Franchisor Bankruptcy: Surviving The Unthinkable

If a franchisee defaults on its obligations, most franchise agreements allow the franchisor to terminate the agreement. But what happens if the franchisor defaults on its obligations to creditors? This circumstance is rarely addressed in franchise agreements, but that doesn’t mean it can’t happen-it does. Franchisors are not immune from tough economic times. For example, Bennigan’s filed for Chapter 7 liquidation in 2008, and Friendly’s Restaurants, Sbarro and Marie Callender’s all filed for Chapter 11 reorganization in 2011, just to name a few.

If your franchisor files for bankruptcy, several negative things can happen. You might be cut off from suppliers; negative press could impact your revenues; your franchise contract could be assigned to a franchisor or other third party who knows little about your business; or, the franchise could be liquidated, in which case you will lose your investment. At the very least, bankruptcy spells uncertainty.

So, what should you know and what can you do? First, remember this: if you snooze, you lose! If you hear a rumor or suspect that your franchisor is defaulting on its obligations or headed for bankruptcy, consider it a red flag. If your franchisor is collecting advertising fees, but isn’t advertising, ask questions. Also, review your franchise agreement to determine your rights under the agreement. Don’t ignore these warning signs because once bankruptcy is filed, things happen quickly.

Next, consider what alternatives would exist for you if your franchisor defaults. Make a list of alternate suppliers and maintain extra supplies. Contact other franchisees to share information and resources. Better yet, consider forming a franchisee group to share costs, strategize and obtain joint legal representation, since a group should have increased negotiating power before any bankruptcy filing, and especially during the bankruptcy proceedings. For example, the group could act quickly to require the franchisor to honor its obligations or to potentially gain status in the bankruptcy proceedings as a formal franchisee committee. A substantial sized group could potentially acquire assets or locate a friendly buyer before or during bankruptcy-think economies of scale.

The moral of this story is to pay attention to your franchisor’s financial status and to act quickly if you learn it is at risk. You can survive the unthinkable, but it may not be easy. You’ll have more control over your destiny the sooner you act!