The Homologation Private Agreement Act ("WHOA") was introduced in early 2021. This allows not only for debt restructuring but also for amending or terminating contracts that hang like a millstone around the company's neck.
When terminating and amendingn agreements, it is obvious to think of the company's lease, where high penalties are payable in the event of early termination. See also this article.
However, it is often forgotten that the legal provision in this regard can be used much more broadly and is not limited to rental and lease agreements. In this post, therefore, I take a closer look at possibilities for a retail company to modify or terminate the franchise agreement frequently used in that industry.
I will address both the situation where the franchisor is in "financial distress" (the situation where a debtor is in a state where it is reasonably plausible that it will not be able to proceed with the payment of its debts) and the situation where the franchisee is in financial distress.
Legal framework
The basic premise of the WHOA is the offering of an agreement to the company's creditors, which agreement is ultimately approved ("homologated") by the court and thus becomes generally binding on all creditors, including those who opposed the agreement. Its purpose is to prevent bankruptcies.
With the introduction of the WHOA, the legislature added Section 373 to the Bankruptcy Code. This article contains the principles for restructuring agreements. Employment contracts are exempt from it (Article 369 paragraph 4 Fw). At its core, this is the regulation:
- The debtor may propose to his contracting party to modify or terminate the contract.
- If the contracting party does not agree to the proposal, the debtor can terminate the agreement with the court's consent.
- The court will generally always give that permission if the agreement is homologated.
- Consent is denied if the court denies the homologation or it is established that the debtor was not in distress.
- Any fines or compensation claims due because of the termination can be included by the debtor in the agreement (373 subsection 2 Fw) and thus also remediate them through a percentage offer or, for example, a debt for equity swap.
The franchisor in financial distress
In recent years, franchisors have regularly found themselves in distress. Consider, for example, Hema and Mitra. Hema was successfully restructured, but Mitra was declared bankrupt.
As a franchisor, why would you want to restructure franchise agreements? The franchise agreement may give only a few circumstances under which an agreement can be amended or terminated. This has to do with the fact that the franchisee often has to invest heavily to operate under the franchisor's banner. Nevertheless, it is conceivable that the franchisor may want to part with franchisees after restructuring. Perhaps the margins are under too much pressure or it is better for the future of the franchisor to continue with only (part of) its own stores to change course for the future.
Thus, where the franchise agreement often does not provide an exit, the WHOA does provide that possibility. The franchisor can propose to modify or terminate the agreement. This can have major consequences for franchisees; after all, without a contract, the future of their business is uncertain. They must continue independently or join another franchise organization. Both will require a substantial investment, a makeover of the store and often in the ICT and software structures. The franchisees do have a right to compensation for damages, but these may also be included in the settlement (see point 5 above).
The franchisee in financial distress
As a rule, the franchisee will more quickly face a situation where it may be better to continue under "his own banner" or affiliated with another franchise organization. This may have to do with purchase obligations, costs for using the franchise, or perhaps the formula no longer meets the wishes of the franchisee and/or the public. If the company is also in financial distress in the process, the WHOA not only offers the possibility to restructure debts but also to modify or terminate the franchise agreement.
Oppose modification or termination?
As a contracting party facing a proposal to modify or terminate the franchise agreement, can you do anything against it?
If you do not agree with the amendment or termination of the franchise agreement, you must object to it yourself. Until the day of the homologation hearing, an application can be filed with the court to reject the modification or termination of the agreement.
A contracting party may not invoke a ground for rejection if he has not protested to the debtor or the restructuring expert (if one has been appointed) on the matter within a reasonable time after he discovered or reasonably should have discovered the possible existence of that ground for rejection: you snooze, you lose....
A successful objection requires that the contracting party be able to show that the debtor is not in a condition in which it is reasonably likely that the debtor will be unable to continue to pay its creditors: i.e., contest the distress situation.
Since the court will only grant the request for permission to terminate the contract if the (entire) agreement is homologated, the contracting party can also attempt to oppose the homologation of the agreement itself. The contracting party can then invoke the legal grounds for rejection.
It is good to realize that the starting point is that if the agreement can be homologated, the debtor is in principle allowed to modify or terminate the agreements. Thus, the court does not (really) test the interests of the contracting party, but in larger terms whether no creditor is worse off than if bankruptcy were to follow. So it is quite a task to oppose the modification or termination of contracts as a contracting party, because in a much broader sense the contracting party will have to see the entire agreement undercut.
However, if the objection succeeds, the agreement will not proceed, at least not be amended or terminated. This may result in the debtor subsequently being declared bankrupt.
The consequences of bankruptcy
As a contracting party, it is therefore wise to weigh the consequences of bankruptcy for the agreement. After all, you should always be able to weigh the various scenarios against each other in order to make a good decision.
It is also important for the debtor to consider the consequences of bankruptcy: if the franchise agreement includes lease provisions, the contracting party will have an estate claim in bankruptcy for up to 3 months under Article 40 Bankruptcy Code.
For the rent payments for those months - the estate claim - the contracting party may be "in the money" sooner. You have to take that into account in the agreement, because in-the-money creditors have a special role in the WHOA. It is better to terminate the agreement in compliance with that three-month period, which again saves on class certification.
Conclusion
Under the WHOA, agreements can be amended or terminated. This also applies to franchise agreements. Resisting this power is by no means easy, unless the contracting party can invoke a statutory ground for rejection.
For questions about this article, guidance on a WHOA proceeding or bids for appointment as a restructuring expert, please contact Erik Jansen or Reinier Pijls.
