Business Rescue and Franchising

The general principles of business rescue are useful to consider when contemplating the possibility of a party to a franchise agreement going into business rescue.

The Companies Act 71 of 2008 (the Act) imposes a general moratorium on claims against a company or close corporation in business rescue. Section 133(1) of the Act provides that during business rescue no legal proceedings, including enforcement action, may be taken against the company or in relation to its property or property lawfully in its possession, except with the consent of the business rescue practitioner or the leave of the court, or as a set-off of monetary claims. For example, if a franchisee is placed into business rescue, this would mean that unless the consent of the court or the practitioner is obtained, no creditor, including the franchisor, is permitted to take any legal action to force the franchisee to comply with any of its contractual obligations – including, but not limited to, the making of any payments that may be contractually due.

Complementary to section 134 is section 136, which deals with the effect of business rescue on contracts of the company. Section 136(2) provides that the practitioner may entirely, partially or conditionally suspend, for the duration of the company's business rescue proceedings, any obligation of the company that arises under an agreement to which the company was a party when the business rescue proceedings commenced. This means that:

  • The company's obligations are not automatically suspended merely because it is placed under business rescue.
  • The company's contracts will remain in full force and effect unless and until the practitioner furnishes to a creditor a written notice suspending all or any of the obligations due to that creditor.
  • Until such time as a written notice of suspension is received from the practitioner by a creditor, the creditor would be entitled to rely on a breach, even if committed after the commencement of business rescue, for purposes of cancelling the agreement (although the creditor cannot enforce rights or claims under the agreement by virtue of the section 134 moratorium).
  • A practitioner supervising a franchisee in business rescue may furnish to the franchisor and to the franchisee's bankers a notice suspending all or any of the franchisee's contractual obligations.
  • A franchisee or franchisor would, if the other party to a franchise agreement breached the agreement, be entitled by written notice to the practitioner given before receiving a suspension notice from that practitioner, to cancel the franchise agreement.

It must be noted that the subsection specifically prevents the practitioner's power from being contractually excluded. Thus it is not possible for the franchise agreement to exclude the application of section 136 of the Act – and a clause to this effect would be unenforceable and disregarded by the practitioner and by the courts.

There are two further important aspects to section 136:

1. The practitioner does not have the power to cancel contracts, only to suspend contractual obligations. Should the practitioner wish to cancel a particular contract, s/he would have to apply to court for leave to do so in terms of section 136(2)(b) and the court will only grant such an order on terms that are "just and reasonable in the circumstances". It is therefore not open to the practitioner to simply cancel a franchise agreement by notice and any court application to obtain a cancellation order would have to be brought on notice to the other party.

2. The practitioner's general power to suspend and the court's general power to cancel contracts do not apply to employment contracts.Employees of the company continue after business rescue proceedings commence to be employed on the same terms and conditions. Their terms and conditions of employment may only be varied and they may be retrenched only in terms of the procedures laid down in the Labour Relations Act 66 of 1995. For example, section 136(1)(a)(ii) specifically requires any retrenchment process to follow the procedures of section 189 of the LRA. It must be emphasised therefore that placing a company in business rescue should not be seen as a fast-track method of implementing staff cuts.

The Act does provide a limited remedy for the counter-party in a case where the practitioner has decided to suspend a contractual obligation to it or the court has cancelled its contract with the company in business rescue. Section 136(3) provides that the aggrieved party may lodge a damages claim against the company in business rescue. A damages claim would of course not be applicable in cases where the creditor's rights consist of a monetary claim in the first place. A damages claim may provide redress where the debtor's failure to perform causes the creditor to suffer a loss of profit.

The fact that contractual obligations may be suspended does not mean they disappear. In the case of unmet payment obligations owed to a franchisor, these obligations will confer on the franchisor the status of a creditor of the company in business rescue. This will entitled the franchisor to vote on the practitioner's business rescue plan according to the rand value of its monetary claims, plus any damages claim, and to participate in any distribution to creditors, should the plan be adopted and implemented. The extent to which the creditor can recover suspended contractual obligations will vary depending on the terms of the business rescue plan. If the plan is adopted by the requisite majority of the voting creditors, its terms are in terms of section 152(4) binding on all creditors, whether or not they attended the meeting or voted for or against the plan. The plan can therefore be seen as a renegotiation and compulsory variation of all contractual and statutory obligations of the company to all its creditors. As a general rule, it is common for the creditors to be asked in the proposed plan to take a "haircut" on their monetary claims and/or agree to payment of instalments over a lengthy period.

The counter-party may also have a common law remedy against the company in business rescue, which would be particularly apposite in the case of a franchise agreement. Generally speaking, where obligations owed by contracting parties to each other are reciprocal in nature, it is not open to the party that is unable or unwilling to perform, to insist that the other party must perform. This common law principle is not in my view overruled by section 136 of the Act. Thus for example, a practitioner suspends by notice some or all of the franchisee's marketing fee obligations to the franchisor, the franchisor would be entitled to refuse to render any continuing services or supply any continuing materials or support, unless and until the practitioner tenders to comply with all the franchisee's current obligations to pay marketing fees.

This common law principle will not prevail entirely. In the circumstances outlined above the reciprocity principle will not entitle the franchisor to refuse to render (for example) marketing support because of unpaid marketing fees that fell due before the business rescue commenced. Furthermore, care must be taken in each case to determine on the specific facts, whether the obligations in question are in fact truly reciprocal, or are merely contained in the same agreement.

Where the continued operation of the business requires the support of the counter-party, it would be prudent for the practitioner to make an arrangement with the creditor to pay all current charges. The practitioner has the right to do so in terms of section 135(3) of the Act and such payments will be treated as "costs arising out of the business rescue", ranking above all other claims against the company including the remuneration of employees.

It is hoped that where a franchisee or franchisor is placed under business rescue, all the parties including the practitioner would adopt a prudent and business-like approach.

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