Nobody starts a business expecting it to go under, but nothing is ever guaranteed. Buying a franchise actually offers a better chance for success than starting a company from scratch because there is already an established brand, business procedures, and support for the franchisee in place. This makes starting a franchise almost a "shortcut" to owning a business. All of the groundwork is already taken care of. You don't have to establish your "new" product or service, you don't have to build consumer trust, and you don't need to build a consumer base. Those are some of the advantages of buying a franchise as opposed to starting a business from the ground up. Knowing all of this, it's easy to think that buying a franchise means you will automatically be successful and that there is no way your franchise can go under. Unfortunately, this isn't always true.
You no doubt did your research before entering into an arrangement with a franchise, but this doesn't mean the franchisor can't file bankruptcy. Things change along with the economy, and while many well-established franchises are capable of withstanding changes in economic stability, nothing in business is guaranteed and you should always be prepared for every eventuality, including a franchise that goes bankrupt.
What Type of Bankruptcy
Franchises don't often file bankruptcy, but if it happens and you are a part of that franchise, what are your legal obligations as a franchise owner? How does it affect you when the company you buy a franchise from declares bankruptcy?
Keep in mind, there are two types of bankruptcy. There's Chapter 7, where the company will go completely out of business. If this happens, the franchise agreements will be voided. In many cases, the franchisee can still continue with their individual franchise outlets (meaning they can continue to sell the product and use the brand and trademark), but they are no longer obligated to make royalty payments to the parent company and are not bound by other elements of the franchise agreement. This sounds like a good deal for the franchise owner, but the other side of the coin is not being able to get the product you require to run the franchise. It will be much more difficult when the parent company isn't providing it. There will also be no access to the structural back up that previously existed with the franchise. In short, franchisees are on their own.
More common in the franchise industry is Chapter 11, bankruptcy. This occurs when the company has a well-established brand name and no desire to dissolve the brand entirely. In this situation, a company doesn't want to cease operations, they just need some time to reorganize and redirect operations. Maybe the company has too much debt. In Chapter 11, the court will appoint someone to run the company while structuring (along with a committee of major creditors), a reorganization plan to allow the company to emerge from Chapter 11 status with a new plan and a stronger financial structure.
What Are the Legal Ramifications if Your Franchise Goes Under?
First and foremost, start with your franchise agreement. That agreement is solid and will outline every aspect of the franchisor's agreement with you. Your obligations to the company are limited to what is in that franchise agreement. If need be, you can hire an attorney to help you review the franchise agreement and ensure that regardless of the franchisor's bankruptcy, the company still meets its obligations to you.
If your franchise is filing for Chapter 11, there's a good chance you will see only marginal changes in operations. The company will still be together and you will be a part of the reorganization that will allow the franchise to continue to grow. The franchisee's rights and responsibilities after a Chapter 11 filing (providing your contract with the company doesn't get voided during the restructuring process) will be the same as they were before the filing. As a franchisee, you will still be obligated to continue operating your business under the same terms and conditions, which includes paying all royalties, while the franchisor will be bound to providing all services stated in the contract. Whether or not your contract is voided will be decided based upon a determination of its value to the overall restructuring of the company.
The real issues comes with a Chapter 7 filing. Unless you intend to walk away from the franchise entirely, which you have the legal right to do in a Chapter 7 filing, you will need to consider some basics about continuing to operate a franchise without the support of the parent company. This can be done, but it is difficult and many franchisees take the loss and move on rather than try to operate under a failed franchise.
Some of the things you will want to look at, particularly when a company continues to operate after filing bankruptcy (as is often the case) is whether or not you can continue to use the franchise intellectual property. Many franchise lawyers will suggest looking into an extension of the franchise license agreement, which will allow the franchisee to continue operating the franchise using the brand.
Remember, when a company goes under, it is obligated to its franchisees by the franchise agreement. Your obligations as a franchisee are no more than what is stated in the franchise agreement. Your concern shouldn't be for what you will owe the franchisor, but how the franchisor's bankruptcy will affect the future of your franchise. Rush Nigut, a franchise attorney from Iowa, states that franchisees should be proactive and even band together with other franchisees to "protect their interests," rather than sit around waiting to see how the franchisor is going to handle the situation. The bottom line is, do your research. Your future is on the line and you want to arm yourself with all the knowledge you need to move ahead in life. The more you know about a franchise opportunity before you get involved, the better off you will be in the long run.
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