A franchisor is entitled to terminate a franchise agreement entered into with a franchisee undergoing statutory administration without the need for permission from court.

This was the holding in the case of Hoggers Limited (In Administration) v John Lee Halamandres & 11 others [2021] eKLR (the “Hoggers Case”). The High Court of Kenya held that termination and non-renewal of franchise agreements take effect upon service of the required contractual notice and are not legal proceedings requiring the consent of an Administrator or leave of the court with the meaning of section 560 of the Insolvency Act No. 18 of 2015 (the “Insolvency Act”) and upheld the terms of the contract in favour of the franchisor.

Background

The brief facts are that Hoggers Limited (“Hoggers”) was licensed by various franchise agreements entered with Famous Brands Management Company (Pyt) Limited (“Famous Brands”) to operate food outlets under the trade marks “Debonairs Pizza” and “Steers” across various locations in Kenya. Owing to heavy borrowing by Hoggers, Hoggers entered administration on 19th February 2020.

Between June and July 2020, Famous Brands issued notices of termination/nonrenewal of the franchise agreements to Hoggers on the basis that it had failed to adhere to the operational standards set out in the agreements. The agreements lapsed on 31st July 2020.

Hoggers sought an injunctive order restraining Famous Brands from terminating the agreements based on illegality, alleging that it was done while the company was under administration and that there was a statutory moratorium that barred the termination as per the Insolvency Act. Hoggers further asserted that the demands made by Famous Brands for de-branding would defeat the purpose and objectives of administration, which are to maintain the company as a going concern in order to achieve a better outcome for its creditors.

Famous Brands filed a counter application by which it prayed for a declaration that it validly issued the notices of termination, and non-renewal and an injunction restraining Hoggers from using the “Debonairs Pizza” and “Steers” trade marks, and trading using its intellectual property including its formulations, recipes and specially formulated products.

Determination as regards termination or non-renewal

The main issue for determination was whether Famous Brands could terminate or refuse to renew the franchise agreements in light of the provisions of section 560 the Insolvency Act. Section 560 provides that while a company is under administration, there shall be a moratorium on beginning or continuing legal process while administration order has effect without consent of the administrator or leave of the court.

Honourable Majanja J. held that termination and non-renewal are simple acts that take effect upon service of the contractually required notice. These were not “legal proceedings” within the meaning of section 560 of the Insolvency Act.

In arriving at this decision, the judge rejected the argument that proceedings covered every sort of step which may be taken against the company under administration, including its contracts or its property or that the intention of parliament was to prevent all such actions without the leave of the court or consent of administrators. As highlighted in the judge’s decision, the use of “legal proceedings” in the statute narrows the scope and application of the moratorium to proceedings of judicial or quasi-judicial nature.

However, the court also clarified that the purpose of the statutory moratorium was preservation of the opportunity to save the company or its business by preventing the dismemberment of its assets through execution or distress. For this reason the court dismissed the cross application by Famous Brands and held that it required consent of the Administrator or apply for leave to commence proceedings against the administrator in order to require the debranding of the franchisee’s premises.

Why is this relevant for franchisors and franchisees?

The Hogger’s Case provides useful jurisprudential validation and guidance on the termination of franchise agreements by franchisors on grounds of material breach of contract by the franchisee for failing to uphold contractually stipulated operational standards.

Operating standards are usually set by franchisors as a tool to ensure that the quality of goods and/or services received from one outlet match the uniformity standards required by the franchisor in the operation of their franchised business across the board in all territories the franchised business operates in. This allows the Franchisor to prevent damage and disrepute to their brand and to continue to protect and enhance brand value. Operating standards usually contain detailed, mandatory and suggested procedures, standards and other minimum requirements that the franchisee is expected to adhere to in the operation of their business, i.e. specific stock and maintenance requirements, and the look and feel of stores.

Hoggers was in breach of the franchise agreements by failing to uphold Famous Brands’ contractually stipulated operational standards. The company had been given ample time to rectify the identified breaches and failed to do so.

Typically, courts will uphold the freedom of parties to contract, and its function is to enforce contracts and not re-write them. Parties are not fee to run from the terms of their agreements.

The fact that a company is in administration does not act to allow the breach of the terms of a Franchise Agreement to continue unremedied. The moratorium provided under the Insolvency Act functions as a tool intended to offer breathing space for insolvent companies but does not freeze the exercise of all contractual rights except those specifically mentioned in the Insolvency Act.