Room on the board

It’s important for franchisees to understand their legal responsibilities and restrictions, especially in relation to appointing new directors, advise Sarah Astley and Gabriela Alexandru

It’s common for entrepreneurs setting up limited liability companies to opt to join a franchise in order to operate their business, not least because franchisees have a distinct advantage granted by the existing experience and goodwill of the franchisor.

A franchise arrangement limits the risks of setting up a new business, often by giving the franchisee assistance and training alongside the rights to use the franchisor’s name and products, as well as the advantage of gaining access to a pre-existing market without the initial effort needed to establish a new brand in the eyes of the consumer base.

Legal restrictions

What directors can’t minimise, however, are their legal duties to the franchisor company and its shareholders, as set out in the Companies Act 2006. These include promoting the success of the company, acting within the powers of the company, exercising independent judgement, exercising reasonable skill, care, and diligence, declaring interests in any proposed or existing transactions, not accepting benefits from third parties (i.e. lavish entertaining) and avoiding conflicts of interest.

What is often less than clear is whether it’s possible to appoint a new director to a franchise business, and if so, what circumstances would allow it?

Be aware of liability

Most franchise agreements require a personal guarantee from all the directors of the franchisee business. This means that the directors are personally liable if the franchisee company fails to uphold all the terms of the franchise agreement, including any payment of money when it is due to the franchisor. Among other considerations, such an arrangement stops the directors from putting the franchisee company into administration in order to avoid their financial liabilities to the franchisor.

It’s also common for the franchise agreement to have a clause that requires the directors of the franchisee company to remain directors at all times. This, however, will cause difficulties if a director is incapacitated in any way (for example through poor health or even death), or if they’re removed as a company director because they have breached their duties set out in the Companies Act 2006.

Most often, the franchise agreement will allow the franchisor to end the agreement where a company director(s) is convicted of a criminal offence or if they have behaved in a way that could damage the reputation of the franchisor’s business.

Check the terms of contract

Because of the possible impact on their business, as well as on themselves in a personal capacity, it’s important that the owners of a franchisee business ensure the inclusion in the franchise agreement of clear terms dealing with what would happen if they were unable to carry on as a company director. This can cover them either individually or collectively, and allow for the appointment of a new director/s, who would need to take over personal liability when joining the business.

Other measures should include providing training and guidance to all directors of the franchisee business to ensure they understand their legal duties and responsibilities and keeping records of the training given. Recording such steps not only ensures that vital training isn’t overlooked, but could also provide proof that the company as a whole did everything it could in the event of any allegation by the franchisor that directors’ duties have been breached.

Regular board meetings, which are correctly minuted and always carried out in accordance with the company’s articles of association, will also be vital, as they record the decision process and outcomes, especially where an individual director may have objected to a specific course of action approved by the majority of directors.

Directors should always make sure that they’re aware of the day-to-day business operations and decision-making required of them individually. Independent legal advice should always be sought when the situation requires it, especially in relation to duties or concerns touching the Companies Act 2006. An example of such an issue could be concerns around wrongful trading if the business (whether the franchisee business or another business) is experiencing financial difficulties, or whether a situation they’re in may give rise to a conflict of interest, preventing them from participating in the decision-making process.

What if things go wrong?

If a director is found to have breached their duties as set out in the Companies Act 2006, the consequences can vary from being disqualified from acting as a company director for up to 15 years to personal criminal liability. An example of the latter would be prosecution under the Insolvency Act 1986 if a director is believed to have taken part in fraud in the anticipation of a business being wound up, or if they have made false representations to their creditors.

There are clear consequences for contractual breaches by directors in all businesses, but potentially increased personal risk for the directors of franchisee businesses, given the added layer of obligations which inevitably come with entering into a franchise agreement. It’s therefore important to make sure you have access to the right professional advice and support to help you make informed decisions.

The author

Sarah Astley and Gabriela Alexandru are associates at Gullands Solicitors. Contact them at s.astley@gullands.com or g.alexandru@ gullands.com.