Joint and several liability in a BV (limited liability company) in franchising
Legal
One of the main reasons why (franchise) entrepreneurs prefer to choose a Private Limited Company (BV) as a legal form instead of a sole proprietorship or a general partnership (VOF) is liability. A BV is not called a limited liability company for nothing. However, in many franchise contracts, it is stated that the franchisee remains jointly (personally) liable to the franchisor, even when using a BV. This way, the franchisor circumvents the protection that the franchisee receives in their private situation against risks by operating from a BV.
Why does the franchisor require joint liability in the franchise contract?
Joint liability is beneficial for the franchisor. It provides more certainty that the franchisee, even in case of bankruptcy or other problems, will still settle their outstanding invoices and other damages or fines. Even if there's nothing left to recover from the BV. For the same reason, banks almost always require entrepreneurs to co-sign personally. The bank wants to be as sure as possible that the loan provided with interest will be repaid. However, for the franchisee, this means losing part of the protection, which is one of the main reasons for establishing the BV. The limitation of liability still applies to other suppliers in such cases, but not towards the franchisor or bank.
How does the limited liability of a BV work?
An entrepreneur who sets up a BV becomes the director of this BV. However, the director is not automatically exempt from all financial risks. A Private Limited Company is a legal entity. This means the BV can enter into obligations like a natural (living) person. The legal entity is then liable for these obligations. In practice, this means that a director of a BV is personally only at risk up to the value of the nominal share capital, or the amount that they have invested in a BV.
This basic rule is extended with what is known as directors' liability. The actual directors of the BV can still be held liable for the actions of the private limited company under this rule.
When can you still be held personally liable as a director of a BV?
As a director of a BV, you may be personally liable in cases of mismanagement. This means that the continuity of the BV has been endangered by the decisions the director has made. Examples include taking on obligations that you know in advance the BV cannot meet. Some other examples of mismanagement are:
- Sloppy bookkeeping
- Not actually depositing the share capital upon forming the BV
- Lack of an annual account
- Failure to file required documents with the Chamber of Commerce
- Incorrect representation in the annual report
- Selective payment of creditors
- Acting in conflict with the statutory objectives of the BV
- Receiving or paying under-the-table (black) money
Director liability can often be avoided by acting in good faith, keeping good records, and obviously not engaging in illegal activities. This prevents your personal assets from being claimed to pay off the BV’s liabilities.
Continuing against better judgment
Often, there comes a point when it is clear to the director that bankruptcy of their business is impending. If you, as a director, enter into obligations on behalf of the BV (or let them continue) knowing that the BV cannot fulfill them, you are committing a tort against this third party. The third party can then seek compensation from you as the director for such damages.
Liability as a passive shareholder
Sometimes, a BV has passive shareholders. These are investors not involved in the day-to-day management of the private limited company. These shareholders are also partly liable in the event of the BV’s bankruptcy. This liability is limited to the amount they received as distributed assets. This liability only applies if the distribution led to the BV being unable to meet its obligations. The liability of a passive shareholder is therefore much less than that of a director.
Liability towards third parties
Finally, joint liability can occur if you, as a director, consciously agree to it. This is often what franchisors and lenders like banks require when going into business with a franchisee. Especially with franchisors, this can sometimes be a very harsh measure towards franchisees when the risks faced by the franchisor are actually limited. In such situations, other solutions are conceivable.
What are the alternatives to joint liability in a BV in franchising?
Jointly liable up to a specified amount
Franchisors are usually paid for their services only after the fact. The franchise fee is often calculated based on the revenue the franchisee has achieved. In mutual consultation, it can be determined what risk the franchisor is willing to take. For example, it can be agreed that personal liability is limited to several months' worth of invoices from the franchisor to the franchisee. This way, the franchisor can still recoup part of their money, but the franchisee can avoid serious personal financial difficulties if the business isn't doing well and avoid, for instance, having to sell their house to pay back the franchisor.
If the franchisor is also the supplier of the products being sold, this should also be considered in the calculation. A retention of title until payment has occurred in the delivery conditions can already ensure that the franchisor simply gets their goods back, thus limiting the financial risk for franchisors as suppliers. Such joint liability up to a specific amount must also be well legally documented, for example, in an addendum to the franchise contract.
Having other BVs co-sign, such as the holding company
In addition to limiting liability, many entrepreneurs with a successful business choose a BV for tax reasons. A BV allows entrepreneurs to avoid having to pay income tax on all earnings immediately. In such situations, a structure is often chosen with an operating company, the BV with which the business is actually conducted, and a holding company, which is essentially a kind of savings BV where the money is stored safely without having to pay income tax on it. The holding is then 100% owner of the operating company, and the entrepreneur themselves is the director and shareholder of the holding.
In this structure, the operating company often has virtually all obligations. Most contracts are concluded with the operating company, and that BV is liable to suppliers. If things go wrong, there's often little to be recovered from the operating company. If a franchisee has an operating company with a holding above it where much money is stored, it could be sufficient for the franchisor's risks if the franchisee is not personally jointly liable, but co-signs with their holding.
Require a franchisee deposit
Instead of joint liability up to a specified amount, it can also be agreed that the franchisee pays a deposit to the franchisor amounting to a certain sum. This approach to covering risks is commonly adopted in renting premises. Almost every property owner requires a three-month rent deposit to cover any damages or unpaid rent.
Which rights and obligations from the franchise contract must always be joint?
The above solutions are particularly suitable for the financial risks of the franchisee and franchisor. However, there are also rights and obligations in most franchise agreements that are intended as personal rights and obligations of the franchisee. When joint liability through a BV is limited, it is important that these remain intact. Consider, for example:
The non-compete clause and confidentiality clause
When the franchise contract is entered into by a BV, a non-compete clause and confidentiality clause are strictly speaking only applicable to that BV. The franchisee could therefore simply set up a second BV and compete against the franchisor with this BV. This is obviously not the intention behind such clauses.
Upon transfer of the business by the franchisee
When a business within a BV is transferred, there are two options:
1. Asset-liability transaction
Firstly, it could be an asset-liability transaction. Then, all assets (all items and things of value) are simply transferred to another sole proprietorship, VOF, or BV. When this is done with the franchisor’s approval, there is no problem. When this approval is not granted, there is often nothing left to obtain from the franchisee’s BV. Everything has been sold, and the franchisee will have already extracted the money from the BV. Personal joint liability is therefore necessary for the franchisor to avoid being left empty-handed.
2. Transfer BV
It may also be decided to sell the BV including all rights and obligations (and thus all contracts including the franchise contract) as a whole. Then a new person becomes the director. Also in this case, when this occurs with the franchisor’s approval, there is no problem. When the franchisor has not given their approval, they suddenly find themselves with a different (new) franchisee against their will. On the one hand, this is often a termination ground in most franchise contracts, allowing the franchisor to immediately terminate the franchise agreement. On the other hand, it is important for the franchisor that they can recover their damages in these situations from the franchisee as the person who sold without permission.
Post-contractual provisions
Often, there are other provisions that remain valid after a franchise contract has ended. It is often crucial that the franchisee continues to comply with these as a person.
Provisions concerning illness or death of the franchisee
A Private Limited Company cannot fall ill or die. Only a natural person can. So, it is logical that these provisions are extended to the franchisee as a person.
Penalties
Many franchise agreements also contain a penalty clause. This often describes situations where the franchisee has acted in bad faith. In other words, where the franchisee has deliberately done things prohibited by the franchise contract. Because the damage from such actions is often difficult to ascertain, it is often stipulated that a certain, predetermined penalty can be imposed. The idea is not that franchisees can intentionally cause harm to the franchisor and circumvent the consequences through their private limited company.
In conclusion: these are exceptional cases
If you are concerned about joint liability with a BV, remember these are all exceptional cases. If you simply conduct your business normally as an entrepreneur and do not do anything reckless, the risks are almost always manageable. If you want to discuss the risks applicable to you or the solution best suited to your situation, please feel free to contact us using the form below. We would be happy to consider your personal situation.
