If Your Franchisor Declares Bankruptcy

If your franchisor declares bankruptcy, you may find yourself in an unfavorable position if you have not addressed the issue in your contract. As franchisees generally do not have proprietary control over the brand name and company assets, a franchise operator may lose the license to use after bankruptcy is declared. In the case of a reorganization bankruptcy, contracts must be reaffirmed or they can be voided. Fortunately, franchisees do retain certain rights during a franchisor bankruptcy.

Franchisor Bankruptcy

As with any bankruptcy, a debtor's creditors get the assets. Because franchisees are not considered part of that class, they cannot make any claims during the bankruptcy. The issue on assets such as brand names, trade secrets, and even recipes will most likely be decided by the court (and the creditors), leaving the franchisees out in the cold.

The Bankruptcy Reform Act of 2005 provides that debtors can enter into agreements with lenders to reaffirm contractual obligations. However, franchisors are under no obligation to reaffirm particular franchisee contracts and these may be voided. A franchise owner can find its operation being shut down in this case.

Royalties

During a bankruptcy, if the franchise agreement becomes null and void, the franchise operator's duty to pay royalties also becomes voided. At this point, royalty payments should be discontinued unless the original agreement provided for payment contingencies in case of a bankruptcy.

Protective Measures for Franchisees

Brand Name

An independent franchise owner may decide to continue operations under the brand name (unless the court has made a determination that would bar this). Some franchise agreements may include contingency provisions that address retention of a brand name, allowing the owner a temporary license to continue using the name.

Continuing Operations

In the event of a bankruptcy, the franchisee should notify its customers that it will continue operations. Make public relations efforts to assure them that the franchise is independently owned and inform them about any changes that may affect them. Also, contact existing vendors and other contacts regarding supplies. They will also need assurances about continued operations. If necessary, contact alternative vendors. As soon as signs of a possible franchisor bankruptcy become evident, begin amassing a surplus of supplies.

Other Franchisees

Meet with other franchisees to address similar concerns and issues. Trade ideas about how to keep operations going and downplay any adverse publicity. Plan a co-operative PR strategy that will benefit everyone, especially the customers.

Media

Contact local media such as newspapers and newsletters to let them know that the franchise will continue to serve the local community. Take this opportunity also to field inquiries.

Find an Attorney

If your franchisor declares bankruptcy, you may find your operations vulnerable to a determination by both the bankruptcy court and the creditors. Consult an attorney experienced with franchising to discuss your rights as well as determine the best way to insulate your business from any adverse fallout.