Franchisee as a subtenant in particular in bankruptcy

It often happens that a franchisor takes care of finding a suitable rental location for the franchisee to operate his business in, before the parties enter into a franchise agreement. In the lease agreement with the landlord, the franchisor will like to be regarded as a tenant in addition to the franchisee as a subtenant. The Civil Code offers a tenant more far-reaching protection than a subtenant. In addition, the franchisor will want to retain ownership of the lease rights to the property after the end of the franchise agreement. This is because before the franchisor has entered into the lease, the franchisor has usually had an extensive and costly market and location survey carried out into the best market area for the company to establish itself in. The location is therefore very important in this respect, especially given the fact that the franchisor also wishes to guarantee a successive franchisee a good profitable location. (This in connection with the fact that the franchisor is responsible for the forecasted turnover). Of course, it should also not be forgotten that the location of the company is already known to the existing clientele and that moving to another location in the first period can have a negative effect on turnover. In order to be assured of the retention of the leased property, a provision is often included in the franchise agreement stating that the end of the franchise agreement also entails the end of the sublease agreement.

In addition to the fact that a tenant enjoys more far-reaching protection in the Civil Code than a subtenant, the franchisee also has a dependent position in the event of a weak franchise organisation. It is customary for the franchisee, as a subtenant, to pay the rent to the franchisor, who then makes these rents payable to the lessor. If the franchisor’s liquid position is weak, there is a risk that the rent will not be paid in whole or in part to the lessor, which in turn will result in the latter being able to terminate the rent without further ado.

In the event that the franchisor goes bankrupt, both the trustee and the lessor are authorized to immediately terminate the lease with a notice period of up to 3 months. The franchisee of the bankrupt is free to try to get hold of the property as a tenant in consultation with the landlord because the person wishes to make an independent restart in the property. After bankruptcy, the trustee will want to settle the estate as quickly as possible and will not enforce the tenancy rights, since the estate does not benefit from continuation of the lease agreements. However, the so-called destination clause can proverbially throw a spanner in the works for the (former) franchisee who wishes to make an independent restart. This is because the landlord may have included a destination clause in the rental agreement and determine that he only gives permission to operate a similar business in this relevant rental property. If the franchisee considers this to be a restrictive provision, the franchisee will therefore still have to give up the property.

If, during the bankruptcy of the franchisor, an acquiring party reports to the trustee and eventually obtains permission from the trustee to purchase the bankrupt estate, the description with regard to acquiring the lease rights is more nuanced. The acquiring party will wish to keep the locations as the bankrupt operated them, or at least a large part of them. Entrepreneurs who decide to work with the acquiring party and thus become a franchisee again, will have to agree to the fact that they will operate the property on the basis of sublease. Their new franchisor will have the same reasons as their old franchisor for wanting to continue to hold the tenancy rights. The franchisor can make this a condition for entering into a new franchise agreement with the franchisee in its entirety. In the (exceptional) case that the rental rights are already in the hands of the franchisee, the new franchisor will have to claim through the subdistrict court that the duration of the rental agreement is linked to the duration of the franchise agreement and that the franchisee after the end of the franchise agreement will cooperate with a so-called ‘substitution’ of the franchisor. A substitution means that the tenant can transfer the lease of the business space to a third party against the will of the lessor in connection with the transfer of the business that is carried on in the business space. Incidentally, the substitution by the tenant must be claimed at the subdistrict court. A substitution prevents the lessor from renting the property to a third party who is not interested. In the event that the lease rights are still with the trustee, the former franchisee who does not intend to enter into a franchise agreement with the acquiring party will be in a difficult position if he wishes to get hold of the lease rights. Even if the entrepreneur has found the landlord willing, after termination of the existing lease with the trustee, to enter into a lease with him, the threat of a claim for substitution by the trustee will remain real. In principle, the receiver can only demand substitution before the business transfer is realized or during the notice period of the rental agreement. A weighty interest in business transfer is required as an argument in court. Whether, against the background of the approaching end of the rental agreement, it is still useful for the trustee to demand authorization for substitution depends on the concrete circumstances.

Ludwig & Van Dam franchise attorneys, franchise legal advice