UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM N-CSR

CERTIFIED SHAREHOLDER REPORT OF REGISTERED MANAGEMENT INVESTMENT COMPANIES

Investment Company Act file number 811-21306
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FRANKLIN MUTUAL RECOVERY FUND
---------------------------------
(Exact name of registrant as specified in charter)

101 JOHN F. KENNEDY PARKWAY, SHORT HILLS, NJ 07078-2705
-----------------------------------------------------------
Address of principal executive offices) (Zip code)

CRAIG S. TYLE, ONE FRANKLIN PARKWAY, SAN MATEO, CA 94403-1906
-----------------------------------------------------------------
(Name and address of agent for service)

Registrant's telephone number, including area code: (210) 912-2100
----------------
Date of fiscal year end: 03/31
--------

Date of reporting period: 03/31/09
---------

ITEM 1. REPORTS TO STOCKHOLDERS.

MARCH 31, 2009

ANNUAL REPORT
AND SHAREHOLDER LETTER

VALUE

FRANKLIN
MUTUAL RECOVERY FUND

(FRANKLIN TEMPLETON INVESTMENTS(R) LOGO)

Franklin - Templeton - MUTUAL SERIES

Franklin Templeton Investments

GAIN FROM OUR PERSPECTIVE(R)

Franklin Templeton's distinct multi-manager
structure combines the specialized expertise of
three world-class investment management
groups--Franklin, Templeton and Mutual Series.

SPECIALIZED EXPERTISE Each of our portfolio management groups
operates autonomously, relying on its own
research and staying true to the unique
investment disciplines that underlie its
success.

FRANKLIN. Founded in 1947, Franklin is a
recognized leader in fixed income investing and
also brings expertise in growth- and
value-style U.S. equity investing.

TEMPLETON. Founded in 1940, Templeton pioneered
international investing and, in 1954, launched
what has become the industry's oldest global
fund. Today, with offices in over 25 countries,
Templeton offers investors a truly global
perspective.

MUTUAL SERIES. Founded in 1949, Mutual Series
is dedicated to a unique style of value
investing, searching aggressively for
opportunity among what it believes are
undervalued stocks, as well as arbitrage
situations and distressed securities.

TRUE DIVERSIFICATION Because our management groups work
independently and adhere to different
investment approaches, Franklin, Templeton and
Mutual Series funds typically have distinct
portfolios. That's why our funds can be used to
build truly diversified allocation plans
covering every major asset class.

RELIABILITY YOU CAN TRUST At Franklin Templeton Investments, we seek to
consistently provide investors with exceptional
risk-adjusted returns over the long term, as
well as the reliable, accurate and personal
service that has helped us become one of the
most trusted names in financial services.

MUTUAL FUNDS | RETIREMENT PLANS | 529 COLLEGE SAVINGS PLANS | SEPARATE ACCOUNTS

(GRAPHIC)

Not part of the annual report

Contents

SHAREHOLDER LETTER......................................................... 1
ANNUAL REPORT
Franklin Mutual Recovery Fund.............................................. 5
Performance Summary........................................................ 11
Your Fund's Expenses....................................................... 16
The Fund's Repurchase Offers............................................... 18
Financial Highlights and Statement of Investments.......................... 19
Financial Statements....................................................... 30
Notes to Financial Statements.............................................. 35
Report of Independent Registered Public Accounting Firm.................... 50
Tax Designation............................................................ 51
Board Members and Officers................................................. 52
Shareholder Information.................................................... 57

Shareholder Letter

Dear Shareholder:

The fiscal year ended March 31, 2009, is over. Like many other investors, we are
not sorry to see it pass. From a purely financial perspective, it was a painful
year, bringing a drop of 38.09% for the Standard & Poor's 500 Index, similar
declines around the globe, a credit crisis and a climate of fear that prompted a
global recession.(1) These events have effectively wiped out the owners of such
institutions as Fannie Mae, Freddie Mac, AIG, Bear Stearns, Lehman Brothers,
Fortis, Washington Mutual and Wachovia Bank, and have led to extraordinary
government intervention in the financial markets. Policy makers appear to have
no definitive playbook for guidance, and the world of finance is being remade
before our eyes.

Franklin Mutual Recovery Fund was launched to provide investors a concentrated
exposure to Franklin Mutual Advisers' traditional expertise in event-driven
situations, including distressed securities, risk arbitrage and undervalued
equities with an identifiable catalyst to unlock value. As stewards of our
investors' capital, we have always followed an investment approach that attempts
to limit our portfolio's downside exposure. This is inherent in our focus on
buying companies cheaply -- when their securities are trading at a meaningful
discount to our analysis of intrinsic value -- and selling them as they trade
close to that value.

With markets down as much as they were in the past 12 months, and given that we
are primarily "long" investors, we believe it would be unrealistic to

(1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information
contained herein: (1) is proprietary to Morningstar and/or its content
providers; (2) may not be copied or distributed; and (3) is not warranted
to be accurate, complete or timely. Neither Morningstar nor its content
providers are responsible for any damages or losses arising from any use of
this information. Past performance is no guarantee of future results. The
S&P 500 consists of 500 stocks chosen for market size, liquidity and
industry group representation. Each stock's weight in the index is
proportionate to its market value. The S&P 500 is one of the most widely
used benchmarks of U.S. equity performance.

NOT FDIC INSURED | MAY LOSE VALUE | NO BANK GUARANTEE

Not part of the annual report | 1

expect positive returns in this environment. Nevertheless, we clearly are
disappointed with the extent of the Fund's loss for the year. Several factors
contributed to this, some market related and others specific to the Fund.

The Fund's performance was hit hardest by the event-driven, value equities
portion of the portfolio. Many of these companies were in the midst of
restructuring efforts or had completed deals and were trying to reduce their
debt. Shares of these companies were punished by the generally indiscriminate
devaluation of assets across industries, geographies and market capitalizations.
They were often vulnerable to the repricing of corporate credit risk and
paralysis in the credit markets.

Our value equities also included some companies exposed to economically
sensitive sectors. We underestimated the ferocity of the economic downturn and
its impact on these companies, including the oil and commodity companies. While
we did not buy into the oil and commodity bubble that burst in July 2008, we did
own or had established from late July until early October positions in a number
of companies directly or indirectly exposed to oil or other commodities. Such
companies' share prices plunged in the latter half of 2008.

The distressed debt and private equity investments also failed to perform well
during the downturn. Our debt positions fell on a mark-to-market basis as the
markets priced in ever higher required returns on credit. We substantially wrote
down several private transactions in which we were invested.

The merger arbitrage strategy contributed to the Fund's negative performance as
well, with several merger arbitrage positions that declined sharply after deals
failed to close. Our steady gains on the majority of the positions failed to
outweigh some notable losses.

In a year of few highlights, we did get some things right. A portion of the
Fund's assets were held in cash during the year, with about 20% of total net
assets in cash at year-end, reflecting our caution about valuations in general.
We selectively used market puts at various points during the year to protect
against large downward market movements. We did have our share of positive stock
stories as noted in the following shareholder report.

Looking forward, we are focused on a number of factors. Rather than try to be
macroeconomists or market strategists, we are instead focused on our discipline
of buying securities at what we think are very attractive prices and investing
for the long term. However, one cannot ignore the macroeconomic backdrop, and we
are proceeding with a fairly high degree of caution.

2 | Not part of the annual report

Although the actions of central banks across the globe have temporarily
stabilized the financial system, we are not convinced that all of the bad
economic news is behind us. Nevertheless, given the indiscriminate nature of the
market carnage, such an environment can create opportunities -- and we are
focused on four particular areas:

- Distressed debt, a quiet area for the past several years due to robust
economic and capital market conditions. We believe the leveraged
buyout boom from 2005 through mid-2007 is likely to result in defaults
by many good companies with bad balance sheets in the coming years.
Currently we see two types of opportunities. The first is senior
secured corporate loans that are trading at "equity-like" returns
with, in our view, a low risk of principal loss. The second is more
traditional distressed debt, where a restructuring appears likely to
occur and we can identify securities that we believe present an
attractive return and a margin of safety. We believe this category
could grow significantly in 2009.

- Merger arbitrage, where strategic mergers and acquisitions (M&A)
continue to occur. We believe financial buyers may remain on the
sidelines in 2009, but strong corporate buyers are continuing to use
M&A to reshape their companies and industries in the downturn.

- Stocks disproportionately punished by the market, perhaps because they
were owned heavily by hedge funds or have a higher degree of leverage
but have no need to access the credit markets for a number of years.

- Stocks of strong companies that are well positioned to exploit
distressed markets. We are looking for companies who have either
hoarded capital or raised fresh capital and are positioned to acquire
assets at distressed prices.

Periods of economic and market instability historically have created favorable
opportunities for long-term, patient and disciplined investors. We believe the
basic institutions that underlie our economic and political system have proven
their ability to adapt to changing conditions and emerge stronger from severe
dislocations. We are excited about the prospects of participating in this
chapter, albeit a difficult one, of our economic history and are confident our
approach should serve our shareholders well.

Not part of the annual report | 3

As a final note, I want to thank Michael Embler for his years of service as a
portfolio manager for the Fund. Effective May 1, Mike is leaving Franklin Mutual
Advisers, and we wish him the best in his future pursuits. Christian Correa and
Shawn Tumulty will continue in their current capacity as portfolio managers and,
along with the entire Franklin Mutual Advisers team, we appreciate your past
support and look forward to a more prosperous year ahead.

Sincerely,

/s/ Peter A. Langerman
Peter A. Langerman
Chairman, President and Chief Executive Officer
Franklin Mutual Advisers, LLC

THIS LETTER REFLECTS OUR ANALYSIS AND OPINIONS AS OF MARCH 31, 2009. THE
INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET, COUNTRY,
INDUSTRY, SECURITY OR FUND. STATEMENTS OF FACT ARE FROM SOURCES CONSIDERED
RELIABLE.

4 | Not part of the annual report

Annual Report

Franklin Mutual Recovery Fund

YOUR FUND'S GOAL AND MAIN INVESTMENTS: Franklin Mutual Recovery Fund's goal is
capital appreciation. The Fund seeks to achieve superior risk-adjusted returns
with a moderate correlation to U.S. equity markets by investing in distressed
companies, merger arbitrage securities and special situation/undervalued
securities. The Fund may take long and short positions, with the latter
typically utilized in connection with the merger arbitrage strategy.

PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE
RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE
A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM
FIGURES SHOWN. PLEASE VISIT franklintempleton.com OR CALL (800) 342-5236 FOR
MOST RECENT MONTH-END PERFORMANCE.

ASSET ALLOCATION
Based on Total Net Assets as of 3/31/09

(PIE CHART)

Equity ....................... 51.8%*
Debt Instruments ............. 20.0%
Short-Term Investments &
Other Net Assets .......... 28.2%

* Net of short positions.

This annual report for Franklin Mutual Recovery Fund covers the fiscal year
ended March 31, 2009.

PERFORMANCE OVERVIEW

For the 12 months under review, Franklin Mutual Recovery Fund - Class A had a
- -39.55% cumulative total return. The Fund performed comparably to its benchmark,
the Standard & Poor's 500 Index (S&P 500), which had a

THE DOLLAR VALUE, NUMBER OF SHARES OR PRINCIPAL AMOUNT, AND NAMES OF ALL
PORTFOLIO HOLDINGS ARE LISTED IN THE FUND'S STATEMENT OF INVESTMENTS (SOI). THE
SOI BEGINS ON PAGE 23.

Annual Report | 5

- -38.09% total return for the same period.(1) The Fund underperformed the +6.70%
total return of the Bloomberg/EFFAS U.S. Government 3-5 Years Total Return
Index.(2) The performance of the Fund relative to the Bloomberg index is used as
the basis for calculating the performance adjustment to the base management fee
paid to the Fund's adviser. You can find more of the Fund's performance data in
the Performance Summary beginning on page 11.

ECONOMIC AND MARKET OVERVIEW

During the 12-month period ended March 31, 2009, economic conditions generally
deteriorated. In February 2009, The Conference Board's Consumer Confidence Index
fell to an all-time low since it began in 1967 as the U.S. economy faltered and
stock markets declined. The government's abrupt conservatorship of Fannie Mae
and Freddie Mac in early September 2008 and the failure of several blue chip
banks and financial institutions roiled equity markets during the period.
Despite government interventions and massive emergency funding, the nation's
economic troubles were exacerbated as manufacturing activity weakened at its
fastest pace in nearly 30 years and as home prices continued to fall in early
2009. Jobless claims mounted and the unemployment rate rose to 8.5% by
period-end.(3) Although home sales declined for most of the period, they
increased near period-end. Reflecting a broad-based contraction in consumer
spending, falling corporate profits and slowing exports, economic growth, as
measured by gross domestic product (GDP), fell in the third and fourth quarters
of 2008 at annualized rates of 0.5% and 6.3% after increasing at a 2.8%
annualized rate in the second quarter. In 2009's first quarter, GDP declined at
an estimated 6.1% annualized rate.

Oil prices stood at $102 per barrel at the beginning of the period, but
retreated dramatically to $50 by period-end. Many other commodities such as
agricultural products and base metals followed similar trends. Partially as a
result of the steep price corrections, inflation declined significantly during

(1.) Source: (C) 2009 Morningstar. All Rights Reserved. The information
contained herein: (1) is proprietary to Morningstar and/or its content
providers; (2) may not be copied or distributed; and (3) is not warranted
to be accurate, complete or timely. Neither Morningstar nor its content
providers are responsible for any damages or losses arising from any use of
this information. The S&P 500 consists of 500 stocks chosen for market
size, liquidity and industry group representation. Each stock's weight in
the index is proportionate to its market value. The S&P 500 is one of the
most widely used benchmarks of U.S. equity performance. The index is
unmanaged and includes reinvested dividends. One cannot invest directly in
an index, nor is an index representative of the Fund's portfolio.

(2.) Source: Bloomberg LP. The Bloomberg/EFFAS U.S. Government 3-5 Years Total
Return Index is designed as a transparent benchmark for the U.S. government
bond market. The index is unmanaged and includes price
appreciation/depreciation only. One cannot invest directly in an index, nor
is an index representative of the Fund's portfolio. Please see Notes to
Financial Statements for more information about the performance-based
management fee.

(3.) Source: Bureau of Labor Statistics.

6 | Annual Report

the period, and March's inflation rate was an annualized -0.4%.(3) Core
inflation, which excludes food and energy costs, rose at a 1.8% annual rate,
which was within the Federal Reserve Board's (Fed's) informal target range of
1.5%-2.0%.(3)

A slowing economy and decelerating inflation prompted policymakers to further
lower interest rates and enact stimulus plans. During the 12 months under
review, the Fed lowered the federal funds target rate to a range of 0% to 0.25%
from 2.25% at the start of the period. The Fed and U.S. Treasury Department
introduced new programs intended to enhance market liquidity. The government
also outlined details of its Public-Private Investment Program, with an
objective of removing devalued real estate-related assets from banks' balance
sheets.

Market volatility intensified during the reporting period as stocks fluctuated
wildly and Treasury prices soared. Near period-end, stock markets rebounded
somewhat from severely depressed levels, but still declined significantly over
the period. For the 12 months under review, the blue chip stocks of the Dow
Jones Industrial Average had a total return of -35.94%, the broader S&P 500 a
- -38.09% total return, and the technology-heavy NASDAQ Composite Index a -32.29%
total return.(4) All sectors lost value, and the financials, materials and
industrials sectors had the largest declines.

INVESTMENT STRATEGY

We follow a distinctive investment approach and can seek investments in
distressed companies, merger arbitrage and special situations/undervalued
stocks. The availability of investments at attractive prices in each of these
categories varies with market cycles. Therefore, the percentage of the Fund's
assets invested in each of these areas will fluctuate as we attempt to take
advantage of opportunities afforded by cyclical changes. We employ rigorous,
fundamental analysis to find investment opportunities. In choosing investments,
we look at the market price of an individual company's securities relative to
our evaluation of its asset value based on such factors as book value, cash flow
potential, long-term earnings and earnings multiples. We may invest in
distressed companies if we believe the market overreacted to adverse
developments or failed to appreciate positive changes.

(4.) Source: (C) 2009 Morningstar. The Dow Jones Industrial Average is price
weighted based on the average market price of 30 blue chip stocks of
companies that are generally industry leaders. See footnote 1 for a
description of the S&P 500. The NASDAQ Composite Index measures all NASDAQ
domestic and international based common type stocks listed on The NASDAQ
Stock Market. The index is market value weighted and includes more than
3,000 companies.

TOP 10 HOLDINGS
3/31/09

COMPANY % OF TOTAL
SECTOR/INDUSTRY, COUNTRY NET ASSETS
- ------------------------ ----------

Wyeth 5.1%
PHARMACEUTICALS, U.S.
Symetra Financial 3.9%
INSURANCE, U.S.
Constellation Energy Group 3.3%
ENERGY TRADERS, U.S.
Revel Entertainment Group LLC 3.2%
MEDIA, U.S.
Smurfit-Stone Container Enterprises 3.1%
CONTAINERS & PACKAGING, U.S.
Weyerhaeuser Co. 3.1%
PAPER & FOREST PRODUCTS, U.S.
CVS Caremark Corp. 3.0%
FOOD & STAPLES RETAILING, U.S.
Japan Tobacco Inc. 2.9%
TOBACCO, JAPAN
Alliance One International Inc. 2.7%
TOBACCO, U.S.
Cadbury PLC 2.4%
FOOD PRODUCTS, U.K.

Annual Report | 7

TOP 10 SECTORS/INDUSTRIES
3/31/09

% OF TOTAL
NET ASSETS
----------

Tobacco 7.0%
Pharmaceuticals 4.2%
Independent Power Producers &
Energy Traders 4.2%
Paper & Forest Products 4.0%
Media 4.0%
Semiconductors & Semiconductor
Equipment 3.5%
Food & Staples Retailing 3.0%
Health Care Providers & Services 3.0%
Insurance 2.9%
Airlines 2.9%

MANAGER'S DISCUSSION

During the year ended March 31, 2009, our worst performers included Fund
holdings Fortis, Constellation Energy and Weyerhaeuser.

Fortis, the Benelux financial services company, fell in value as the company
struggled to raise capital as lenders dramatically tightened credit due to the
ongoing global economic and financial crisis. In this environment, market fears
about any bank with capital needs led to panic selling among investors, and
Fortis was not spared from these negative trends. Near the end of the period
under review, Fortis received emergency capital from the governments of Belgium,
Luxembourg and the Netherlands in an effort to shore up its balance sheet. At
period-end, the Fund no longer held common shares of Fortis.

Our investment in Constellation Energy, a Maryland-based utility that also
produces, markets and trades energy through several business units, lost value
as market fears about the company's energy trading operations drove the shares
down. Unable to reverse investor sentiment and other negative trends, the
company was forced into a distressed sale. Constellation had some collateral
needs related to its trading business, and in the days following the bankruptcy
of Lehman Brothers, rumors swirled about the health of Constellation's business.
Ratings agencies threatened a downgrade of the firm, causing a liquidity
squeeze. Under pressure, Constellation's board signed a deal with Berkshire
Hathaway's MidAmerican Energy Holdings. Late in 2008, that deal was abandoned
when Electricte de France offered to buy certain Constellation assets as an
alternative to the full distressed sale to Berkshire.

Weyerhaeuser is a forest products company that primarily grows and harvests
trees, builds homes and manufactures a range of forest products. Its shares also
declined during the year as the company's real estate and wood products
businesses were negatively impacted by the deteriorating housing market. Within
its wood products division, low capacity utilization rates and weak product
pricing led to negative cash generation and eliminated the operating profit. The
company's home-building operations also performed poorly as demand for its
output shrank and write-downs increased within the division.

The Fund's best performing investments during the fiscal year were shares of
Esmark and Redwood Trust. The Fund's performance also benefited from its
investments in S&P 500 Index put options, which allow holders to profit if the
market declines within a preset period of time.

8 | Annual Report

Shares of Esmark, a U.S.-based steel company, climbed in value as the company
received competing takeover offers and was ultimately sold to Russian steel
company Severstal in a transaction that closed in August 2008. The Fund, along
with other mutual funds managed by Franklin Mutual Advisers, LLC, participated
in the funding of Esmark at various stages, beginning with its acquisitions of
several service center companies and culminating in its purchase of
Wheeling-Pittsburgh Steel.

The Fund also benefited from its position in Redwood Trust, a U.S.-based real
estate investment trust that primarily invests in residential and commercial
real estate loans and in asset-backed securities backed by real estate loans.
The company's share price climbed as investors were satisfied that the company's
fourth-quarter results provided guidance on three positive ongoing trends:
Redwood Trust's existing portfolio was generating strong cash flows, the
company's financial position was strong and management maintained a positive
outlook for investment opportunities. The Fund's investment in Redwood Trust
began in January 2009 when the company came to market to raise additional equity
to invest in the distressed mortgage market. Since then, Redwood's shares have
appreciated as management has invested at attractive rates the funds raised from
the equity. In addition, Redwood Trust's share price benefited as investor
pessimism about the mortgage market appeared to decline slightly.

The Fund's positions in puts on the S&P 500, which typically appreciate as
equity markets decline, climbed significantly as the index fell and were a major
positive contributor during the year. Since mid-2007 the Fund has periodically
acquired positions in index options when we determined the puts were
inexpensively priced relative to the hedging advantages they offered. The most
recent positions were initiated and then unwound when the perceived pricing
anomaly reversed itself or the benefits of the hedges were realized. The Fund's
manager views purchasing put options as a risk control strategy that we may
employ from time to time in periods of unusual market upheavals.

Annual Report | 9

Thank you for your interest and participation in Franklin Mutual Recovery Fund.
We look forward to serving your future investment needs.

(PHOTO OF MICHAEL J. EMBLER)

/s/ Michael J. Embler
Michael J. Embler
Co-Portfolio Manager

(PHOTO OF CHRISTIAN CORREA)

/s/ Christian Correa
Christian Correa
Co-Portfolio Manager

(PHOTO OF SHAWN M. TUMULTY)

/s/ Shawn M. Tumulty
Shawn M. Tumulty
Co-Portfolio Manager

Franklin Mutual Recovery Fund

THE FOREGOING INFORMATION REFLECTS OUR ANALYSIS, OPINIONS AND PORTFOLIO HOLDINGS
AS OF MARCH 31, 2009, THE END OF THE REPORTING PERIOD. THE WAY WE IMPLEMENT OUR
MAIN INVESTMENT STRATEGIES AND THE RESULTING PORTFOLIO HOLDINGS MAY CHANGE
DEPENDING ON FACTORS SUCH AS MARKET AND ECONOMIC CONDITIONS. THESE OPINIONS MAY
NOT BE RELIED UPON AS INVESTMENT ADVICE OR AN OFFER FOR A PARTICULAR SECURITY.
THE INFORMATION IS NOT A COMPLETE ANALYSIS OF EVERY ASPECT OF ANY MARKET,
COUNTRY, INDUSTRY, SECURITY OR THE FUND. STATEMENTS OF FACT ARE FROM SOURCES
CONSIDERED RELIABLE, BUT THE INVESTMENT MANAGER MAKES NO REPRESENTATION OR
WARRANTY AS TO THEIR COMPLETENESS OR ACCURACY. ALTHOUGH HISTORICAL PERFORMANCE
IS NO GUARANTEE OF FUTURE RESULTS, THESE INSIGHTS MAY HELP YOU UNDERSTAND OUR
INVESTMENT MANAGEMENT PHILOSOPHY.

10 | Annual Report

Performance Summary as of 3/31/09

Your dividend income will vary depending on dividends or interest paid by
securities in the Fund's portfolio, adjusted for operating expenses of each
class. Capital gain distributions are net profits realized from the sale of
portfolio securities. The performance table and graphs do not reflect any taxes
that a shareholder would pay on Fund dividends, capital gain distributions, if
any, or any realized gains on the sale of Fund shares. Total return reflects
reinvestment of the Fund's dividends and capital gain distributions, if any, and
any unrealized gains or losses.

PRICE AND DISTRIBUTION INFORMATION

CLASS A (SYMBOL: FMRAX) CHANGE 3/31/09 3/31/08
- ----------------------- ------ ------- -------

Net Asset Value (NAV) -$4.96 $7.02 $11.98
DISTRIBUTIONS (4/1/08-3/31/09)
Dividend Income $0.1852
Short-Term Capital Gain $0.0081
Long-Term Capital Gain $0.0005
TOTAL $0.1938

CLASS B (SYMBOL: N/A) CHANGE 3/31/09 3/31/08
- ----------------------- ------ ------- -------

Net Asset Value (NAV) -$4.85 $6.91 $11.76
DISTRIBUTIONS (4/1/08-3/31/09)
Dividend Income $0.1081
Short-Term Capital Gain $0.0081
Long-Term Capital Gain $0.0005
TOTAL $0.1167

CLASS C (SYMBOL: FCMRX) CHANGE 3/31/09 3/31/08
- ----------------------- ------ ------- -------

Net Asset Value (NAV) -$4.84 $6.91 $11.75
DISTRIBUTIONS (4/1/08-3/31/09)
Dividend Income $0.1055
Short-Term Capital Gain $0.0081
Long-Term Capital Gain $0.0005
TOTAL $0.1141

ADVISOR CLASS (SYMBOL: FMRVX) CHANGE 3/31/09 3/31/08
- ----------------------------- ------ ------- -------

Net Asset Value (NAV) -$5.02 $7.08 $12.10
DISTRIBUTIONS (4/1/08-3/31/09)
Dividend Income $0.2311
Short-Term Capital Gain $0.0081
Long-Term Capital Gain $0.0005
TOTAL $0.2397

Annual Report | 11

Performance Summary (CONTINUED)

PERFORMANCE

CUMULATIVE TOTAL RETURN EXCLUDES SALES CHARGES. AVERAGE ANNUAL TOTAL RETURN AND
VALUE OF $10,000 INVESTMENT INCLUDE MAXIMUM SALES CHARGES. CLASS A: 5.75%
MAXIMUM INITIAL SALES CHARGE; CLASS B: CONTINGENT DEFERRED SALES CHARGE (CDSC)
DECLINING FROM 4% TO 1% OVER SIX YEARS, AND ELIMINATED THEREAFTER; CLASS C: 1%
CDSC IN FIRST YEAR ONLY; ADVISOR CLASS: NO SALES CHARGES.

CLASS A 1-YEAR 5-YEAR INCEPTION (11/3/03)
- ------- ------- ------- -------------------

Cumulative Total Return(1) -39.55% -22.30% -15.98%
Average Annual Total Return(2) -43.02% -6.04% -4.22%
Value of $10,000 Investment(3) $ 5,698 $ 7,323 $ 7,919
Total Annual Operating Expenses(4) 2.48%

CLASS B 1-YEAR 5-YEAR INCEPTION (11/3/03)
- ------- ------- ------- -------------------

Cumulative Total Return(1) -39.97% -24.79% -18.84%
Average Annual Total Return(2) -42.33% -5.83% -3.92%
Value of $10,000 Investment(3) $ 5,767 $ 7,404 $ 8,053
Total Annual Operating Expenses(4) 3.13%

CLASS C 1-YEAR 5-YEAR INCEPTION (11/3/03)
- ------- ------- ------- -------------------

Cumulative Total Return(1) -39.85% -24.71% -18.69%
Average Annual Total Return(2) -40.45% -5.52% -3.75%
Value of $10,000 Investment(3) $ 5,955 $ 7,529 $ 8,131
Total Annual Operating Expenses(4) 3.13%

ADVISOR CLASS 1-YEAR 5-YEAR INCEPTION (6/2/03)
- ------------- ------- ------- -------------------

Cumulative Total Return(1) -39.29% -20.91% -4.96%
Average Annual Total Return(2) -39.29% -4.58% -0.87%
Value of $10,000 Investment(3) $ 6,071 $ 7,909 $9,504
Total Annual Operating Expenses(4) 2.13%

PERFORMANCE DATA REPRESENT PAST PERFORMANCE, WHICH DOES NOT GUARANTEE FUTURE
RESULTS. INVESTMENT RETURN AND PRINCIPAL VALUE WILL FLUCTUATE, AND YOU MAY HAVE
A GAIN OR LOSS WHEN YOU SELL YOUR SHARES. CURRENT PERFORMANCE MAY DIFFER FROM
FIGURES SHOWN. FOR MOST RECENT MONTH-END PERFORMANCE, SEE "FUNDS AND
PERFORMANCE" AT franklintempleton.com OR CALL (800) 342-5236.

12 | Annual Report

Performance Summary (CONTINUED)

TOTAL RETURN INDEX COMPARISON FOR A HYPOTHETICAL $10,000 INVESTMENT

Total return represents the change in value of an investment over the periods
shown. It includes any current, applicable, maximum sales charge, Fund expenses,
account fees and reinvested distributions. The unmanaged index includes
reinvestment of any income or distributions. It differs from the Fund in
composition and does not pay management fees or expenses. One cannot invest
directly in an index.

CLASS A (11/3/03-3/31/09)

(PERFORMANCE GRAPH)

FRANKLIN MUTUAL RECOVERY S&P 500 TR (IA Extended)
DATE FUND - CLASS A S&P 500 INDEX (%Total Return)
- ------------- ------------------------ ------------- ------------------------

11/3/2003 $ 9,422 $10,000
11/30/2003 $ 9,677 $10,088 0.87983000%
12/31/2003 $10,035 $10,617 5.24445000%
1/31/2004 $10,181 $10,812 1.83551000%
2/29/2004 $10,309 $10,962 1.38995000%
3/31/2004 $10,215 $10,797 -1.50865000%
4/30/2004 $10,121 $10,627 -1.56980000%
5/31/2004 $10,095 $10,773 1.37226000%
6/30/2004 $10,292 $10,983 1.94449000%
7/31/2004 $10,138 $10,619 -3.30966000%
8/31/2004 $10,275 $10,662 0.40449000%
9/30/2004 $10,352 $10,778 1.08308000%
10/31/2004 $10,369 $10,942 1.52768000%
11/30/2004 $11,001 $11,385 4.04616000%
12/31/2004 $11,351 $11,772 3.40287000%
1/31/2005 $11,179 $11,485 -2.43748000%
2/28/2005 $11,342 $11,727 2.10440000%
3/31/2005 $11,433 $11,519 -1.77080000%
4/30/2005 $11,370 $11,301 -1.89656000%
5/31/2005 $11,659 $11,661 3.18186000%
6/30/2005 $11,820 $11,677 0.14197000%
7/31/2005 $12,025 $12,111 3.71883000%
8/31/2005 $12,072 $12,001 -0.91240000%
9/30/2005 $12,063 $12,098 0.80994000%
10/31/2005 $11,624 $11,896 -1.66708000%
11/30/2005 $11,857 $12,346 3.78221000%
12/31/2005 $12,116 $12,351 0.03481000%
1/31/2006 $12,538 $12,678 2.64778000%
2/28/2006 $12,595 $12,712 0.27133000%
3/31/2006 $12,863 $12,870 1.24475000%
4/30/2006 $12,815 $13,043 1.34278000%
5/31/2006 $12,930 $12,668 -2.87814000%
6/30/2006 $12,953 $12,685 0.13557000%
7/31/2006 $13,012 $12,763 0.61685000%
8/31/2006 $13,336 $13,067 2.37931000%
9/30/2006 $13,474 $13,404 2.57700000%
10/31/2006 $13,917 $13,840 3.25861000%
11/30/2006 $14,064 $14,104 1.90160000%
12/31/2006 $14,371 $14,301 1.40278000%
1/31/2007 $14,818 $14,518 1.51232000%
2/28/2007 $14,869 $14,234 -1.95588000%
3/31/2007 $15,275 $14,393 1.11850000%
4/30/2007 $15,610 $15,030 4.42953000%
5/31/2007 $16,129 $15,555 3.48951000%
6/30/2007 $15,991 $15,296 -1.66133000%
7/31/2007 $15,490 $14,822 -3.10048000%
8/31/2007 $15,292 $15,044 1.49901000%
9/30/2007 $15,386 $15,607 3.73988000%
10/31/2007 $15,584 $15,855 1.59068000%
11/30/2007 $14,927 $15,192 -4.18066000%
12/31/2007 $14,512 $15,087 -0.69376000%
1/31/2008 $13,701 $14,182 -5.99816000%
2/29/2008 $13,416 $13,721 -3.24858000%
3/31/2008 $13,131 $13,662 -0.43180000%
4/30/2008 $13,657 $14,328 4.87031000%
5/31/2008 $13,931 $14,513 1.29526000%
6/30/2008 $12,594 $13,290 -8.43036000%
7/31/2008 $12,473 $13,178 -0.84062000%
8/31/2008 $12,594 $13,369 1.44647000%
9/30/2008 $11,158 $12,177 -8.91073000%
10/31/2008 $ 9,021 $10,132 -16.79479000%
11/30/2008 $ 8,297 $ 9,405 -7.17546000%
12/31/2008 $ 8,466 $ 9,505 1.06403000%
1/31/2009 $ 7,983 $ 8,704 -8.42864000%
2/28/2009 $ 7,477 $ 7,777 -10.64778000%
3/31/2009 $ 7,919 $ 8,458 8.75952000%

Total Returns -20.81% -15.42%

AVERAGE ANNUAL TOTAL RETURN

CLASS A 3/31/09
- ------- -------

1-Year -43.02%
5-Year -6.04%
Since Inception (11/3/03) -4.22%

CLASS B (11/3/03-3/31/09)

(PERFORMANCE GRAPH)

FRANKLIN MUTUAL S&P 500 TR (IA Extended)
DATE RECOVERY FUND - CLASS B S&P 500 INDEX (%Total Return)
- ------------- ----------------------- ------------- ------------------------

11/3/2003 $10,000 $10,000
11/30/2003 $10,270 $10,088 0.87983000%
12/31/2003 $10,647 $10,617 5.24445000%
1/31/2004 $10,793 $10,812 1.83551000%
2/29/2004 $10,920 $10,962 1.38995000%
3/31/2004 $10,820 $10,797 -1.50865000%
4/30/2004 $10,720 $10,627 -1.56980000%
5/31/2004 $10,684 $10,773 1.37226000%
6/30/2004 $10,883 $10,983 1.94449000%
7/31/2004 $10,720 $10,619 -3.30966000%
8/31/2004 $10,856 $10,662 0.40449000%
9/30/2004 $10,938 $10,778 1.08308000%
10/31/2004 $10,947 $10,942 1.52768000%
11/30/2004 $11,600 $11,385 4.04616000%
12/31/2004 $11,976 $11,772 3.40287000%
1/31/2005 $11,784 $11,485 -2.43748000%
2/28/2005 $11,947 $11,727 2.10440000%
3/31/2005 $12,043 $11,519 -1.77080000%
4/30/2005 $11,966 $11,301 -1.89656000%
5/31/2005 $12,263 $11,661 3.18186000%
6/30/2005 $12,420 $11,677 0.14197000%
7/31/2005 $12,637 $12,111 3.71883000%
8/31/2005 $12,676 $12,001 -0.91240000%
9/30/2005 $12,656 $12,098 0.80994000%
10/31/2005 $12,193 $11,896 -1.66708000%
11/30/2005 $12,430 $12,346 3.78221000%
12/31/2005 $12,693 $12,351 0.03481000%
1/31/2006 $13,128 $12,678 2.64778000%
2/28/2006 $13,179 $12,712 0.27133000%
3/31/2006 $13,462 $12,870 1.24475000%
4/30/2006 $13,402 $13,043 1.34278000%
5/31/2006 $13,513 $12,668 -2.87814000%
6/30/2006 $13,526 $12,685 0.13557000%
7/31/2006 $13,589 $12,763 0.61685000%
8/31/2006 $13,911 $13,067 2.37931000%
9/30/2006 $14,046 $13,404 2.57700000%
10/31/2006 $14,504 $13,840 3.25861000%
11/30/2006 $14,649 $14,104 1.90160000%
12/31/2006 $14,963 $14,301 1.40278000%
1/31/2007 $15,414 $14,518 1.51232000%
2/28/2007 $15,468 $14,234 -1.95588000%
3/31/2007 $15,887 $14,393 1.11850000%
4/30/2007 $16,221 $15,030 4.42953000%
5/31/2007 $16,747 $15,555 3.48951000%
6/30/2007 $16,597 $15,296 -1.66133000%
7/31/2007 $16,068 $14,822 -3.10048000%
8/31/2007 $15,847 $15,044 1.49901000%
9/30/2007 $15,946 $15,607 3.73988000%
10/31/2007 $16,134 $15,855 1.59068000%
11/30/2007 $15,439 $15,192 -4.18066000%
12/31/2007 $15,021 $15,087 -0.69376000%
1/31/2008 $14,168 $14,182 -5.99816000%
2/29/2008 $13,857 $13,721 -3.24858000%
3/31/2008 $13,557 $13,662 -0.43180000%
4/30/2008 $14,099 $14,328 4.87031000%
5/31/2008 $14,376 $14,513 1.29526000%
6/30/2008 $12,992 $13,290 -8.43036000%
7/31/2008 $12,842 $13,178 -0.84062000%
8/31/2008 $12,969 $13,369 1.44647000%
9/30/2008 $11,494 $12,177 -8.91073000%
10/31/2008 $ 9,280 $10,132 -16.79479000%
11/30/2008 $ 8,531 $ 9,405 -7.17546000%
12/31/2008 $ 8,700 $ 9,505 1.06403000%
1/31/2009 $ 8,197 $ 8,704 -8.42864000%
2/28/2009 $ 7,682 $ 7,777 -10.64778000%
3/31/2009 $ 8,053 $ 8,458 8.75952000%

Total Returns -19.47% -15.42%

AVERAGE ANNUAL TOTAL RETURN

CLASS B 3/31/09
- ------- -------

1-Year -42.33%
5-Year -5.83%
Since Inception (11/3/03) -3.92%

Annual Report | 13

Performance Summary (CONTINUED)

AVERAGE ANNUAL TOTAL RETURN

CLASS C 3/31/09
- ------- -------

1-Year -40.45%
5-Year -5.52%
Since Inception (11/3/03) -3.75%

CLASS C (11/3/03-3/31/09)

(PERFORMANCE GRAPH)

FRANKLIN MUTUAL S&P 500 TR (IA Extended)
DATE RECOVERY FUND - CLASS C S&P 500 INDEX (%Total Return)
- ------------- ----------------------- ------------------------ ------------------------

11/3/2003 $10,000 $10,000
11/30/2003 $10,270 $10,088 0.87983000%
12/31/2003 $10,646 $10,617 5.24445000%
1/31/2004 $10,800 $10,812 1.83551000%
2/29/2004 $10,927 $10,962 1.38995000%
3/31/2004 $10,827 $10,797 -1.50865000%
4/30/2004 $10,718 $10,627 -1.56980000%
5/31/2004 $10,682 $10,773 1.37226000%
6/30/2004 $10,882 $10,983 1.94449000%
7/31/2004 $10,718 $10,619 -3.30966000%
8/31/2004 $10,854 $10,662 0.40449000%
9/30/2004 $10,936 $10,778 1.08308000%
10/31/2004 $10,945 $10,942 1.52768000%
11/30/2004 $11,598 $11,385 4.04616000%
12/31/2004 $11,974 $11,772 3.40287000%
1/31/2005 $11,782 $11,485 -2.43748000%
2/28/2005 $11,945 $11,727 2.10440000%
3/31/2005 $12,041 $11,519 -1.77080000%
4/30/2005 $11,964 $11,301 -1.89656000%
5/31/2005 $12,261 $11,661 3.18186000%
6/30/2005 $12,418 $11,677 0.14197000%
7/31/2005 $12,635 $12,111 3.71883000%
8/31/2005 $12,674 $12,001 -0.91240000%
9/30/2005 $12,654 $12,098 0.80994000%
10/31/2005 $12,191 $11,896 -1.66708000%
11/30/2005 $12,427 $12,346 3.78221000%
12/31/2005 $12,691 $12,351 0.03481000%
1/31/2006 $13,136 $12,678 2.64778000%
2/28/2006 $13,177 $12,712 0.27133000%
3/31/2006 $13,460 $12,870 1.24475000%
4/30/2006 $13,399 $13,043 1.34278000%
5/31/2006 $13,511 $12,668 -2.87814000%
6/30/2006 $13,524 $12,685 0.13557000%
7/31/2006 $13,586 $12,763 0.61685000%
8/31/2006 $13,919 $13,067 2.37931000%
9/30/2006 $14,054 $13,404 2.57700000%
10/31/2006 $14,501 $13,840 3.25861000%
11/30/2006 $14,657 $14,104 1.90160000%
12/31/2006 $14,960 $14,301 1.40278000%
1/31/2007 $15,411 $14,518 1.51232000%
2/28/2007 $15,476 $14,234 -1.95588000%
3/31/2007 $15,884 $14,393 1.11850000%
4/30/2007 $16,228 $15,030 4.42953000%
5/31/2007 $16,744 $15,555 3.48951000%
6/30/2007 $16,599 $15,296 -1.66133000%
7/31/2007 $16,070 $14,822 -3.10048000%
8/31/2007 $15,849 $15,044 1.49901000%
9/30/2007 $15,948 $15,607 3.73988000%
10/31/2007 $16,136 $15,855 1.59068000%
11/30/2007 $15,441 $15,192 -4.18066000%
12/31/2007 $15,021 $15,087 -0.69376000%
1/31/2008 $14,167 $14,182 -5.99816000%
2/29/2008 $13,855 $13,721 -3.24858000%
3/31/2008 $13,555 $13,662 -0.43180000%
4/30/2008 $14,098 $14,328 4.87031000%
5/31/2008 $14,375 $14,513 1.29526000%
6/30/2008 $12,990 $13,290 -8.43036000%
7/31/2008 $12,852 $13,178 -0.84062000%
8/31/2008 $12,979 $13,369 1.44647000%
9/30/2008 $11,490 $12,177 -8.91073000%
10/31/2008 $ 9,287 $10,132 -16.79479000%
11/30/2008 $ 8,537 $ 9,405 -7.17546000%
12/31/2008 $ 8,704 $ 9,505 1.06403000%
1/31/2009 $ 8,200 $ 8,704 -8.42864000%
2/28/2009 $ 7,685 $ 7,777 -10.64778000%
3/31/2009 $ 8,131 $ 8,458 8.75952000%

Total Returns -18.69% -15.42%

AVERAGE ANNUAL TOTAL RETURN

ADVISOR CLASS 3/31/09
- ------------- -------

1-Year -39.29%
5-Year -4.58%
Since Inception (6/2/03) -0.87%

ADVISOR CLASS (6/2/03-3/31/09)

(PERFORMANCE GRAPH)

FRANKLIN MUTUAL RECOVERY S&P 500 TR (IA Extended)
DATE FUND - ADVISOR CLASS S&P 500 INDEX (%Total Return)
- ------------- ------------------------ ----------------------- ------------------------

6/2/2003 $10,000 $10,000
6/30/2003 $10,120 $10,128 1.27564000%
7/31/2003 $10,190 $10,306 1.76316000%
8/31/2003 $10,340 $10,507 1.95021000%
9/30/2003 $10,630 $10,396 -1.06195000%
10/31/2003 $11,070 $10,984 5.65700000%
11/30/2003 $11,370 $11,080 0.87983000%
12/31/2003 $11,795 $11,661 5.24445000%
1/31/2004 $11,976 $11,875 1.83551000%
2/29/2004 $12,127 $12,040 1.38995000%
3/31/2004 $12,016 $11,859 -1.50865000%
4/30/2004 $11,906 $11,673 -1.56980000%
5/31/2004 $11,886 $11,833 1.37226000%
6/30/2004 $12,117 $12,063 1.94449000%
7/31/2004 $11,946 $11,664 -3.30966000%
8/31/2004 $12,107 $11,711 0.40449000%
9/30/2004 $12,207 $11,838 1.08308000%
10/31/2004 $12,217 $12,019 1.52768000%
11/30/2004 $12,961 $12,505 4.04616000%
12/31/2004 $13,391 $12,930 3.40287000%
1/31/2005 $13,188 $12,615 -2.43748000%
2/28/2005 $13,380 $12,881 2.10440000%
3/31/2005 $13,498 $12,653 -1.77080000%
4/30/2005 $13,423 $12,413 -1.89656000%
5/31/2005 $13,775 $12,808 3.18186000%
6/30/2005 $13,963 $12,826 0.14197000%
7/31/2005 $14,216 $13,303 3.71883000%
8/31/2005 $14,271 $13,181 -0.91240000%
9/30/2005 $14,260 $13,288 0.80994000%
10/31/2005 $13,753 $13,067 -1.66708000%
11/30/2005 $14,029 $13,561 3.78221000%
12/31/2005 $14,333 $13,565 0.03481000%
1/31/2006 $14,853 $13,925 2.64778000%
2/28/2006 $14,909 $13,962 0.27133000%
3/31/2006 $15,236 $14,136 1.24475000%
4/30/2006 $15,191 $14,326 1.34278000%
5/31/2006 $15,327 $13,914 -2.87814000%
6/30/2006 $15,351 $13,933 0.13557000%
7/31/2006 $15,432 $14,019 0.61685000%
8/31/2006 $15,814 $14,352 2.37931000%
9/30/2006 $15,988 $14,722 2.57700000%
10/31/2006 $16,509 $15,202 3.25861000%
11/30/2006 $16,706 $15,491 1.90160000%
12/31/2006 $17,067 $15,708 1.40278000%
1/31/2007 $17,594 $15,946 1.51232000%
2/28/2007 $17,678 $15,634 -1.95588000%
3/31/2007 $18,169 $15,809 1.11850000%
4/30/2007 $18,564 $16,509 4.42953000%
5/31/2007 $19,186 $17,085 3.48951000%
6/30/2007 $19,023 $16,801 -1.66133000%
7/31/2007 $18,433 $16,280 -3.10048000%
8/31/2007 $18,199 $16,524 1.49901000%
9/30/2007 $18,334 $17,142 3.73988000%
10/31/2007 $18,568 $17,415 1.59068000%
11/30/2007 $17,781 $16,687 -4.18066000%
12/31/2007 $17,299 $16,571 -0.69376000%
1/31/2008 $16,342 $15,577 -5.99816000%
2/29/2008 $15,993 $15,071 -3.24858000%
3/31/2008 $15,656 $15,006 -0.43180000%
4/30/2008 $16,303 $15,737 4.87031000%
5/31/2008 $16,640 $15,941 1.29526000%
6/30/2008 $15,048 $14,597 -8.43036000%
7/31/2008 $14,893 $14,474 -0.84062000%
8/31/2008 $15,061 $14,683 1.44647000%
9/30/2008 $13,340 $13,375 -8.91073000%
10/31/2008 $10,791 $11,129 -16.79479000%
11/30/2008 $ 9,924 $10,330 -7.17546000%
12/31/2008 $10,132 $10,440 1.06403000%
1/31/2009 $ 9,558 $ 9,560 -8.42864000%
2/28/2009 $ 8,957 $ 8,542 -10.64778000%
3/31/2009 $ 9,504 $ 9,290 8.75952000%

Total Returns -4.96% -7.10%

14 | Annual Report

Performance Summary (CONTINUED)

ENDNOTES

THE FUND MAY INVEST IN COMPANIES ENGAGED IN MERGERS, REORGANIZATIONS OR
LIQUIDATIONS, WHICH INVOLVE SPECIAL RISKS, AS PENDING DEALS MAY NOT BE COMPLETED
ON TIME OR ON FAVORABLE TERMS, AS WELL AS LOWER-RATED BONDS, WHICH ENTAIL HIGHER
CREDIT RISK. THE FUND IS A NONDIVERSIFIED FUND AND MAY EXPERIENCE INCREASED
SUSCEPTIBILITY TO ADVERSE ECONOMIC OR REGULATORY DEVELOPMENTS AFFECTING SIMILAR
ISSUERS OR SECURITIES. THE FUND MAY INVEST IN FOREIGN SECURITIES WHOSE RISKS
INCLUDE CURRENCY FLUCTUATIONS, AND ECONOMIC AND POLITICAL UNCERTAINTIES. THE
FUND IS STRUCTURED AS A CONTINUOUSLY OFFERED, CLOSED-END FUND AND DOES NOT OFFER
DAILY REDEMPTIONS. INSTEAD, THE FUND HAS A POLICY TO PROVIDE INVESTORS ACCESS TO
THEIR MONEY BY MAKING QUARTERLY TENDER OFFERS FOR 5% TO 25% OF THE FUND'S
OUTSTANDING SHARES. THE FUND MAY SUSPEND OR POSTPONE A TENDER OFFER SUBJECT TO
APPROVAL BY THE FUND'S BOARD. THE FUND'S PROSPECTUS ALSO INCLUDES A DESCRIPTION
OF THE MAIN INVESTMENT RISKS.

CLASS B: These shares have higher annual fees and expenses than Class A
shares.

CLASS C: Prior to 1/1/04, these shares were offered with an initial
sales charge; thus actual total returns would have differed.
These shares have higher annual fees and expenses than Class A
shares.

ADVISOR CLASS: Shares are available to certain eligible investors as described
in the prospectus.

(1.) Cumulative total return represents the change in value of an investment
over the periods indicated.

(2.) Average annual total return represents the average annual change in value
of an investment over the periods indicated.

(3.) These figures represent the value of a hypothetical $10,000 investment in
the Fund over the periods indicated.

(4.) Figures are as stated in the Fund's prospectus current as of the date of
this report. In periods of market volatility, assets may decline
significantly, causing total annual Fund operating expenses to become
higher than the figures shown.

(5.) Source: (C) 2009 Morningstar. The S&P 500 consists of 500 stocks chosen for
market size, liquidity and industry group representation. Each stock's
weight in the index is proportionate to its market value. The S&P 500 is
one of the most widely used benchmarks of U.S. equity performance.

Annual Report | 15

Your Fund's Expenses

As a Fund shareholder, you can incur two types of costs:

- - Transaction costs, including sales charges (loads) on Fund purchases; and

- - Ongoing Fund costs, including management fees, distribution and service
(12b-1) fees, and other Fund expenses. All mutual funds have ongoing costs,
sometimes referred to as operating expenses.

The following table shows ongoing costs of investing in the Fund and can help
you understand these costs and compare them with those of other mutual funds.
The table assumes a $1,000 investment held for the six months indicated.

ACTUAL FUND EXPENSES

The first line (Actual) for each share class listed in the table provides actual
account values and expenses. The "Ending Account Value" is derived from the
Fund's actual return, which includes the effect of Fund expenses.

You can estimate the expenses you paid during the period by following these
steps. OF COURSE, YOUR ACCOUNT VALUE AND EXPENSES WILL DIFFER FROM THOSE IN THIS
ILLUSTRATION:

(1.) Divide your account value by $1,000.

IF AN ACCOUNT HAD AN $8,600 VALUE, THEN $8,600 / $1,000 = 8.6.

(2.) Multiply the result by the number under the heading "Expenses Paid During
Period."

IF EXPENSES PAID DURING PERIOD WERE $7.50, THEN 8.6 x $7.50 = $64.50.

In this illustration, the estimated expenses paid this period are $64.50.

HYPOTHETICAL EXAMPLE FOR COMPARISON WITH OTHER FUNDS

Information in the second line (Hypothetical) for each class in the table can
help you compare ongoing costs of investing in the Fund with those of other
mutual funds. This information may not be used to estimate the actual ending
account balance or expenses you paid during the period. The hypothetical "Ending
Account Value" is based on the actual expense ratio for each class and an
assumed 5% annual rate of return before expenses, which does not represent the
Fund's actual return. The figure under the heading "Expenses Paid During Period"
shows the hypothetical expenses your account would have incurred under this
scenario. You can compare this figure with the 5% hypothetical examples that
appear in shareholder reports of other funds.

16 | Annual Report

Your Fund's Expenses (CONTINUED)

PLEASE NOTE THAT EXPENSES SHOWN IN THE TABLE ARE MEANT TO HIGHLIGHT ONGOING
COSTS AND DO NOT REFLECT ANY TRANSACTION COSTS, SUCH AS SALES CHARGES.
Therefore, the second line for each class is useful in comparing ongoing costs
only, and will not help you compare total costs of owning different funds. In
addition, if transaction costs were included, your total costs would have been
higher. Please refer to the Fund prospectus for additional information on
operating expenses.

BEGINNING ACCOUNT ENDING ACCOUNT EXPENSES PAID DURING
VALUE 10/1/08 VALUE 3/31/09 PERIOD* 10/1/08-3/31/09
----------------- -------------- -----------------------

CLASS A
Actual $1,000 $ 711.40 $ 7.64
Hypothetical (5% return before expenses) $1,000 $1,016.01 $ 9.00
CLASS B
Actual $1,000 $ 708.10 $10.43
Hypothetical (5% return before expenses) $1,000 $1,012.72 $12.29
CLASS C
Actual $1,000 $ 709.60 $10.36
Hypothetical (5% return before expenses) $1,000 $1,012.81 $12.19
ADVISOR CLASS
Actual $1,000 $ 712.50 $ 6.23
Hypothetical (5% return before expenses) $1,000 $1,017.65 $ 7.34

* Expenses are calculated using the most recent six-month expense ratio,
annualized for each class (A: 1.79%; B: 2.45%; C: 2.43%; and Advisor:
1.46%), multiplied by the average account value over the period, multiplied
by 182/365 to reflect the one-half year period.

Annual Report | 17

The Fund's Repurchase Offers

The Fund will make quarterly repurchase offers for a portion of its shares. With
any repurchase offer, shareholders may elect to tender (have the Fund
repurchase) all, a portion or none of their shares. With each repurchase offer,
shareholders will be notified in writing about the offer, how to request that
the Fund repurchase their shares and the deadline for submitting repurchase
requests.

Each quarter the Board of Trustees will set the amount of the repurchase offer,
as a percentage of outstanding shares. This amount is known as the repurchase
offer amount and will generally be between 5% and 25% of the Fund's outstanding
shares. If shareholders tender for repurchase more shares than the repurchase
offer amount, the Fund may increase the amount repurchased by up to 2% of the
Fund's outstanding shares. If repurchase requests exceed the repurchase offer
amount, the Fund will prorate requests. The Fund may, however, first accept any
requests to repurchase all of a shareholder's shares if the shareholder owns
less than 100 shares. The Board will also determine the date by which the Fund
must receive shareholders' repurchase requests, which is known as the repurchase
request deadline. The Board will base these decisions on investment management
considerations, market conditions, liquidity of the Fund's assets, shareholder
servicing and administrative considerations and other factors it deems
appropriate. Each repurchase request deadline will occur within the period that
begins 21 days before, and ends 21 days after, the end of the quarterly
interval. The repurchase price of the shares will be the net asset value as of
the close of the NYSE on the date the Board sets as the repurchase pricing date.
The maximum number of days between the repurchase request deadline and the
repurchase pricing date is 14 days.

SUMMARY OF REPURCHASE OFFERS - 4/1/08 THROUGH 3/31/09

REPURCHASE REPURCHASE % OF SHARES NUMBER OF
REQUEST DEADLINE OFFER AMOUNT TENDERED SHARES TENDERED
- ---------------- ------------ ----------- ---------------

4/28/08 15% 16.543% 6,909,695.395
6/30/08 15% 8.658% 3,096,128.405
10/3/08 10% 16.207% 5,421,997.543
1/2/09 15% 17.863% 5,210,142.000

18 | Annual Report

Franklin Mutual Recovery Fund

FINANCIAL HIGHLIGHTS

YEAR ENDED MARCH 31,
-----------------------------------------------------
CLASS A 2009 2008 2007 2006 2005
- ------- ------- -------- -------- -------- -------

PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net asset value, beginning of year .................... $ 11.98 $ 15.04 $ 13.43 $ 12.64 $ 11.91
------- -------- -------- -------- -------
Income from investment operations(a):
Net investment income (loss)(b) .................... 0.08 0.09 0.16 (0.02) 0.02
Net realized and unrealized gains (losses) ......... (4.84) (2.07) 2.27 1.52 1.43
------- -------- -------- -------- -------
Total from investment operations ...................... (4.76) (1.98) 2.43 1.50 1.45
------- -------- -------- -------- -------
Less distributions from:
Net investment income .............................. (0.19) (0.29) -- (0.01) (0.04)
Net realized gains ................................. (0.01) (0.79) (0.82) (0.70) (0.68)
------- -------- -------- -------- -------
Total distributions ................................... (0.20) (1.08) (0.82) (0.71) (0.72)
------- -------- -------- -------- -------
Net asset value, end of year .......................... $ 7.02 $ 11.98 $ 15.04 $ 13.43 $ 12.64
======= ======== ======== ======== =======
Total return(c) ....................................... (39.55)% (14.04)% 18.73% 12.51% 12.48%
RATIOS TO AVERAGE NET ASSETS
Expenses before waiver and payments by
affiliates and expense reduction(d) ................ 1.47% 2.49% 3.36% 3.53% 3.15%
Expenses net of waiver and payments by
affiliates(d) ...................................... 1.47% 2.49% 3.36% 3.53% 3.05%
Expenses net of waiver and payments by
affiliates and expense reduction(d) ................ 1.47% 2.48% 3.36% 3.52% 3.05%
Ratios to average net assets, excluding dividend
expense on securities sold short:
Expenses before waiver and payments by
affiliates and expense reduction ................ 1.44% 2.46% 3.16% 3.34% 3.11%
Expenses net of waiver and payments by
affiliates ...................................... 1.44% 2.46% 3.16% 3.34% 3.02%
Expenses net of waiver and payments by
affiliates and expense reduction ................ 1.44% 2.45% 3.16% 3.33% 3.02%
Net investment income (loss) .......................... 0.90% 0.60% 1.11% (0.19)% 0.17%
SUPPLEMENTAL DATA
Net assets, end of year (000's) ....................... $97,975 $238,020 $209,897 $104,694 $57,709
Portfolio turnover rate ............................... 62.22% 89.18% 85.63% 69.20% 87.68%

(a) The amount shown for a share outstanding throughout the period may not
correlate with the Statement of Operations for the period due to the timing
of sales and repurchases of the Fund shares in relation to income earned
and/or fluctuating market value of the investments of the Fund.

(b) Based on average daily shares outstanding.

(d) Includes dividend expense on securities sold short which varies from period
to period. See below for expense ratios that reflect only operating
expenses.

The accompanying notes are an integral part of these financial statements.

Annual Report | 19

Franklin Mutual Recovery Fund

FINANCIAL HIGHLIGHTS (CONTINUED)

YEAR ENDED MARCH 31,
--------------------------------------------
CLASS B 2009 2008 2007 2006 2005
- ------- ------ ------- ------ ----- ------

PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net asset value, beginning of year .................... $11.76 $14.78 $13.29 $12.58 $11.89
------ ------ ------ ------ ------
Income from investment operations(a):
Net investment income (loss)(b)..................... 0.02 (0.01) 0.01 (0.11) (0.06)
Net realized and unrealized gains (losses) ......... (4.75) (2.02) 2.30 1.52 1.43
------ ------ ------ ------ ------
Total from investment operations ...................... (4.73) (2.03) 2.31 1.41 1.37
------ ------ ------ ------ ------
Less distributions from:
Net investment income .............................. (0.11) (0.20) -- -- --
Net realized gains ................................. (0.01) (0.79) (0.82) (0.70) (0.68)
------ ------ ------ ------ ------
Total distributions ................................... (0.12) (0.99) (0.82) (0.70) (0.68)
------ ------ ------ ------ ------
Net asset value, end of year .......................... $ 6.91 $11.76 $14.78 $13.29 $12.58
====== ====== ====== ====== ======
Total return(c) ....................................... (39.97)% (14.67)% 18.00% 11.79% 11.77%
RATIOS TO AVERAGE NET ASSETS
Expenses before waiver and payments by
affiliates and expense reduction(d) ................ 2.12% 3.14% 4.01% 4.18% 3.79%
Expenses net of waiver and payments by
affiliates(d) ...................................... 2.12% 3.14% 4.01% 4.18% 3.69%
Expenses net of waiver and payments by
affiliates and expense reduction(d) ................ 2.12% 3.13% 4.01% 4.17% 3.69%
Ratios to average net assets, excluding
dividend expense on securities sold short:
Expenses before waiver and payments by
affiliates and expense reduction ................ 2.09% 3.11% 3.81% 3.99% 3.75%
Expenses net of waiver and payments by
affiliates ...................................... 2.09% 3.11% 3.81% 3.99% 3.65%
Expenses net of waiver and payments by
affiliates and expense reduction ................ 2.09% 3.10% 3.81% 3.98% 3.65%
Net investment income (loss) .......................... 0.25% (0.05)% 0.46% (0.84)% (0.47)%
SUPPLEMENTAL DATA
Net assets, end of year (000's) ....................... $1,704 $4,333 $5,024 $4,243 $3,246
Portfolio turnover rate ............................... 62.22% 89.18% 85.63% 69.20% 87.68%

(b) Based on average daily shares outstanding.

(d) Includes dividend expense on securities sold short which varies from period
to period. See below for expense ratios that reflect only operating
expenses.

The accompanying notes are an integral part of these financial statements.

20 | Annual Report

Franklin Mutual Recovery Fund

FINANCIAL HIGHLIGHTS (CONTINUED)

YEAR ENDED MARCH 31,
--------------------------------------------------
CLASS C 2009 2008 2007 2006 2005
- ------- ------- ------- ------- ------- -------

PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net asset value, beginning of year .................... $ 11.75 $ 14.78 $ 13.29 $ 12.58 $ 11.89
------- ------- ------- ------- -------
Income from investment operations(a):
Net investment income (loss)(b) .................... 0.02 (0.01) 0.04 (0.11) (0.06)
Net realized and unrealized gains (losses) ......... (4.74) (2.02) 2.27 1.52 1.43
------- ------- ------- ------- -------
Total from investment operations ...................... (4.72) (2.03) 2.31 1.41 1.37
------- ------- ------- ------- -------
Less distributions from:
Net investment income .............................. (0.11) (0.21) -- -- --
Net realized gains ................................. (0.01) (0.79) (0.82) (0.70) (0.68)
------- ------- ------- ------- -------
Total distributions ................................... (0.12) (1.00) (0.82) (0.70) (0.68)
------- ------- ------- ------- -------
Net asset value, end of year .......................... $ 6.91 $ 11.75 $ 14.78 $ 13.29 $ 12.58
======= ======= ======= ======= =======
Total return(c) ....................................... (39.85)% (14.66)% 17.99% 11.79% 11.77%
RATIOS TO AVERAGE NET ASSETS
Expenses before waiver and payments by
affiliates and expense reduction(d) ................ 2.09% 3.14% 3.99% 4.18% 3.78%
Expenses net of waiver and payments by
affiliates(d) ...................................... 2.09% 3.14% 3.99% 4.18% 3.68%
Expenses net of waiver and payments by
affiliates and expense reduction(d) ................ 2.09% 3.13% 3.99% 4.17% 3.68%
Ratios to average net assets, excluding
dividend expense on securities sold short:
Expenses before waiver and payments by
affiliates and expense reduction ................ 2.06% 3.11% 3.79% 3.99% 3.74%
Expenses net of waiver and payments by
affiliates ...................................... 2.06% 3.11% 3.79% 3.99% 3.64%
Expenses net of waiver and payments by
affiliates and expense reduction ................ 2.06% 3.10% 3.79% 3.98% 3.64%
Net investment income (loss) .......................... 0.28% (0.05)% 0.48% (0.84)% (0.46)%
SUPPLEMENTAL DATA
Net assets, end of year (000's) ....................... $38,432 $96,131 $87,018 $55,030 $29,991
Portfolio turnover rate ............................... 62.22% 89.18% 85.63% 69.20% 87.68%

(b) Based on average daily shares outstanding.

(d) Includes dividend expense on securities sold short which varies from period
to period. See below for expense ratios that reflect only operating
expenses.

The accompanying notes are an integral part of these financial statements.

Annual Report | 21

Franklin Mutual Recovery Fund

FINANCIAL HIGHLIGHTS (CONTINUED)

YEAR ENDED MARCH 31,
----------------------------------------------------
ADVISOR CLASS 2009 2008 2007 2006 2005
- ------------- ------- -------- -------- ------- -------

PER SHARE OPERATING PERFORMANCE
(for a share outstanding throughout the year)
Net asset value, beginning of year .................... $ 12.10 $ 15.18 $ 13.50 $ 12.67 $ 11.92
------- -------- -------- ------- -------
Income from investment operations(a):
Net investment income(b) ........................... 0.15 0.14 0.21 0.02 0.06
Net realized and unrealized gains (losses) ......... (4.93) (2.09) 2.29 1.53 1.44
------- -------- -------- ------- -------
Total from investment operations ...................... (4.78) (1.95) 2.50 1.55 1.50
------- -------- -------- ------- -------
Less distributions from:
Net investment income .............................. (0.23) (0.34) -- (0.02) (0.07)
Net realized gains ................................. (0.01) (0.79) (0.82) (0.70) (0.68)
------- -------- -------- ------- -------
Total distributions ................................... (0.24) (1.13) (0.82) (0.72) (0.75)
------- -------- -------- ------- -------
Net asset value, end of year .......................... $ 7.08 $ 12.10 $ 15.18 $ 13.50 $ 12.67
======= ======== ======== ======= =======
Total return .......................................... (39.29)% (13.83)% 19.24% 12.88% 12.88%
RATIOS TO AVERAGE NET ASSETS
Expenses before waiver and payments by
affiliates and expense reduction(c) ................ 1.13% 2.14% 3.01% 3.18% 2.80%
Expenses net of waiver and payments by
affiliates(c) ...................................... 1.13% 2.14% 3.01% 3.18% 2.70%
Expenses net of waiver and payments by
affiliates and expense reduction(c) ................ 1.13% 2.13% 3.01% 3.17% 2.70%
Ratios to average net assets, excluding
dividend expense on securities sold short:
Expenses before waiver and payments by
affiliates and expense reduction ................ 1.10% 2.11% 2.81% 2.99% 2.76%
Expenses net of waiver and payments by
affiliates ...................................... 1.10% 2.11% 2.81% 2.99% 2.66%
Expenses net of waiver and payments by
affiliates and expense reduction ................ 1.10% 2.10% 2.81% 2.98% 2.66%
Net investment income ................................. 1.24% 0.95% 1.46% 0.16% 0.52%
SUPPLEMENTAL DATA
Net assets, end of year (000's) ....................... $33,920 $155,570 $152,068 $80,420 $71,586
Portfolio turnover rate ............................... 62.22% 89.18% 85.63% 69.20% 87.68%

(b) Based on average daily shares outstanding.

(c) Includes dividend expense on securities sold short which varies from period
to period. See below for expense ratios that reflect only operating
expenses.

The accompanying notes are an integral part of these financial statements.

22 | Annual Report

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009

SHARES/WARRANTS/
COUNTRY CONTRACTS/RIGHTS VALUE
-------------- ---------------- -----------

COMMON STOCKS AND OTHER EQUITY INTERESTS 57.5%
AIRLINES 2.9%
(a) ACE Aviation Holdings Inc., A ..................................... Canada 201,052 $ 885,059
(a) Delta Air Lines Inc. .............................................. United States 723,325 4,072,320
(a, b) Northwest Airlines Corp., Contingent Distribution ................. United States 7,455,000 4,697
-----------
4,962,076
-----------
AUTO COMPONENTS 0.0%(c)
(a, b, d) Collins & Aikman Products Co., Contingent Distribution ............ United States 53,682 537
(a) Dana Holding Corp. ................................................ United States 28,017 12,888
(a, b, d) Dana Holding Corp., Contingent Distribution ....................... United States 661,000 --
-----------
13,425
-----------
AUTOMOBILES 0.1%
(a, e) IACNA Investor LLC ................................................ United States 10,457 105
(a, e, f) International Automotive Components Group Brazil LLC .............. Brazil 185,241 59,183
(a, e, f) International Automotive Components Group Japan LLC ............... Japan 16,213 18,919
(a, e, f) International Automotive Components Group LLC ..................... Luxembourg 660,308 8,386
(a, e, f) International Automotive Components Group NA LLC, A ............... United States 299,438 34,555
-----------
121,148
-----------
BEVERAGES 0.8%
Carlsberg AS, B ................................................... Denmark 34,249 1,403,948
-----------
BUILDING PRODUCTS 0.0%(c)
(a) Armstrong World Industries Inc. ................................... United States 252 2,774
-----------
COMMERCIAL BANKS 1.0%
(a, e) Elephant Capital Holdings Ltd. .................................... Japan 721 --
(a, e) First Chicago Bancorp ............................................. United States 410,714 1,624,930
(a, e) NCB Warrant Holdings Ltd., A ...................................... Japan 31,928 --
-----------
1,624,930
-----------
CONSUMER FINANCE 2.4%
(a, e) CB FIM Coinvestors LLC ............................................ United States 1,432,222 3,150,888
(a, e) Cerberus CG Investor I LLC ........................................ United States 1,874,481 356,151
(a, e) Cerberus CG Investor II LLC ....................................... United States 1,874,481 356,151
(a, e) Cerberus CG Investor III LLC ...................................... United States 937,240 178,076
(a, e) Cerberus FIM Investors Holdco LLC ................................. United States 1,777,250 124,408
-----------
4,165,674
-----------
DIVERSIFIED FINANCIAL SERVICES 0.0%
(a) Fortis, rts., 7/01/14 ............................................. Belgium 221,485 --
(a, e) GLCP Harrah's Investment LP ....................................... United States 4,502,725 --
-----------
--
-----------

Annual Report | 23

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009 (CONTINUED)

SHARES/WARRANTS/
COUNTRY CONTRACTS/RIGHTS VALUE
-------------- ---------------- -----------

COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED)
DIVERSIFIED TELECOMMUNICATION SERVICES 1.2%
(a, e, f) AboveNet Inc. ..................................................... United States 41,983 $ 2,099,150
(a, e, f) AboveNet Inc., stock grant, grant price $20.95,
expiration date 9/09/13 ........................................... United States 55 828
-----------
2,099,978
-----------
FOOD & STAPLES RETAILING 3.0%
(g) CVS Caremark Corp. ................................................ United States 190,829 5,245,889
-----------
FOOD PRODUCTS 2.4%
Cadbury PLC ....................................................... United Kingdom 554,112 4,189,860
-----------
HEALTH CARE PROVIDERS & SERVICES 3.0%
(a, g) Community Health Systems Inc. ..................................... United States 179,834 2,758,653
(a, e) Kindred Healthcare Inc. ........................................... United States 104,434 1,483,224
(a) Tenet Healthcare Corp. ............................................ United States 766,804 889,493
-----------
5,131,370
-----------
HOTELS, RESTAURANTS & LEISURE 0.0%(c)
(a) Trump Entertainment Resorts Inc. .................................. United States 70,164 5,613
-----------
INDEPENDENT POWER PRODUCERS & ENERGY TRADERS 4.2%
Constellation Energy Group ........................................ United States 273,655 5,653,712
(a) NRG Energy Inc. ................................................... United States 86,041 1,514,322
-----------
7,168,034
-----------
INDUSTRIAL CONGLOMERATES 1.2%
(f) Orkla ASA ......................................................... Norway 293,399 2,015,259
-----------
INSURANCE 5.3%
(a, e) Imagine Group Holdings Ltd. ....................................... Bermuda 287,034 2,350,809
(a, e) Symetra Financial ................................................. United States 445,440 6,775,142
-----------
9,125,951
-----------
INTERNET SOFTWARE & SERVICES 0.2%
(a, h) Yahoo! Inc. ....................................................... United States 27,810 356,246
-----------
IT SERVICES 1.3%
(a) Alliance Data Systems Corp. ....................................... United States 61,805 2,283,695
-----------
MACHINERY 0.0%
(a, e) Motor Coach Industries International Inc., wts., 5/27/09 .......... United States 1 --
-----------
MEDIA 4.0%
(a) Adelphia Recovery Trust ........................................... United States 11,280,134 180,482
(a, b) Adelphia Recovery Trust, Arhova Contingent Value
Vehicle, Contingent Distribution .................................. United States 1,018,915 86,608
(a, b) Century Communications Corp., Contingent Distribution ............. United States 2,826,000 --
Time Warner Cable Inc. ............................................ United States 114,274 2,833,994
Time Warner Inc. .................................................. United States 13,633 263,110
(g) Virgin Media Inc. ................................................. United Kingdom 717,289 3,442,987
-----------
6,807,181
-----------

24 | Annual Report

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009 (CONTINUED)

SHARES/WARRANTS/
COUNTRY CONTRACTS/RIGHTS VALUE
-------------- ---------------- -----------

COMMON STOCKS AND OTHER EQUITY INTERESTS (CONTINUED)
PAPER & FOREST PRODUCTS 4.0%
(a) Domtar Corp. ...................................................... United States 1,637,587 $ 1,555,708
Weyerhaeuser Co. .................................................. United States 195,052 5,377,583
-----------
6,933,291
-----------
PHARMACEUTICALS 7.1%
Schering-Plough Corp. ............................................. United States 149,220 3,514,131
(g) Wyeth ............................................................. United States 204,270 8,791,781
-----------
12,305,912
-----------
REAL ESTATE INVESTMENT TRUST (REIT) 1.5%
Redwood Trust Inc. ................................................ United States 173,400 2,661,690
-----------
SEMICONDUCTORS & SEMICONDUCTOR EQUIPMENT 3.5%
(a) LSI Corp. ......................................................... United States 1,113,749 3,385,797
Maxim Integrated Products Inc. .................................... United States 195,585 2,583,678
-----------
5,969,475
-----------
SOFTWARE 1.4%
(a) i2 Technologies Inc. .............................................. United States 295,790 2,336,741
-----------
TOBACCO 7.0%
(a) Alliance One International Inc. ................................... United States 1,229,730 4,722,163
Japan Tobacco Inc. ................................................ Japan 1,883 4,979,379
Lorillard Inc. .................................................... United States 38,520 2,378,225
-----------
12,079,767
-----------
TRANSPORTATION INFRASTRUCTURE 0.0%(c)
(a) Groupe Eurotunnel SA .............................................. France 962 5,108
(a) Groupe Eurotunnel SA, wts., 12/30/11 .............................. France 27,397 3,455
-----------
8,563
-----------
TOTAL COMMON STOCKS AND OTHER EQUITY INTERESTS
(COST $188,626,932) ............................................ 99,018,490
-----------
PREFERRED STOCKS 2.1%
AUTO COMPONENTS 0.0%(c)
(e) Dana Holding Corp., 4.00%, cvt. pfd., B ........................... United States 2,377 22,582
-----------
DIVERSIFIED FINANCIAL SERVICES 2.1%
Citigroup Cap IX, 6.00%, pfd., S .................................. United States 85,931 657,372
Citigroup Inc., 8.125%, pfd., AA .................................. United States 134,100 2,049,048
Citigroup Inc., 8.50% pfd., F ..................................... United States 60,600 922,938
-----------
3,629,358
-----------
TOTAL PREFERRED STOCKS (COST $2,451,613) .......................... 3,651,940
-----------

Annual Report | 25

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009 (CONTINUED)

PRINCIPAL
COUNTRY AMOUNT(i) VALUE
-------------- ---------------- ------------

CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS 12.2%
(j) Boston Generating LLC, FRN,
Revolver, 1.334%, 12/21/13 ..................................... United States 48,278 $ 29,055
Synthetic Letter of Credit, 1.334%, 12/21/13 ................... United States 172,322 103,706
Term Loan B, 2.729%, 12/21/13 .................................. United States 761,578 458,331
(j) Calpine Corp., Exit Term Loan, FRN, 4.335%, 3/29/14 ............... United States 1,835,116 1,406,795
(e, p) Cerberus CG Investor I LLC, 12.00%, 7/31/14 ....................... United States 1,645,200 312,588
(e, p) Cerberus CG Investor II LLC, 12.00%, 7/31/14 ...................... United States 1,645,200 312,588
(e, p) Cerberus CG Investor III LLC, 12.00%, 7/31/14 ..................... United States 822,600 156,294
(e, p) Cerberus FIM Investors Holdco LLC, 12.00%, 11/22/13 ............... United States 5,330,691 373,148
(j) First Data Corp., Term Loan, FRN, 3.272%, 9/24/14,
B-1 ............................................................ United States 448,921 304,116
B-2 ............................................................ United States 629,505 426,057
B-3 ............................................................ United States 177,300 119,961
Groupe Eurotunnel SA, cvt., sub. bond, NRS I,
T2, 3.00%, 7/28/09 ............................................. France 1,100 EUR 1,211
T2, 3.00%, 7/28/09 ............................................. France 1,773 GBP 2,488
T3, 3.00%, 7/28/10 ............................................. France 805,919 GBP 1,130,757
T3, 3.00%, 7/28/10 ............................................. France 1,561,200 EUR 1,719,225
(k) Indianapolis Downs LLC, 144A,
senior secured note, 11.00%, 11/01/12 .......................... United States 1,000,000 540,000
(l) senior secured sub. note, PIK, 15.50%, 11/01/13 ................... United States 4,065,145 1,443,126
(e, f, p) International Automotive Components Group NA LLC, 9.00%,
4/01/17 ........................................................ United States 90,167 28,441
(d, f, j) International Automotive Components Group NA Inc.,
Revolver, FRN, 5.75%, 1/18/14 .................................. United States 59,381 59,381
(e, f, j, m) Pontus I LLC, junior note, 144A, FRN, 5.283%, 7/24/09 ............. United States 1,693,973 1,693,186
(e, f, j, m) Pontus II Trust, junior profit-participating note,
144A, FRN, 8.256%, 6/25/09 ..................................... United States 268,587 75,141
(j) Realogy Corp., FRN,
(o) 2.768%, 4/10/13 ................................................ United States 2,415,520 1,135,294
Delayed Draw Term B Loan, 3.518%, 10/10/13 ..................... United States 188,113 108,706
Initial Term Loan B, 3.518%, 10/10/13 .......................... United States 1,037,455 599,520
Synthetic Letter of Credit, 0.312%, 10/10/13 ................... United States 279,292 161,396
(d, j) Revel Entertainment Group LLC, FRN,
First Lien Loan, 4.98%, 5/30/09 ................................ United States 3,000,000 2,760,000
Second Lien Loan, 7.98%, 5/30/09 ............................... United States 3,000,000 2,760,000
Rite Aid Corp., senior note, 9.50%, 6/15/17 ....................... United States 3,000,000 705,000
(j) Texas Competitive Electric Holdings Co. LLC, FRN,
4.033%, 10/10/14 ............................................... United States 357,894 237,440
Initial Tranche B-1 Term Loan, 4.033%, 10/10/14 ................ United States 2,261,620 1,499,171
Term Loan B3, 4.033%, 10/10/14 ................................. United States 537,647 355,807
------------
TOTAL CORPORATE BONDS, NOTES & SENIOR FLOATING RATE
INTERESTS (COST $42,019,005).................................... 21,017,929
------------

26 | Annual Report

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009 (CONTINUED)

PRINCIPAL
COUNTRY AMOUNT(i) VALUE
-------------- ---------------- ------------

CORPORATE BONDS, NOTES & SENIOR FLOATING RATE INTERESTS
IN REORGANIZATION 7.8%
(j, p) Charter Communications Operating LLC, FRN,
10.50%, 3/06/14 ................................................ United States 539,674 $ 501,897
Term Loan B, 5.18%, 3/06/14 .................................... United States 3,072,550 2,522,050
(j, p) Motor Coach Industries International Inc., FRN,
(o) First Lien DIP Revolver, 8.50%, 9/19/09 ........................... United States 273,633 267,975
Second Lien DIP Trust A Term Loan, 12.75%, 9/19/09 ............. United States 368,654 295,845
Second Lien DIP Trust B Term Loan, 15.25%, 9/19/09 ............. United States 225,332 191,532
Second Lien Senior Secured Term Loan, 11.00%, 12/01/08 ......... United States 303,825 238,502
(d) Third Lien Senior Secured Term Loan, 15.649%, 12/01/08 ............ United States 3,484,298 188,849
(j, n, p) Quebecor World Inc., DIP Term Loan, FRN, 8.25%,
7/21/09 ........................................................ Canada 2,359,581 2,021,375
(j, p) Smurfit-Stone Container Canada Inc., FRN,
2.579%, 11/01/09 ............................................... Canada 1,424,381 961,457
Term Loan C-1, 2.44%,11/01/11 .................................. Canada 559,027 375,771
(j, p) Smurfit-Stone Container Enterprises, FRN,
3.25%, 11/01/09 ................................................ United States 4,295,294 2,899,324
2.44%, 11/01/11 ................................................ United States 1,848,979 1,242,861
2.44%, 11/01/11 ................................................ United States 980,975 659,399
L/C Deposit-Funded CMMT, 1.313%, 11/01/10 ...................... United States 861,996 579,424
(j, n, p) Spectrum Brands Inc., FRN,
Dollar Term Loan B, 8.00%, 4/01/13 ............................. United States 195,031 140,179
Letter of Credit Commitment, 6.25%, 4/01/13 .................... United States 9,966 7,163
(p) Trump Entertainment Resorts Inc., 8.50%, 5/20/15 .................. United States 2,801,691 238,144
(f, p) Wimar OPCO LLC/Finance Corp., senior sub. note, 9.625%,
12/15/14 ....................................................... United States 12,892,000 96,690
------------
TOTAL CORPORATE BONDS, NOTES & SENIOR FLOATING RATE
INTERESTS IN REORGANIZATION (COST $26,936,786) ................. 13,428,437
------------
TOTAL INVESTMENTS BEFORE SHORT TERM INVESTMENTS
(COST $260,034,336) ............................................ 137,116,796
------------
SHORT TERM INVESTMENTS 14.8%
U.S. GOVERNMENT AND AGENCY SECURITIES 14.8%
(q) FHLB, 4/01/09 ..................................................... United States 16,500,000 16,500,000
(g, q) U.S. Treasury Bills,
4/09/09 ........................................................ United States 3,000,000 2,999,961
4/23/09 ........................................................ United States 3,000,000 2,999,772
5/28/09 ........................................................ United States 3,000,000 2,999,217
------------
TOTAL U.S. GOVERNMENT AND AGENCY SECURITIES
(COST $25,499,150) ............................................. 25,498,950
------------
TOTAL INVESTMENTS (COST $285,533,486) 94.4% ....................... 162,615,746
OPTIONS WRITTEN (0.0)%(c).......................................... (84,265)
SECURITIES SOLD SHORT (7.8)% ...................................... (13,404,274)
NET UNREALIZED APPRECIATION (DEPRECIATION) ON FORWARD
EXCHANGE CONTRACTS 0.3% ........................................ 453,670
OTHER ASSETS, LESS LIABILITIES 13.1% .............................. 22,451,072
------------
NET ASSETS 100.0% ................................................. $172,031,949
============

Annual Report | 27

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009 (CONTINUED)

COUNTRY CONTRACTS VALUE
-------------- ---------------- ------------

(r) OPTIONS WRITTEN 0.0%(c)
CALL OPTIONS 0.0%(c)
INTERNET SOFTWARE & SERVICES 0.0%(c)
Yahoo Inc., Apr. 14 Calls, 4/18/09 ................................ United States 135 $ 3,915
------------
PHARMACEUTICALS 0.0%(c)
Pfizer Inc., Jun. 14 Calls, 6/20/09 ............................... United States 500 43,500
Pfizer Inc., Jun. 15 Calls, 6/20/09 ............................... United States 750 32,250
Pfizer Inc., Jun. 16 Calls, 6/20/09 ............................... United States 200 4,600
------------
80,350
------------
TOTAL OPTIONS WRITTEN (PREMIUMS RECEIVED $121,417) ................ $ 84,265
------------

SHARES
------------

(s) SECURITIES SOLD SHORT 7.8%
DIVERSIFIED FINANCIAL SERVICES 2.1%
Citigroup Inc. .................................................... United States 1,420,800 $ 3,594,624
------------
ELECTRIC UTILITIES 0.4%
Exelon Corp. ...................................................... United States 15,225 691,063
------------
INSURANCE 2.4%
AFLAC Inc. ........................................................ United States 71,000 1,374,560
MetLife Inc. ...................................................... United States 62,500 1,423,125
Prudential Financial Inc. ......................................... United States 71,000 1,350,420
------------
4,148,105
------------
PHARMACEUTICALS 2.9%
Merck & Co. Inc. .................................................. United States 163,164 4,364,637
Pfizer Inc. ....................................................... United States 44,482 605,845
------------
4,970,482
------------
TOTAL SECURITIES SOLD SHORT (PROCEEDS $11,815,042) ................ $ 13,404,274
------------

28 | Annual Report

Franklin Mutual Recovery Fund

STATEMENT OF INVESTMENTS, MARCH 31, 2009 (CONTINUED)

See Abbreviations on page 49.

(a) Non-income producing.

(b) Contingent distributions represent the right to receive additional
distributions, if any, during the reorganization of the underlying company.
Shares represent total underlying principal of debt securities.

(d) Security has been deemed illiquid because it may not be able to be sold
within seven days. At March 31, 2009, the aggregate value of these
securities was $5,768,767, representing 3.35% of net assets.

(e) See Note 10 regarding restricted and illiquid securities.

(f) See Note 13 regarding other considerations.

(g) Security or a portion of the security has been segregated as collateral for
securities sold short and open option contracts. At March 31, 2009, the
value of securities and/or cash pledged amounted to $24,492,099.

(h) A portion or all of the security is held in connection with written option
contracts open at year end.

(i) The principal amount is stated in U.S. dollars unless otherwise indicated.

(j) The coupon rate shown represents the rate at period end.

(k) Security was purchased pursuant to Rule 144A under the Securities Act of
1933 and may be sold in transactions exempt from registration only to
qualified institutional buyers or in a public offering registered under the
Securities Act of 1933. These securities have been deemed liquid under
guidelines approved by the Trust's Board of Trustees. At March 31, 2009,
the aggregate value of these securities was $1,983,126, representing 1.15%
of net assets.

(l) Income may be received in additional securities and/or cash.

(m) See Note 1(g) regarding special purpose entities.

(n) A portion or all of the security purchased on a delayed delivery basis. See
Note 1(c).

(o) See Note 11 regarding unfunded loan commitments.

(p) See Note 9 regarding credit risk and defaulted securities.

(q) The security is traded on a discount basis with no stated coupon rate.

(r) See Note 1(e) regarding written options.

(s) See Note 1(f) regarding securities sold short.

The accompanying notes are an integral part of these financial statements.

Annual Report | 29

Franklin Mutual Recovery Fund

FINANCIAL STATEMENTS

STATEMENT OF ASSETS AND LIABILITIES
March 31, 2009

Assets:
Investments in securities:
Cost ......................................................... $ 285,533,486
-------------
Value ........................................................ $ 162,615,746
Cash ............................................................ 100,893
Foreign currency, at value (cost $1,556,596) .................... 1,566,151
Receivables:
Investment securities sold ................................... 3,749,893
Capital shares sold .......................................... 93,205
Dividends and interest ....................................... 619,064
Cash on deposit with brokers ................................. 18,383,287
Unrealized appreciation on forward exchange contracts (Note 8) .. 914,725
Other assets .................................................... 16,211
-------------
Total assets ............................................. 188,059,175
-------------
Liabilities:
Payables:
Investment securities purchased .............................. 1,365,023
Affiliates ................................................... 214,661
Options written, at value (premiums received $121,417) .......... 84,265
Securities sold short, at value (proceeds $11,815,042) .......... 13,404,274
Unrealized depreciation on forward exchange contracts (Note 8) .. 461,055
Unrealized depreciation on unfunded loan commitments (Note 11) .. 182,420
Accrued expenses and other liabilities .......................... 315,528
-------------
Total liabilities ......................................... 16,027,226
-------------
Net assets, at value ................................... $ 172,031,949
-------------
Net assets consist of:
Paid-in capital ................................................. $ 380,835,082
Distributions in excess of net investment income ................ (760,646)
Net unrealized appreciation (depreciation) ...................... (124,184,625)
Accumulated net realized gain (loss) ............................ (83,857,862)
-------------
Net assets, at value ................................... $ 172,031,949
=============

The accompanying notes are an integral part of these financial statements.

30 | Annual Report

Franklin Mutual Recovery Fund
FINANCIAL STATEMENTS (CONTINUED)

STATEMENT OF ASSETS AND LIABILITIES (CONTINUED)
March 31, 2009

CLASS A:
Net assets, at value ................................................... $97,975,121
===========
Shares outstanding ..................................................... 13,965,558
===========
Net asset value per share(a)............................................ $ 7.02
===========
Maximum offering price per share (net asset value per share / 94.25%) .. $ 7.45
===========
CLASS B:
Net assets, at value ................................................... $ 1,704,049
===========
Shares outstanding ..................................................... 246,614
===========
Net asset value and maximum offering price per share(a)................. $ 6.91
===========
CLASS C:
Net assets, at value ................................................... $38,432,337
===========
Shares outstanding ..................................................... 5,559,530
===========
Net asset value and maximum offering price per share(a)................. $ 6.91
===========
ADVISOR CLASS:
Net assets, at value ................................................... $33,920,442
===========
Shares outstanding ..................................................... 4,793,594
===========
Net asset value and maximum offering price per share ................... $ 7.08
===========

(a) Redemption price is equal to net asset value less contingent deferred sales
charges, if applicable.

The accompanying notes are an integral part of these financial statements.

Annual Report | 31

Franklin Mutual Recovery Fund

FINANCIAL STATEMENTS (CONTINUED)

STATEMENT OF OPERATIONS
for the year ended March 31, 2009

Investment income:
Dividends (net of foreign taxes withheld of $218,814) .................. $ 4,808,401
Interest ............................................................... 2,448,076
Income from securities loaned .......................................... 5,276
-------------
Total investment income .......................................... 7,261,753
-------------
Expenses:
Management fees (Note 4a) .............................................. 1,537,630
Administrative fees (Note 4b) .......................................... 617,001
Distribution fees: (Note 4c)
Class A ............................................................. 540,913
Class B ............................................................. 28,204
Class C ............................................................. 606,882
Transfer agent fees (Note 4e) .......................................... 314,964
Custodian fees (Note 5) ................................................ 20,551
Reports to shareholders ................................................ 71,113
Registration and filing fees ........................................... 85,388
Professional fees ...................................................... 331,205
Trustees' fees and expenses ............................................ 138,463
Dividends on securities sold short ..................................... 75,819
Other .................................................................. 278,830
-------------
Total expenses ................................................... 4,646,963
Expense reductions (Note 5) ...................................... (11,354)
-------------
Net expenses .................................................. 4,635,609
-------------
Net investment income ...................................... 2,626,144
-------------
Realized and unrealized gains (losses):
Net realized gain (loss) from:
Investments ......................................................... (87,396,810)
Written options ..................................................... 331,460
Foreign currency transactions ....................................... 5,870,022
Securities sold short ............................................... 5,375,531
-------------
Net realized gain (loss) ...................................... (75,819,797)
-------------
Net change in unrealized appreciation (depreciation) on:
Investments ......................................................... (72,636,789)
Translation of other assets and liabilities denominated in foreign
currencies ....................................................... 4,263,145
-------------
Net change in unrealized appreciation (depreciation) .......... (68,373,644)
-------------
Net realized and unrealized gain (loss) ................................... (144,193,441)
-------------
Net increase (decrease) in net assets resulting from operations ........... $(141,567,297)
=============

The accompanying notes are an integral part of these financial statements.

32 | Annual Report

Franklin Mutual Recovery Fund

FINANCIAL STATEMENTS (CONTINUED)

STATEMENTS OF CHANGES IN NET ASSETS

YEAR ENDED MARCH 31,
-----------------------------
2009 2008
------------- -------------

Increase (decrease) in net assets:
Operations:
Net investment income ....................................................... $ 2,626,144 $ 3,160,345
Net realized gain (loss) from investments, written options, foreign
currency transactions and securities sold short .......................... (75,819,797) 18,209,871
Net change in unrealized appreciation (depreciation) on investments and
translation of assets and liabilities denominated in foreign currencies .. (68,373,644) (105,682,083)
------------- -------------
Net increase (decrease) in net assets resulting from operations .......... (141,567,297) (84,311,867)
------------- -------------
Distributions to shareholders from:
Net investment income:
Class A .................................................................. (2,726,336) (5,371,498)
Class B .................................................................. (31,022) (68,665)
Class C .................................................................. (640,105) (1,530,791)
Advisor Class ............................................................ (1,689,053) (4,040,562)
Net realized gains:
Class A .................................................................. (126,601) (14,781,623)
Class B .................................................................. (2,468) (279,358)
Class C .................................................................. (52,179) (6,008,422)
Advisor Class ............................................................ (62,855) (9,549,411)
------------- -------------
Total distributions to shareholders ............................................ (5,330,619) (41,630,330)
------------- -------------
Capital share transactions: (Note 3)
Class A .................................................................. (63,776,607) 89,194,298
Class B .................................................................. (1,236,489) 403,096
Class C .................................................................. (27,110,428) 33,827,758
Advisor Class ............................................................ (83,000,211) 42,564,143
------------- -------------
Total capital share transactions ............................................ (175,123,735) 165,989,295
------------- -------------
Net increase (decrease) in net assets ................................. (322,021,651) 40,047,098
Net assets:
Beginning of year ........................................................... 494,053,600 454,006,502
------------- -------------
End of year ................................................................. $ 172,031,949 $ 494,053,600
============= =============
Undistributed net investment income (distributions in excess of net
investment income) included in net assets:
End of year ................................................................. $ (760,646) $ 1,170,047
============= =============

The accompanying notes are an integral part of these financial statements.

Annual Report | 33

Franklin Mutual Recovery Fund
FINANCIAL STATEMENTS (CONTINUED)

STATEMENT OF CASH FLOWS
for the year ended March 31, 2009

Cash flow from operating activities:
Dividends, interest and other income received .................................. $ 8,685,049
Operating expenses paid ........................................................ (4,854,745)
Purchases of long-term investments ............................................. (188,349,851)
Cash on deposit with brokers ................................................... (8,259,854)
Realized loss on forward contracts ............................................. 5,870,022
Sales and maturities of long-term investments .................................. 356,027,564
Net sales of short-term investments ............................................ 8,857,346
-------------
Cash provided - operating activities ........................................ 177,975,531
-------------
Cash flow from financing activities:
Proceeds from subscriptions of Fund shares ..................................... 35,687,131
Payment on redemptions of Fund shares .......................................... (214,093,568)
Distributions to shareholders .................................................. (1,233,775)
-------------
Cash used - financing activities ............................................ (179,640,212)
-------------
Net increase (decrease) in cash ................................................... (1,664,681)
Cash at beginning of year ......................................................... 3,331,725
-------------
Cash at end of year ............................................................... $ 1,667,044
=============
Reconciliation of Net Increase (Decrease) in Net Assets Resulting from Operating
Activities to Net Cash Provided in Operating Activities for the year
ended March 31, 2009
Net increase (decrease) in net assets resulting from operating activities ......... $(141,567,297)
Adjustments to reconcile net increase (decrease) in net assets resulting from
operating activities to net cash provided by operating activities:
Decrease in dividends and interest receivable and other assets .............. 2,974,349
Decrease in affiliates, accrued expenses and other liabilities .............. (219,136)
Increase in cash on deposit with brokers .................................... (8,259,854)
Increase in receivables for investments sold ................................ (1,605,808)
Decrease in payable for investments purchased ............................... (128,748)
Decrease in cost of investments ............................................. 258,414,801
Net change in unrealized appreciation/depreciation on investments ........... 68,367,224
-------------
Net cash provided in operating activities ......................................... $ 177,975,531
-------------
Non cash financing activities - reinvestment of dividends ......................... $ 4,096,845

The accompanying notes are an integral part of these financial statements.

34 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

The Franklin Mutual Recovery Fund (Fund) is registered under the Investment
Company Act of 1940, as amended, (1940 Act) as a closed-end, continuously
offered investment company. The Fund offers four classes of shares: Class A,
Class B, Class C, and Advisor Class. Each class of shares differs by its initial
sales load, contingent deferred sales charges, distribution fees, voting rights
on matters affecting a single class and its exchange privilege.

The following summarizes the Fund's significant accounting policies.

A. SECURITY VALUATION

Securities listed on a securities exchange or on the NASDAQ National Market
System are valued at the last quoted sale price or the official closing price of
the day, respectively. Over-the-counter securities and listed securities for
which there is no reported sale are valued within the range of the most recent
quoted bid and ask prices. Securities that trade in multiple markets or on
multiple exchanges are valued according to the broadest and most representative
market.

Corporate debt securities and government securities generally trade in the
over-the-counter market rather than on a securities exchange. The Fund may
utilize independent pricing services, quotations from bond dealers, and
information with respect to bond and note transactions, to assist in determining
a current market value for each security. The Fund's pricing services may use
valuation models or matrix pricing which considers information with respect to
comparable bond and note transactions, quotations from bond dealers, or by
reference to other securities that are considered comparable in such
characteristics as rating, interest rate and maturity date, option adjusted
spread models, prepayment projections, interest rate spreads and yield curves,
to determine current value.

Senior secured corporate loans with floating or variable interest rates
generally trade in the over-the-counter market rather than on a securities
exchange. The Fund may utilize independent pricing services, quotations from
loan dealers and other financial institutions, and information with respect to
bond and note transactions, to assist in determining a current market value for
each security. The Fund's pricing services use independent market quotations
from loan dealers or financial institutions and may incorporate valuation
methodologies that consider multiple bond characteristics such as dealer quotes,
issuer type, coupon, maturity, weighted average maturity, interest rate spreads
and yield curves, cash flow and credit risk/quality analysis, to determine
current value.

Foreign securities are valued as of the close of trading on the foreign stock
exchange on which the security is primarily traded, or the NYSE, whichever is
earlier. If no sale is reported at that time, the foreign security will be
valued within the range of the most recent quoted bid and ask prices. The value
is then converted into its U.S. dollar equivalent at the foreign exchange rate
in effect at the close of the NYSE on the day that the value of the foreign
security is determined.

Annual Report | 35

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

A. SECURITY VALUATION (CONTINUED)

The Fund has procedures to determine the fair value of individual securities and
other assets for which market prices are not readily available or which may not
be reliably priced. Methods for valuing these securities may include:
fundamental analysis, matrix pricing, discounts from market prices of similar
securities, or discounts applied due to the nature and duration of restrictions
on the disposition of the securities. Due to the inherent uncertainty of
valuations of such securities, the fair values may differ significantly from the
values that would have been used had a ready market for such investments
existed. Occasionally, events occur between the time at which trading in a
security is completed and the close of the NYSE that might call into question
the availability (including the reliability) of the value of a portfolio
security held by the Fund. The investment manager monitors price movements
following the close of trading in foreign stock markets through a series of
country specific market proxies (such as baskets of American Depository
Receipts, futures contracts and exchange traded funds). These price movements
are measured against established trigger thresholds for each specific market
proxy to assist in determining if an event has occurred. If such an event
occurs, the securities may be valued using fair value procedures, which may
include the use of independent pricing services. All security valuation
procedures are approved by the Fund's Board of Trustees.

B. FOREIGN CURRENCY TRANSLATION

Portfolio securities and other assets and liabilities denominated in foreign
currencies are translated into U.S. dollars based on the exchange rate of such
currencies against U.S. dollars on the date of valuation. Purchases and sales of
securities, income and expense items denominated in foreign currencies are
translated into U.S. dollars at the exchange rate in effect on the transaction
date. Occasionally, events may impact the availability or reliability of foreign
exchange rates used to convert the U.S. dollar equivalent value. If such an
event occurs, the foreign exchange rate will be valued at fair value using
procedures established and approved by the Fund's Board of Trustees.

The Fund does not separately report the effect of changes in foreign exchange
rates from changes in market prices on securities held. Such changes are
included in net realized and unrealized gain or loss from investments on the
Statement of Operations.

Realized foreign exchange gains or losses arise from sales of foreign
currencies, currency gains or losses realized between the trade and settlement
dates on securities transactions and the difference between the recorded amounts
of dividends, interest, and foreign withholding taxes and the U.S. dollar
equivalent of the amounts actually received or paid. Net unrealized foreign
exchange gains and losses arise from changes in foreign exchange rates on
foreign denominated assets and liabilities other than investments in securities
held at the end of the reporting period.

36 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

C. SECURITIES PURCHASED ON A DELAYED DELIVERY BASIS

The Fund may purchase securities on a delayed delivery basis, with payment and
delivery scheduled for a future date. These transactions are subject to market
fluctuations and are subject to the risk that the value at delivery may be more
or less than the trade date purchase price. Although the Fund will generally
purchase these securities with the intention of holding the securities, it may
sell the securities before the settlement date. Sufficient assets have been
segregated for these securities.

D. FOREIGN CURRENCY CONTRACTS

When the Fund purchases or sells foreign securities it may enter into foreign
exchange contracts to minimize foreign exchange risk from the trade date to the
settlement date of the transactions. A foreign exchange contract is an agreement
between two parties to exchange different currencies at an agreed upon exchange
rate at a future date. Realized and unrealized gains and losses on these
contracts are included in the Statement of Operations.

The Fund may also enter into forward exchange contracts to hedge against
fluctuations in foreign exchange rates. These contracts are valued daily by the
Fund and the unrealized appreciation or depreciation on the contracts, as
measured by the difference between the contractual forward foreign exchange
rates and the forward rates at the reporting date, are included in the Statement
of Assets and Liabilities. Realized and unrealized gains and losses on these
contracts are included in the Statement of Operations.

The risks of these contracts include movement in the values of the foreign
currencies relative to the U.S. dollar and the possible inability of the
counterparties to fulfill their obligations under the contracts, which may be in
excess of the amount reflected in the Statement of Assets and Liabilities.

E. OPTIONS

The Fund may purchase or write options. Options are contracts entitling the
holder to purchase or sell securities, or other financial instruments at a
specified price, or, in the case of index options, to receive or pay the
difference between the index value and the strike price of the index option.
Options purchased are recorded as investments; options written (sold) are
recorded as liabilities. Upon closing of an option which results in a cash
settlement, the difference between the premium (original option value) and the
settlement proceeds is realized as a gain or loss. When securities are acquired
or delivered upon exercise of an option, the acquisition cost or sale proceeds
are adjusted by the amount of the premium. When an option expires, the premium
is realized as a gain for options written or as a loss for options purchased.
The risks include the possibility there may be an illiquid options market or the
inability of the counterparties to fulfill their obligations under the contract.
Writing options involves, to varying degrees, elements of market risk in excess
of the amount recognized in the Statement of Assets and Liabilities.

Annual Report | 37

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

F. SECURITIES SOLD SHORT

The Fund is engaged in selling securities short, which obligates the Fund to
replace a borrowed security with the same security at current market value. The
Fund incurs a loss if the price of the security increases between the date of
the short sale and the date on which the Fund replaces the borrowed security.
The Fund realizes a gain if the price of the security declines between those
dates. Gains are limited to the price at which the Fund sold the security short,
while losses are potentially unlimited in size.

The Fund is required to establish a margin account with the broker lending the
security sold short. While the short sale is outstanding, the broker retains the
proceeds of the short sale and the fund must maintain a deposit with broker
consisting of cash and securities having a value equal to a specified percentage
of the value of the securities sold short. The Fund is obligated to pay the
counterparty any dividends or interest due on securities sold short. Such
dividends and interest are recorded as an expense to the Fund.

G. SPECIAL PURPOSE ENTITIES

At March 31, 2009, the Fund had contributed an additional $1,189,823 as a
subordinated note holder of certain special purpose entities ("SPEs"). Such
contributions, while made at the discretion of the Fund, represent additional
capital contributions to the SPE in support of its underlying investments and
are subject first to the claims of the senior note holders of the SPE. These
contributions are recorded as an addition to the Fund's cost basis in the SPE
and are subject to the risk of loss in the event of continued unfavorable market
conditions related to the SPE's underlying investments.

H. SECURITIES LENDING

The Fund participates in an agency based security lending program. The Fund
receives cash collateral against the loaned securities in an amount equal to at
least 102% of the market value of the loaned securities. Collateral is
maintained over the life of the loan in an amount not less than 100% of the
market value of loaned securities, as determined at the close of fund business
each day; any additional collateral required due to changes in security values
is delivered to the Fund on the next business day. The collateral is invested in
a non-registered money market fund managed by the Fund's custodian on the Fund's
behalf. The Fund receives income from the investment of cash collateral, in
addition to lending fees and rebates paid by the borrower. The Fund bears the
market risk with respect to the collateral investment, securities loaned, and
the risk that the agent may default on its obligations to the Fund. The
securities lending agent has agreed to indemnify the Fund in the event of
default by a third party borrower. At March 31, 2009, the Fund had no securities
on loan.

38 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

I. INCOME TAXES

No provision has been made for U.S. income taxes because it is the Fund's policy
to qualify as a regulated investment company under the Internal Revenue Code and
to distribute to shareholders substantially all of its taxable income and net
realized gains.

The Fund has reviewed the tax positions, taken on federal income tax returns,
for each of the three open tax years and as of March 31, 2009, and has
determined that no provision for income tax is required in the Fund's financial
statements.

Foreign securities held by the Fund may be subject to foreign taxation on
dividend and interest income received. Foreign taxes, if any, are recorded based
on the tax regulations and rates that exist in the foreign markets in which the
Fund invests.

J. SECURITY TRANSACTIONS, INVESTMENT INCOME, EXPENSES AND DISTRIBUTIONS

Security transactions are accounted for on trade date. Realized gains and losses
on security transactions are determined on a specific identification basis.
Interest income and estimated expenses are accrued daily. Amortization of
premium and accretion of discount on debt securities are included in interest
income. Dividend income and dividends declared on securities sold short are
recorded on the ex-dividend date except that certain dividends from foreign
securities are recognized as soon as the Fund is notified of the ex-dividend
date. Distributions to shareholders are recorded on the ex-dividend date and are
determined according to income tax regulations (tax basis). Distributable
earnings determined on a tax basis may differ from earnings recorded in
accordance with accounting principles generally accepted in the United States of
America. These differences may be permanent or temporary. Permanent differences
are reclassified among capital accounts to reflect their tax character. These
reclassifications have no impact on net assets or the results of operations.
Temporary differences are not reclassified, as they may reverse in subsequent
periods.

Realized and unrealized gains and losses and net investment income, not
including class specific expenses, are allocated daily to each class of shares
based upon the relative proportion of net assets of each class. Differences in
per share distributions, by class, are generally due to differences in class
specific expenses.

K. ACCOUNTING ESTIMATES

The preparation of financial statements in accordance with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the amounts of income
and expenses during the reporting period. Actual results could differ from those
estimates.

Annual Report | 39

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

L. GUARANTEES AND INDEMNIFICATIONS

Under the Fund's organizational documents, its officers and trustees are
indemnified by the Fund against certain liabilities arising out of the
performance of their duties to the Fund. Additionally, in the normal course of
business, the Fund enters into contracts with service providers that contain
general indemnification clauses. The Fund's maximum exposure under these
arrangements is unknown as this would involve future claims that may be made
against the Fund that have not yet occurred. Currently, the Fund expects the
risk of loss to be remote.

2. TENDER SHARES

On a quarterly basis, the Fund may make tender offers, the amount of which is
determined by the Board of Trustees, for the repurchase of at least 5% but not
more than 25% of the shares outstanding. The repurchase price is the net asset
value on the repurchase pricing date.

3. SHARES OF BENEFICIAL INTEREST

At March 31, 2009, there were an unlimited number of shares authorized ($0.01
par value). Transactions in the Fund's shares were as follows:

YEAR ENDED MARCH 31,
-----------------------------------------------------
2009 2008
------------------------- -------------------------
SHARES AMOUNT SHARES AMOUNT
---------- ------------ ---------- ------------

CLASS A SHARES:
Shares sold .............. 1,823,855 $ 18,054,631 8,791,429 $129,341,636
Shares issued in reinvestment
of distributions ......... 299,696 2,250,714 1,165,011 16,333,602
Shares redeemed ............. (8,031,959) (84,081,952) (4,042,152) (56,480,940)
---------- ------------ ---------- ------------
Net increase (decrease) ..... (5,908,408) $(63,776,607) 5,914,288 $ 89,194,298
========== ============ ========== ============
CLASS B SHARES:
Shares sold ................. 5,602 $ 43,189 30,640 $ 442,201
Shares issued in reinvestment
of distributions ......... 3,897 28,877 21,159 293,557
Shares redeemed ............. (131,283) (1,308,555) (23,404) (332,662)
---------- ------------ ---------- ------------
Net increase (decrease) ..... (121,784) $ (1,236,489) 28,395 $ 403,096
========== ============ ========== ============
CLASS C SHARES:
Shares sold ................. 382,579 $ 3,705,723 2,688,252 $ 39,181,413
Shares issued in reinvestment
of distributions ......... 74,989 555,668 471,058 6,505,843
Shares redeemed ............. (3,077,030) (31,371,819) (867,478) (11,859,498)
---------- ------------ ---------- ------------
Net increase (decrease) ..... (2,619,462) $(27,110,428) 2,291,832 $ 33,827,758
========== ============ ========== ============
ADVISOR CLASS SHARES:
Shares sold ................. 1,152,923 $ 13,065,712 4,697,630 $ 69,422,412
Shares issued in reinvestment
of distributions ......... 166,656 1,261,586 818,746 11,619,901
Shares redeemed ............. (9,378,602) (97,327,509) (2,682,845) (38,478,170)
---------- ------------ ---------- ------------
Net increase (decrease) ..... (8,059,023) $(83,000,211) 2,833,531 $ 42,564,143
========== ============ ========== ============

40 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

4. TRANSACTIONS WITH AFFILIATES

Franklin Resources, Inc. is the holding company for various subsidiaries that
together are referred to as Franklin Templeton Investments. Certain officers and
trustees of the Fund are also officers and/or directors of the following
subsidiaries:

SUBSIDIARY AFFILIATION
- ---------- ----------------------

Franklin Mutual Advisers, LLC (Franklin Mutual) Investment manager
Franklin Templeton Services, LLC (FT Services) Administrative manager
Franklin Templeton Distributors, Inc. (Distributors) Principal underwriter
Franklin Templeton Investor Services, LLC (Investor Services) Transfer agent

A. MANAGEMENT FEES

The Fund pays Franklin Mutual an investment management fee comprised of a "base
fee" and a "performance adjustment". The base fee is calculated at the beginning
of each month using an annual rate of 1.50% of the prior month's average daily
net assets. The performance adjustment is calculated at the beginning of each
month based on how much the Fund's total return exceeded or lagged its
performance fee index, the Bloomberg/EFFAS U.S. Government 3-5 Years Total
Return Index, (Fund performance differential), over the preceding twelve-month
period (performance period). A performance adjustment is applicable if the Fund
performance differential exceeds 1.00%, either upwards (an increase to the base
fee) or downwards (a decrease to the base fee). The performance adjustment rate
is equal to 0.01% for each additional 0.05% that the Fund performance
differential exceeds 1.00%. The performance adjustment amount is determined by
multiplying the performance adjustment rate by the average daily net assets of
the performance period. The performance adjustment rate may not exceed 1.00%
annualized, either upwards or downwards. At the end of each month, an annualized
investment management fee ratio is calculated (total investment management fees
divided by fiscal year to date average daily net assets). In accordance with the
Investment Management Agreement, the investment management fee ratio may not
exceed 2.50% or fall below 0.50% for the fiscal year. For the period, the total
annualized management fee rate, including the performance adjustment, was 0.50%
of the average daily net assets of the Fund.

B. ADMINISTRATIVE FEES

The Fund pays an administrative fee to FT Services of 0.20% per year of the
average daily net assets of the Fund.

C. DISTRIBUTION FEES

The Fund's Board of Trustees has adopted distribution plans for each share
class, with the exception of Advisor Class shares, pursuant to Rule 12b-1 under
the 1940 Act.

On December 2, 2008, the Fund's Board of Trustees approved a modification to the
Class A distribution plan, changing the form of the plan from a compensation to
a reimbursement distribution plan. Under the distribution plan, the Fund
reimburses Distributors for cost incurred in connection with the servicing, sale
and distribution of the Fund's shares up to the maximum annual plan rate.

Annual Report | 41

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

4. TRANSACTIONS WITH AFFILIATES (CONTINUED)

C. DISTRIBUTION FEES (CONTINUED)

This change was effective February 1, 2009. Prior to February 1, 2009, under the
Fund's Class A compensation distribution plan, the Fund paid Distributors for
costs incurred in connection with the servicing, sale and distribution of the
Fund's shares up to a certain percentage per year of its average daily net
assets.

In addition, under the Fund's Class B and C compensation distribution plans, the
Fund pays Distributors for costs incurred in connection with the servicing, sale
and distribution of the Fund's shares up to the maximum annual plan rate for
each class.

The maximum annual plan rates, based on the average daily net assets, for each
class, are as follows:

Class A................................ 0.35%
Class B................................ 1.00%
Class C................................ 1.00%

Effective February 1, 2009, the Board of Trustees has set the current rate at
0.30% per year for Class A shares until further notice and approval by the
Board.

D. SALES CHARGES/UNDERWRITING AGREEMENTS

Distributors has advised the Fund of the following commission transactions
related to the sales and redemptions of the Fund's shares for the year:

Sales charges retained net of commissions paid to
unaffiliated broker/dealers .................. $17,639
Contingent deferred sales charges retained ...... $76,774

E. TRANSFER AGENT FEES

For the year ended March 31, 2009, the Fund paid transfer agent fees of
$314,964, of which $191,644 was retained by Investor Services.

5. EXPENSE OFFSET ARRANGEMENT

The Fund has entered into an arrangement with its custodian whereby credits
realized as a result of uninvested cash balances are used to reduce a portion of
the Fund's custodian expenses. During the year ended March 31, 2009, the
custodian fees were reduced as noted in the Statement of Operations.

42 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

6. INCOME TAXES

For tax purposes, capital losses may be carried over to offset future capital
gains, if any. At March 31, 2009, the Fund had tax basis capital losses of
$41,981,552 expiring in 2017.

For tax purposes, realized capital losses occurring subsequent to October 31,
may be deferred and treated as occurring on the first day of the following
fiscal year. At March 31, 2009, the Fund deferred realized capital losses of
$36,808,102.

The tax character of distributions paid during the years ended March 31, 2009
and 2008, was as follows:

2009 2008
---------- -----------

Distributions paid from:
Ordinary income ..................... $5,318,333 $30,697,918
Long term capital gain .............. 12,286 10,932,412
---------- -----------
$5,330,619 $41,630,330
========== ===========

At March 31, 2009, the cost of investments, net unrealized appreciation
(depreciation), and undistributed ordinary income for income tax purposes were
as follows:

Cost of investments ......................................... $ 290,117,532
=============
Unrealized appreciation ..................................... $ 7,475,865
Unrealized depreciation ..................................... (134,977,651)
-------------
Net unrealized appreciation (depreciation) .................. $(127,501,786)
=============
Distributable earnings - undistributed ordinary income ...... $ 1,952,660
=============

Net investment income (loss) differs for financial statement and tax purposes
primarily due to differing treatments of defaulted securities, foreign currency
transactions, passive foreign investment company shares, payments-in-kind, bond
discounts and premiums, certain dividends on securities sold short, partnership
distributions, recognition of partnership income and corporate action
adjustments.

Net realized gains (losses) differ for financial statement and tax purposes
primarily due to differing treatments of wash sales, foreign currency
transactions, passive foreign investment company shares, bond discounts and
premiums, certain dividends on securities sold short, partnership distributions,
recognition of partnership income, index options and corporate action
adjustments.

Annual Report | 43

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

7. INVESTMENT TRANSACTIONS

Purchases and sales of investments (excluding short term securities and
securities sold short) for the year ended March 31, 2009, aggregated
$167,834,913 and $316,222,996, respectively.

Transactions in options written during the year ended March 31, 2009, were as
follows:

NUMBER OF PREMIUMS
CONTRACTS RECEIVED
--------- ---------

Options outstanding at March 31, 2008 .......... 500 $ 24,500
Options written ................................ 3,550 430,712
Options expired ................................ (2,180) (263,500)
Options exercised .............................. -- --
Options closed ................................. (285) (70,295)
----- ---------
Options outstanding at March 31, 2009 .......... 1,585 $ 121,417
===== =========

8. FORWARD EXCHANGE CONTRACTS

At March 31, 2009, the Fund had the following forward exchange contracts
outstanding:

CONTRACT SETTLEMENT UNREALIZED UNREALIZED
AMOUNT DATE APPRECIATION DEPRECIATION
---------- ---------- ------------ ------------

CONTRACTS TO BUY
16,600,000 Japanese Yen ..... $ 178,450 4/20/09 $ -- $ (10,794)
2,350,293 Euro ............. 3,002,632 5/13/09 117,322 --
155,000 Euro ............. 221,559 5/13/09 -- (15,800)
11,760,000 Norwegian Krone .. 1,655,480 5/19/09 89,461 --
600,000 British Pound .... 874,689 7/13/09 -- (13,459)
1,035,154 Canadian Dollar .. 834,553 8/31/09 -- (11,640)
1,000,137 Canadian Dollar .. 791,830 8/31/09 3,246 --
5,167,934 Danish Krone ..... 882,067 10/23/09 36,317 --
CONTRACTS TO SELL
371,656,484 Japanese Yen ..... 3,991,865 4/20/09 238,204 --
2,300,000 Euro ............. 2,919,036 5/13/09 -- (134,154)
1,470,000 Euro ............. 2,024,864 5/13/09 73,477 --
34,333,848 Norwegian Krone .. 4,897,663 5/19/09 -- (196,769)
3,833,977 British Pound .... 5,823,812 7/13/09 320,589 --
180,000 British Pound .... 253,795 7/13/09 -- (4,574)
3,066,570 Canadian Dollar .. 2,473,041 8/31/09 35,219 --
12,071,771 Danish Krone ..... 2,071,386 10/23/09 -- (73,865)
239,600 Danish Krone ..... 43,469 10/23/09 890 --
-------- --------
Unrealized appreciation (depreciation)
on forward exchange contracts ............................ 914,725 (461,055)
-------- --------
NET UNREALIZED APPRECIATION ON
FORWARD EXCHANGE CONTRACTS ............................ $453,670
========

44 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

9. CREDIT RISK AND DEFAULTED SECURITIES

The Fund may purchase the pre-default or defaulted debt of distressed companies.
Distressed companies are financially troubled and are about to be/or are already
involved in financial restructuring or bankruptcy. The Fund does not accrue
income on these securities, if it becomes probable that the income will not be
collected. Risks associated with purchasing these securities include the
possibility that the bankruptcy or other restructuring process takes longer than
expected, or that distributions in restructuring are less than anticipated,
either or both of which may result in unfavorable consequences to the Fund. At
March 31, 2009, the aggregate value of these securities was $14,611,496,
representing 8.49% of the Fund's net assets. For information as to specific
securities, see the accompanying Statement of Investments.

10. RESTRICTED SECURITIES

The Fund may invest in securities that are restricted under the Securities Act
of 1933 (1933 Act) or which are subject to legal, contractual, or other agreed
upon restrictions on resale. Restricted securities are often purchased in
private placement transactions, and cannot be sold without prior registration
unless the sale is pursuant to an exemption under the 1933 Act. Disposal of
these securities may require greater effort and expense, and prompt sale at an
acceptable price may be difficult. The Fund may have registration rights for
restricted securities. The issuer generally incurs all registration costs.

At March 31, 2009, the Fund held investments in restricted securities, excluding
144A securities deemed to be liquid, valued in accordance with procedures
approved by the Fund's Board of Trustees as reflecting fair value, as follows:

PRINCIPAL
AMOUNT/
SHARES/WARRANTS/ ACQUISITION
CONTRACTS ISSUER DATES COST VALUE
- ---------------- --------------------------------------- ----------------- ---------- ----------

41,983 AboveNet Inc. ......................... 9/03/03 - 8/08/08 $1,625,260 $ 2,099,150
55 AboveNet Inc., stock grant, grant price
$20.95, expiration date 9/09/13 .... 4/17/06 - 9/08/06 -- 828
1,432,222 CB FIM Coinvestors LLC ................ 1/15/09 1,432,222 3,150,888
1,874,481 Cerberus CG Investor I LLC ............ 7/26/07 - 6/17/08 1,868,061 356,151
1,645,200 Cerberus CG Investor I LLC, 12.00%,
7/31/14 ............................ 7/26/07 1,645,200 312,588
1,874,481 Cerberus CG Investor II LLC ........... 7/26/07 - 6/17/08 1,868,061 356,151
1,645,200 Cerberus CG Investor II LLC, 12.00%,
7/31/14 ............................ 7/26/07 1,645,200 312,588
937,240 Cerberus CG Investor III LLC .......... 7/26/07 - 6/17/08 934,030 178,076
822,600 Cerberus CG Investor III LLC, 12.00%,
7/31/14 ............................ 7/26/07 822,600 156,294
1,777,250 Cerberus FIM Investors Holdco LLC ..... 11/20/06 1,777,250 124,408
5,330,691 Cerberus FIM Investors Holdco LLC,
12.00%, 11/22/13 ................... 11/21/06 5,330,691 373,148
2,377 (a)Dana Holding Corp., 4.00%, cvt.
pfd., B ............................ 12/27/07 237,700 22,582

Annual Report | 45

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

10. RESTRICTED SECURITIES (CONTINUED)

PRINCIPAL
AMOUNT/
SHARES/WARRANTS/ ACQUISITION
CONTRACTS ISSUER DATES COST VALUE
- ---------------- --------------------------------------- ------------------ ---------- -----------

721 Elephant Capital Holdings Ltd. ........ 10/22/03 - 3/11/08 $ 83,893 $ --
410,714 First Chicago Bancorp ................. 11/16/06 5,749,996 1,624,930
4,502,725 GLCP Harrah's Investment LP ........... 1/15/08 4,502,725 --
10,457 IACNA Investor LLC .................... 7/24/08 10,709 105
287,034 Imagine Group Holdings Ltd. ........... 8/31/04 2,939,659 2,350,809
185,241 International Automotive Components
Group Brazil LLC ................... 4/13/06 - 12/26/08 124,262 59,183
16,213 International Automotive Components
Group Japan LLC .................... 9/26/06 - 3/27/07 140,753 18,919
660,308 International Automotive Components
Group LLC .......................... 3/15/06 - 4/04/08 660,479 8,386
90,167 (b)International Automotive Components
Group NA LLC, 9.00%, 4/01/17 ....... 3/30/07 91,519 28,441
299,438 (b)International Automotive Components
Group NA LLC, A .................... 3/30/07 - 10/10/07 296,408 34,555
104,434 Kindred Healthcare Inc. ............... 3/10/04 - 7/08/08 2,015,626 1,483,224
1 (c)Motor Coach Industries International
Inc., wts., 5/27/09 ................ 3/30/07 -- --
31,928 NCB Warrant Holdings Ltd., A .......... 12/16/05 - 3/11/08 2,153,981 --
1,693,973 Pontus I LLC, junior note, 144A, FRN,
5.283%, 7/24/09 .................... 1/22/08 - 2/25/08 2,844,200 1,693,186
268,587 Pontus II Trust, junior profit-
participating note, 144A, FRN,
8.256%, 6/25/09 .................... 2/29/08 308,185 75,141
445,440 Symetra Financial ..................... 7/27/04 5,120,000 6,775,142
-----------
TOTAL RESTRICTED SECURITIES
(12.55% of Net Assets) ............. $21,594,873
===========

(a) The Fund also invests in unrestricted securities of the issuer, valued at
$12,888 as of March 31, 2009.

(b) The Fund also invests in unrestricted securities of the issuer, valued at
$59,381 as of March 31, 2009.

11. UNFUNDED LOAN COMMITMENTS

The Fund may enter into certain credit agreements, all or a portion of which may
be unfunded. The Fund is obligated to fund these loan commitments at the
borrowers' discretion. Funded portions of credit agreements are presented on the
Statement of Investments.

At March 31, 2009, unfunded commitments were as follows:

UNFUNDED
BORROWER COMMITMENT
- -------- ----------

Motor Coach Industries International Inc., FRN,
First Lien DIP Revolver, 8.50%, 9/19/09 ....... $118,507
Realogy Corp., FRN, 2.768%, 4/10/13 .............. 603,880
--------
$722,387
========

46 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

11. UNFUNDED LOAN COMMITMENTS (CONTINUED)

Unfunded loan commitments and funded portions of credit agreements are marked to
market daily and any unrealized appreciation or depreciation is included in the
Statement of Assets and Liabilities and Statement of Operations.

12. UNFUNDED CAPITAL COMMITMENTS

The Fund may enter into certain capital commitments and may be obligated to
perform on such agreements at a future date. Unfunded capital commitments
requiring recognition are monitored for impairment and any unrealized
deprecation is included in the Statement of Assets and Liabilities and the
Statement of Operations. At March 31, 2009, the Fund had aggregate unfunded
capital commitments of $15,585,622, for which no depreciation has been
recognized.

13. OTHER CONSIDERATIONS

Officers, directors or employees of the Fund's Investment Manager may serve from
time to time as members of bondholders' steering committees, official creditors'
committees, or boards of directors of companies in which the Fund invests. Such
participation may result in the possession by the Investment Manager of material
non-public information which, pursuant to the Fund's policies and the
requirements of applicable securities laws, could prevent the Fund from trading
in the securities of such companies for limited or extended periods of time.

Franklin Mutual serves as investment manager to certain special purpose entities
that issue securities held by the Fund. Franklin Mutual is not compensated for
such services and does not invest in or exercise control over such entities. As
investment manager, Franklin Mutual is primarily responsible for recommending
investments in unaffiliated issuers to be held by the special purpose entities.
Securities issued by these special purpose entities are restricted under the
Securities Act of 1933 and are deemed to be illiquid.

14. CREDIT FACILITY

The Fund participates in a $50 million senior unsecured revolving credit
facility to fund shareholder redemptions or meet unfunded loan commitments.
Under the terms of the current credit facility, which expires on May 31, 2009
and may or may not be extended for subsequent periods on the same or different
terms, the Fund shall, in addition to interest charged on any borrowings made by
the Fund, pay an annual commitment fee based upon the unused portion of the
credit facility.

During the year ended March 31, 2009, the Fund utilized the credit facility as
follows:

YEAR ENDED MARCH 31, 2009
Amount outstanding at March 31, 2009 .. $ --
Average borrowing(a) .................. $7,307,692
Average interest rate ................. 3.53%

(a) Loan was outstanding for 13 days during the period.

Annual Report | 47

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

15. FAIR VALUE MEASUREMENTS

The Fund adopted Financial Accounting Standards Board (FASB) Statement No. 157,
"Fair Value Measurement" (SFAS 157), on April 1, 2008. SFAS 157 defines fair
value, establishes a framework for measuring fair value, and expands disclosures
about fair value measurements. The Fund has determined that the implementation
of SFAS 157 did not have a material impact on the Fund's financial statements.

SFAS 157 establishes a fair value hierarchy that distinguishes between market
data obtained from independent sources (observable inputs) and the Fund's own
market assumptions (unobservable inputs). These inputs are used in determining
the value of the Fund's investments and are summarized in the following fair
value hierarchy:

- Level 1 - quoted prices in active markets for identical securities

- Level 2 - other significant observable inputs (including quoted prices
for similar securities, interest rates, prepayment speed, credit risk,
etc.)

- Level 3 - significant unobservable inputs (including the Fund's own
assumptions in determining the fair value of investments)

The inputs or methodology used for valuing securities are not an indication of
the risk associated with investing in those securities.

The following is a summary of the inputs used as of March 31, 2009, in valuing
the Fund's assets and liabilities carried at fair value:

LEVEL 1 LEVEL 2 LEVEL 3 TOTAL
----------- ----------- ----------- ------------

ASSETS:
Investments in Securities ...... $92,753,568 $42,307,006 $27,555,172 $162,615,746
Other Financial Instrumentsa ... -- 914,725 -- 914,725
LIABILITIES:
Options ........................ 84,265 -- -- 84,265
Securities Sold Short .......... 13,404,274 -- -- 13,404,274
Other Financial Instruments(a).. -- 643,475 -- 643,475

(a) Other financial instruments include net unrealized appreciation
(depreciation) of forward exchange contracts and unfunded loan commitments.

48 | Annual Report

Franklin Mutual Recovery Fund

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

15. FAIR VALUE MEASUREMENTS (CONTINUED)

At March 31, 2009, the reconciliation of assets in which significant
unobservable inputs (Level 3) were used in determining the Fund's fair value, is
as follows:

INVESTMENTS IN
SECURITIES
--------------

Beginning Balance - April 1, 2008 ........................ $ 53,984,007
Net realized gain (loss) .............................. 498,753
Net change in unrealized appreciation (depreciation) .. (16,985,791)
Net purchases (sales) ................................. (10,133,329)
Transfers in and/or out of Level 3 ....................... 191,532
------------
Ending Balance ........................................... $ 27,555,172
============
Net change in unrealized appreciation (depreciation)
attributable to assets still held at end of year ...... $(22,705,254)
============

16. NEW ACCOUNTING PRONOUNCEMENTS

In April 2009, FASB issued FASB Staff Position FSP FAS 157-4, "Determining Fair
Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly" (FSP
FAS 157-4), which provides additional guidance when the volume and level of
activity for the asset or liability measured at fair value have significantly
decreased. Additionally, FSP FAS 157-4 amends SFAS 157, expanding disclosure
requirements by reporting entities surrounding the major categories of assets
and liabilities carried at fair value. FSP FAS 157-4 is effective for interim
and annual periods ending after June 15, 2009. The Fund is currently evaluating
the impact, if any, of applying FSP FAS 157-4.

In March 2008, FASB issued FASB Statement No. 161, "Disclosures about Derivative
Instruments and Hedging Activities, an amendment of FASB Statement No. 133"
(SFAS 161), which expands disclosures about derivative investments and hedging
activities. SFAS 161 is effective for fiscal years and interim periods beginning
after November 15, 2008. The Fund believes applying the various provisions of
SFAS 161 will not have a material impact on its financial statements.

ABBREVIATIONS

CURRENCY

EUR - Euro

GBP - British Pound

SELECTED PORTFOLIO

DIP - Debtor-In-Possession

FHLB - Federal Home Loan Bank

FRN - Floating Rate Note

L/C - Letter of Credit

PIK - Payment-In-Kind

Annual Report | 49

Franklin Mutual Recovery Fund

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF TRUSTEES AND SHAREHOLDERS OF THE FRANKLIN MUTUAL RECOVERY FUND:

We have audited the accompanying statement of assets and liabilities of Franklin
Mutual Recovery Fund (the "Fund"), including the statement of investments, as of
March 31, 2009, and the related statement of operations for the year then ended,
the statements of changes in net assets for each of the two years in the period
then ended, and the financial highlights for each of the five years in the
period then ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.

We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements and financial highlights are free of material misstatement. We were
not engaged to perform an audit of the Fund's internal control over financial
reporting. Our audits included consideration of internal control over financial
reporting as a basis for designing audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the
effectiveness of the Fund's internal control over financial reporting.
Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements and financial highlights, assessing the accounting principles used
and significant estimates made by management, and evaluating the overall
financial statement presentation. Our procedures included confirmation of
securities owned as of March 31, 2009, by correspondence with the custodian and
brokers or by other appropriate auditing procedures where replies from the
brokers were not received. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of
Franklin Mutual Recovery Fund at March 31, 2009, the results of its operations
for the year then ended, the changes in its net assets for each of the two years
in the period then ended, and the financial highlights for each of the five
years in the period then ended, in conformity with U.S. generally accepted
accounting principles.

(ERNST & YOUNG LLP)

Boston, Massachusetts
May 21, 2009

50 | Annual Report

Franklin Mutual Recovery Fund

TAX DESIGNATION (UNAUDITED)

Under Section 852(b)(3)(C) of the Internal Revenue Code (Code), the Fund
designates the maximum amount allowable but no less than $12,286 as a long term
capital gain dividend for the fiscal year ended March 31, 2009.

Under Section 854(b)(2) of the Code, the Fund designates the maximum amount
allowable but no less than the $4,285,778 as qualified dividends for purposes of
the maximum rate under Section 1(h)(11) of the Code for the fiscal year ended
March 31, 2009. In January 2010, shareholders will receive Form 1099-DIV which
will include their share of qualified dividends distributed during the calendar
year 2009. Shareholders are advised to check with their tax advisors for
information on the treatment of these amounts on their individual income tax
returns.

Under Section 871(k)(2)(c) of the Code, the Fund designates the maximum amount
allowable but no less than $228,572 as a short term capital gain dividend for
purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the
fiscal year ended March 31, 2009.

Under Section 871(k)(1)(C) of the Code, the Fund designates the maximum amount
allowable but no less than the $1,147,369 as interest related dividends for
purposes of the tax imposed under Section 871(a)(1)(A) of the Code for the
fiscal year ended March 31, 2009.

Under Section 854(b)(2) of the Code, the Fund designates 57.31% of the ordinary
income dividends as income qualifying for the dividends received deduction for
the fiscal year ended March 31, 2009.

Annual Report | 51

Franklin Mutual Recovery Fund

BOARD MEMBERS AND OFFICERS

The name, year of birth and address of the officers and board members, as well
as their affiliations, positions held with the Fund, principal occupations
during the past five years and number of portfolios overseen in the Franklin
Templeton Investments fund complex are shown below.

INDEPENDENT BOARD MEMBERS

NUMBER OF
PORTFOLIOS IN
FUND COMPLEX
NAME, YEAR OF BIRTH LENGTH OF OVERSEEN BY
AND ADDRESS POSITION TIME SERVED BOARD MEMBER* OTHER DIRECTORSHIPS HELD
- ------------------- --------------- -------------------- -------------- -------------------------------------

EDWARD I. ALTMAN, PH.D. (1941) Trustee Since 2003 7 None
c/o Franklin Mutual Advisers, LLC
101 John F. Kennedy Parkway
Short Hills, NJ 07078-2789