Franchise Bankruptcy and Reorganization

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Franchise Bankruptcy and Chapter 11

Our Dallas and New York franchise bankruptcy attorneys have complied a brief list of issues to consider when a franchisee bankruptcy is imminent.

Franchise Basics

There are three basic types of franchises:

  1. Distributorships, which grant the right to sell their parent company’s product(s) such as auto dealerships (Toyota, Ford, GM, Mercedes, etc).
  2. Trademark or brand name licensing, which gives the licensees the right to use the parent company’s trademark or brand in conjunction with the operation of their own business ie. beverages (CocaCola) and sport franchises (Miami Dolphins, New York Yankees, etc).
  3. Business format franchises, the type most people are familiar with (Subway, Meineke Muffler, Circle K)

Franchise Bankruptcy Reorganization Issues

A franchise relationship may be evidenced by a single contract or a series of related agreements. These contractual relationships can include the following:

  • The actual franchise agreement: The franchise agreement licenses the rights to the franchisee to use the franchisor’s trademarks, copyrights, service marks, patent, and business systems. In addition to providing for the payment of an ongoing royalty fee, a franchise agreement might contain provisions for the payment of fees for advertising or production costs.
  • Future Development agreements: A development agreement gives a franchisee the right of future development in particular areas.
  • Real property leases: In certain instances where a franchisor operates a mixed franchise system, the franchisor may sell off some of its corporate stores to franchisees. If the franchisor was the lessee at that location, the franchisor may enter a sublease with the new franchisee to maintain the location.
  • Procurement contracts: One market advantage of franchising is the purchasing power of the franchisor to make purchases for the franchise system as a whole. It is typical for the franchisor to enter into procurement contracts with vendors on behalf of its franchisees to achieve economies of scale. These economies may be passed through to the franchisees, or the franchisor may receive rebates from the vendor, as long as such rebates are disclosed to the franchisees.

 

Accordingly, when faced with a bankruptcy of a franchisor or a franchisee, counsel for the parties must determine whether these various contracts will be regarded as a unitary contract or separate obligations.

Franchise agreements are not estate property if properly terminated pre-petition

Generally, if a valid termination notice, which is effective upon receipt, has been delivered before the filing of bankruptcy, then the franchise agreement is not property of the estate. A franchise agreement that has expired by its own terms or that is properly terminated under state or federal law before a bankruptcy filed is not protected, because it is not considered in force. Since the franchise agreement is no longer in existence, it will not be considered property of the estate when the bankruptcy case is filed.

However, the franchise agreement is assumable if the franchisee still has the contractual opportunity to cure before the termination is contractually complete.

Other Franchise Bankruptcy Issues:

Other issues in franchise bankruptcies include:

  • Can the Franchisor lift the automatic stay to terminate the franchise agreement after the petition date and lack of adequate protection?
  • Can the Franchisee properly assume the franchise agreement?Here, issues arise with respect to the cure of noneconomic defaults and the adequate assurance of future performance.
  • Can the franchise and related agreements be assigned by the company to a purchaser?
  • Does the franchisor have a lien on cash collateral?
  • Can the assumption/rejection deadline be extended past 210 days?

Common warning signs

Warning signs that might mean that a Chapter 11 filing is imminent include:

  • Delinquencies to key vendors required by the franchisor for sourcing
  • Delinquencies to the franchisor or its affiliates
  • Delinquencies to the landlord or secured lender
  • Desperate attempts to sell the business on expedited closing terms
  • elimination of cash-flow problems
  • Excessive number of lawsuits by or against the franchisee
  • Excessive trade debt in relation to other franchisees
  • Frequent financial restructuring
  • Frequent requests for franchisor assistance in financial restructuring or
  • Revolving door for financial executives or auditors
  • Unexplained but frequent change of key vendors, or unexplained disloyalty to vendors

Contact Us:

Dallas: Richard G. Grant, Practice Chair | Direct: 214-210-2929
New York: Robert W. Dremluk | Direct: 516-883-2759