article.
Consequences under the partnership agreement
It is good business practice for the potential partners of a partnership to draft and sign a partnership agreement before the partnership starts operating. If the business is run through a company, then this agreement is a shareholders agreement.
The agreement should specify the steps to be taken in the event of irreconcilable differences, dispute resolution and default by a party.
If a break-up arises, the agreement can define the procedural steps to be taken, including how the assets and liabilities are split between the parties and what happens with the business.
A good agreement should also contain an elaborate exit strategy for each of the partners if they wish to exit the partnership without it resulting in dissolution of the whole partnership.
However, more often than not, parties do not put a suitable agreement in place, which in turn complicates matters when the relationship breaks up.
Consequences under the franchise agreement
Most franchise agreements contain a clause allowing the franchisor to terminate the franchise agreement when a partnership, operating as a franchisee, is dissolved. Similar clauses exist for corporate franchisees. This can result in the partners losing their business because the franchisor exercises their contractual rights under the franchise agreement.
In order to maximise the value for all partners upon break-up, the franchised business could be sold as a going concern. This therefore requires the consent of the franchisor.
Even if one partner agrees to buy the other one out, the franchisor’s consent is also required. This might not be required if the exiting partner was integral to the business, or the continuing partner does not separately have the financial resources to run the business.
Generally franchise agreements contain a non-compete clause, which would not allow any partner to operate or be involved in any business similar to the franchised business. These restraints operate within a certain area and for a specific period of time.
It is very likely that each partner has personally guaranteed the performance of the franchise before signing the franchise agreement; similar guarantees would usually be required before signing a lease of premises, in relation to any bank funding and to key suppliers for stock.
If, following the dissolution of the partnership, one partner retains the franchised business, the other partner(s) needs to make sure they receive full releases from any guarantees they provided.
If one of the partners continues with the franchise after the partnership has been dissolved, the remaining partner operating this business will need to immediately apply for new ABN and GST registrations. The old ABN and GST registrations will need to be cancelled and a final tax return and business activity statement of the partnership will need to be submitted to the Australian Taxation Office.
For the exiting partner, any disposal of interest in the franchise is likely to attract capital gains tax and, depending on the state where the franchise is operated, stamp duty.
There are other issues to consider when a partnership breaks up. For instance, obtaining valuation of the business from an independent valuer if the business might be bought out by one of the partners or sold, or dealing with any employee entitlements (such as annual leave and any long service leave). The partnership’s bank account may need to be closed and any outstanding loans paid out – including to the exiting partner.
The business insurance policies of the partnership may need replacing; landlord, debtors, creditors, local council, and regulators will need to be notified of the partnership dissolution and if the business name used by the partnership is transferred to another party, the relevant office of Consumer Affairs also needs to be notified.
Procuring a formal dissolution of the partnership, which can be done by the parties or with assistance from an accountant or a lawyer, is also a consideration.
Tips for preventing partnership break-ups
Prevention is the best cure. So before entering into any joint relationship, it is prudent to evaluate your partner(s), including their skills, financial capabilities, strengths, potential non-financial contributions to the partnership and the level of trust and respect between you. It would be wise to agree on a clear division of the roles and responsibilities of each partner and document it; to draft a comprehensive partnership or shareholder agreement, which sets out exit strategies for each of the partners, and outlines how disputes are to be dealt with.
Raise any complaints quickly, before they fester, and seek advice if they are not resolved and if there is to be a change in ownership of the franchise, don’t delay telling the franchisor, financiers and landlord and be honest and commercial in your dealings.