Is There a Silver Lining to Franchisee Bankruptcy? | Franchise News

While bankruptcy is usually not the most attractive option for a franchisee, it is also not the worst outcome, and it is not always bad for the franchisor.

Looking holistically at the future of the brand, reorganizing the business under Chapter 11 bankruptcy can help a franchisee get rid of some debt, freeing up capital to invest in their property. or otherwise invest in the brand, noted Robert Haupt, lawyer at Lathrop GPM. , which ultimately benefits the franchise system as a whole. However, franchisors must first determine if they want the franchisee to remain in the system.

“The first question a franchisor should always ask is: do I want the franchisee? Is he a good franchisee? said Haupt, a bankruptcy and commercial litigation lawyer. “And it’s not a question of personality, but do they contribute to the brand or do they harm it.” From there, the franchisor can assess the viability of the business and assess a restructuring plan.

The most common types of bankruptcies in franchising, Chapters 7, Chapters 11 and 13 all provide different levels of protection, from outright liquidation (Chapter 7) to business reorganization (Chapter 11) and reimbursement. debt over three to five years (Chapter 13). However, Chapters 11 and 13 both allow the franchisee to continue operating under a franchise agreement.

“Most of the franchise agreements I’ve seen have some sort of expedited termination provision in the event of the franchisee’s insolvency or bankruptcy,” said Will Jameson of the law firm Spadea Lignana. “Once a bankruptcy is filed, however, the automatic stay imposed under bankruptcy law prohibits the franchisor from enforcing the termination or collection without the approval of the bankruptcy court. In practice, working with a struggling franchisee is often the best way to avoid the franchisee seeking bankruptcy protection and the resulting loss of certain controls of the franchisor under the franchise agreement.

In all scenarios, being proactive is essential, said Haupt, who noted that some franchisors “will act as if they are surprised” when a franchisee files for bankruptcy because they do not have the proper mechanisms to report the signs. chain warning. A late payment pattern, lack of communication, or lender notices are all red flags.

As franchisors assess the performance of franchisees and their locations as pandemic restrictions relax and consumers return to more typical activity, Haupt said if a franchisor decides to intervene before filing for bankruptcy, some could consider discussing the possibility of a sale to another franchisee or, in the case of an oversized system or faced with too many distressed operators, franchisors may have to consider terminating a contract.

“For the franchisor, this is an opportunity to assess where they want to be in the market,” he said, and to consider factors such as market density or the need to reduce the footprint of the system. . “The more engaged you are on the front-end, the more power and flexibility you have.”

Haupt compared this assessment of the system to drawing down a lake: “By lowering the water, it is easier for the big fish to eat the smaller fish, and those big fish become more attractive to trophy anglers. These trophy fish are the large multi-unit operators that many franchisors want to land, Haupt said. “So, do you want a lake full of small fish or a handful of trophy fish?” “

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