When do franchisors buy back the assets of terminated franchisees?

What is an assets buyback in franchising? 

Assets buyback involves buying back the assets of a terminated franchisee after termination of a franchise agreement. 

It enables the franchisor to buy the assets to either operate the business itself or resell the franchised business as a going concern to a new franchisee.   

The franchisor is usually required to pay the book value of the assets. The net book value is the appraised value of the assets, without accounting for goodwill, and net of all equipment depreciation, among other accounting allowances. It is often a relatively small amount, but the assets can also have significant wear and tear to them, especially in a food business.   

Buying back a franchisee’s assets can be mandatory or optional, depending on the situation. 

Scenario 1 – when taking over the location – mandatory buyback 

If the location of the terminated franchisee is a good location, the franchisor will normally want to try to regain control of the location. That assumes that the franchisor has lease rights to the location – either as a tenant under the head lease, or under a tri-party agreement with the landlord that gives the franchisor the right to take over the lease when the franchise agreement is terminated. 

Once a franchisor takes over the location and the franchised business (usually this happens after terminating the franchise agreement), the franchisor is required to buy back the assets of that franchised business. 

Scenario 2 – when not taking over a location – optional buyback 

This is a type of “self-help remedy” that most standard franchise agreements in Canada give franchisors as a consequence of a termination of the franchise agreement.    

If the location of the terminated franchisee is not viable or if the franchisor has otherwise no right to the lease of the location, it may be open to the franchisor to seize the franchisee’s business assets – if that right exists in the franchise agreement. 

Where there is a non-competition restriction against competition by the franchisee after termination, but the franchisor has no control of the lease, buying back the assets can help ensure that the franchisee does not violate the non-competition provisions – because the franchisor will buy back and remove the equipment and other chattels from the existing operation. 

In this sense, the buyback right can have the effect of protecting the franchisor’s business model and making it more difficult for the terminated franchisee to engage in a competing operation after termination of the franchise agreement.   

For the terminated franchisee, the asset buy back can make it less effective to continue operating a competing business – a “poison pill” so to speak. They must start from scratch and raise new capital to purchase the necessary equipment to open a business under a new brand or concept.  

Generally, I don’t see many situations where a franchisor exercises this right – it is not used very often. Where I have seen franchisors exercise this self-help remedy is when they do not have control over the location (i.e., the franchisee controls the lease). In this instance, franchisors could face the financial impact of direct competition from the terminated franchisee who continues to operate their business while the franchisor is waiting for the dispute to be heard in court to enforce a non-compete. This can take a long time.   

By exercising a right to buyback, the assets, they can effectively shut down the terminated franchisee, while at the same time recouping some of their losses. 

What are the mechanics of using a buyback of the franchisee’s assets? 

In either scenario, the franchisor must account for the value of the assets or the proceeds from their sale in the balance owed to them by terminated franchisee.   

Unlike in a franchise rescission, where the franchisor must reimburse the franchisee for equipment, supplies and inventory at the cost that the franchisee paid, the franchisor only pays a nominal fee for the assets. This amount offsets the franchisee’s debt to the franchisor, however, in typical terminations the money owed far exceeds the proceeds from the repurchase and resale of the franchisee’s assets. For the franchisor, it puts a “dent” in damages owed to them. For more on this process see our article Consequences of Franchise Termination and Settlement Options. 

The franchisor is required to obtain a formal appraisal of the assets from a qualified professional. The franchisor is required to then sell the assets – either to a third party or to itself. The proceeds of the assets sale must be applied against the total indebtedness of the terminated franchisee. 

Conclusion  

The buyback provision in a franchise agreement serves as a critical tool for franchisors.  

A franchisor can also use this tool as a pragmatic approach to recoup some of its losses and to try to protect the franchise system from direct competition by the terminated franchisee.  

In navigating these complex dynamics, franchisors should carefully consider their available options arising out of a terminated franchise agreement and how best to comply with its obligations under the franchise agreement. 

— 

The information contained in this article is provided for informational purposes only and does not constitute legal advice. Readers should not act on this information without seeking professional legal advice from a lawyer experienced in this area. The content in this article may not reflect the most current legal developments, and the application of law can vary in different provinces and territories. As such, the information in this article is not guaranteed to be complete, correct, or up to date. The author and the publisher of this article disclaim all liability for any actions taken or not taken based on any or all of the contents of this site.

The Law Works website offers a vast number of resources by way of blog articles, courses and webinars about franchise, commercial and real estate disputes. Subscribe to our newsletters to stay up to date on the latest information from us.

Law Works offers complimentary initial 15-20 min telephone consultations, which you can book online.