Franchise Operators Deal With Kleins Jewellery Bankruptcy
AUSTRALIA (Blue MauMau) - Australian franchise chain Kleins Jewellery seems to be heading towards bankruptcy and experts and franchisees are only now beginning to grapple with what to do when their franchisor may be no more.
Kleins started business importing and retailing affordable jewelry 24 years ago and started franchising in the early 1990s. By 2008 Kleins had 50 company owned stores and 150 franchisees in Australia, New Zealand and South Africa. It was an international success story. Testament to this was that the franchise is listed as one of only 20 ‘Accredited Franchise Systems’ whose franchisees the National Australia Bank (Australia’s biggest bank) will let ‘franchisees borrow up to 70% of the total set up cost of a new franchise, or purchase cost of an existing franchise, without necessarily providing your home as collateral for the loan.’
Kleins should not fail, but, the lower to middle end of the jewellery market (Kleins’ tagline is ‘looking good costs so little’) is becoming increasingly competitive.
The Kleins Group comprises 3 companies.
- Kleins Franchising Pty Ltd - the franchisor,
- The Jewellery Chain Pty Ltd - that owns the Kleins trademarks and is the head lessee for all 200 of the Kleins shops,.
- JDA Imports Pty Ltd.- the importer and supplier of stock to franchisees and company owned stores
Franchisees sign a franchise agreement with Kleins Franchising, licences to use the Kleins trademarks and occupy their retail premises through The Jewellery Chain, and source their stock through JDA.
The Kleins bankruptcy process
An administrator was appointed to all 3 companies in the Kleins Jewellery franchise on 2 May 2008, just a few days before Mothers Day. In Australia Voluntary Administration, under the Corporations Act 2001 (Cth) is a window of time when an administrator is appointed to the failing company. The administrator’s role it is to attempt to rescue the company from impending bankruptcy. There is plenty of information about the process on the Australian Securities and Investments Commission (ASIC) website.
Kleins news was conveyed by the media with headlines ranging from the prosaic ‘Kleins jewellery in administration’ (Sydney Morning Herald 5 May 2008) to the more colourful ‘Collapse exposes chink in the chain’ (Sunday Age 11 May 2008) and ‘When the ring of confidence falters’ (Sydney Morning Herald 17 May 2008) through to the one that would make you rush in to the store, pay off your lay bys and leave with the goods – ‘Kleins jewellery chain goes under with $20m owed’. (Inside Retailing 12 May 2008).
It appears that none of the 3 companies has lodged an Annual Return with the Australian Securities and Investments Commission (ASIC) since 2003. Kleins is thought to have debts of $A20m. It is alleged not to have passed on rent paid to it by franchisees, recently. This would put Kleins in breach of the relevant head leases. It is not known whether the franchisees provided the lease guarantees to the landlords for their franchised stores.
Some issues franchisees are grappling with.- Do I keep paying my rent and keep ordering stock?
- What do I say to customers?
- Does the Franchising Code of Conduct apply to administrators?
- Am I a creditor?
- Can I attend the creditors meeting in Melbourne? Or can I send a representative?
- What can I do?
- What next?
The administrators advertised the Kleins Group for sale on 9 May 2008, calling for expressions of interest by 12 May 2008.
The franchise agreement does not contain a provision permitting the franchisees to elect to terminate the agreement if an administrator is appointed to the franchisor, or one of the group. This means the franchisees do not have a ‘get out of jail free card’, and consequently do not have as much leverage s they might like with the administrator.
Does the Franchising Code of Conduct apply to administrators?
The Australian Competition and Consumer Commission is of the opinion that it does apply.This interpretation has not been tested in court. If it does apply, franchisees are ‘business consumers’ and entitled to remedies available under the Trade Practices Act 1974 (Cth) for breaches of the Franchising Code of Conduct.
If it does not apply, the administrator is regulated only by the Insolvency Practitioners Association’s Code of Professional Conduct and by its obligations under the Corporations Act 2001 (Cth).
Are franchisees creditor?
Possibly, not necessarily.
In Kleins, some franchisees are creditors (are owed money by one of the 3 Kleins companies) and all are possibly debtors (owe money for stock or rent or store outgoings).
- The Kleins franchise agreement contained a guarantee that if annual turnover did not reach a certain level, the franchisor would pay the franchisee an agreed sum of money. Anecdotally, many franchisees received or were entitled to receive these payments. For this money, they are a creditor.
- At least one of the franchisees formally mediated for the franchise guarantee and the franchisor signed a formal IOU. That franchisee is a creditor for the unpaid part of this money.
- Small amounts will be owing to franchsiees by the supplier of the group in respect of the inevitable occasional faulty items of jewellery.
- May be a creditor in relation to any rent payments that the franchisor received from the franchisee but did not pass on to the landlord - arguably held by the franchisor in trust.
What can the Kleins franchisees do?
The legal alternatives seem to be reasonably unsatisfactory.
- Wait and see.
- Try to trigger a breach of the franchise (or one of the other agreements you entered into with the group). When the group member can not deliver, claim a right to terminate the agreement for breach, and walk away!
- Keep honouring obligations under the franchise agreement and hope the administrator finds a buyer for the group.
- For those franchisees that relied on the National Australia Bank’s endorsement, seek legal advice about avenues this might open up for you under the Trade Practices Act.
No amount of due diligence by franchisees that signed on before 2004 would have given the franchisees any idea that the future of the Kleins group was not strong. Thus, the inevitable accusations that franchisees have only themselves to blame as they failed to conduct adequate due diligence, are not justified.
The Kleins story raises so many issues. Changing trading environments, the regulators’ poor understanding of the complexities of the franchise model, the degree of risk accepted by franchisees, the limited value of pre contractual disclosure in the face of franchisor bankruptcy.
