What If Your Franchisor Goes Under?

Most potential franchisees don’t go into a franchise business feeling paranoid about the financial strength of their franchisor. That’s because would-be franchise owners aren’t usually spending a lot of time analyzing a franchisors financial statement.

As a matter of fact, in a post I wrote titled “5 Great Questions To Ask Franchise Company Executives,” I didn’t even include a question concerning franchise company financials. Maybe I should have.

The economic environment over the last three years in the US has been challenging, to say the least. By now, you know that the housing market has been hit hard, lenders for the most part still aren’t freely lending small businesses money, and millions of people are having difficulty finding good jobs.  While signs of optimism are starting to appear, it’s going to be awhile until this optimism is reflected on company balance sheets, including the ones that are located in the finance and accounting offices of franchisors, nationwide.

It’s Not a Perfect World

Hopefully, you weighed the pros and cons of entering into an arrangement with your franchisor well before you became a franchisee, and you did top-notch research. Your research included talking and visiting with several current franchisees, and you spent a day or two at corporate headquarters getting to know the staff there. Basically, everything lined-up the way you’d hoped, and your decision to move forward felt right. Except for one thing;

Your franchisor declared bankruptcy.  In franchising, bankruptcy is not a very common occurrence, but it can and does happen.  So, what can you do to protect your interests?

Protect Your Interests

As angry as you probably are, this isn’t the time to let your emotions get the best of you.  It’s also not the time to gather suggestions from well-meaning friends who “only want to help,” but may in fact make things even worse for you. The most important thing for you to do is to find out exactly where you stand, and it’s relatively easy to do. That’s because it’s all in black and white. Remember that franchise contract you were required to sign?

I reached out to Rush Nigut, an Iowa franchise attorney, and asked him what some of the options are that a franchisee has when their franchisor is in trouble:

Small Business Trends: What is the first thing franchisees who finds themselves in this situation should do?

Rush Nigut: The first thing a franchisee should do if the franchisor is in trouble is to review the franchise agreement to make sure the franchisor is meeting its obligations. If not, a franchisee will want explore whether there is a breach of contract and whether the franchisee can possibly terminate the agreement if that makes sense.

Small Business Trends: Franchisees spend a lot of time and money to find and keep customers. Can they keep their customers if the franchisor goes under?

Rush Nigut: Obviously, franchisees will want to keep their customers or clients; they’ve worked hard to get them. But they need to make sure that they avoid any non-compete enforcement. Many franchisees are under the mistaken belief that the customers belong to them. Instead, the termination provisions and non-compete provision written into franchise agreements tend to favor the franchisor.

Small Business Trends: What about licenses and trademarks? Can a franchisee still use them?

Rush Nigut: A franchisee may want to look at extending their license agreement to allow them to use the trademarks of the franchisor in certain instances. I know of a franchisor that got into trouble and agreed to allow the franchisees to use the franchise name and trademarks even though they could not continue the franchise business. A critical issue in that situation was gaining access to product that had been solely supplied by the distressed franchisor.

Small Business Trends: Rush, I know that every situation is different with regards to franchisors that go under; one size doesn’t fit all. How proactive should franchisees be in situations like this? How aggressive should they be?

Rush Nigut: Joel, my goal in distressed franchisor situations is to make sure my clients don’t sink with the captain. It’s crucial for franchisees to be proactive, and they need to try to be aggressive in enforcing their rights. It may even be beneficial for franchisees to band together. Waiting to see if the franchisor will make it is probably not good business, in most cases. Franchisees need to see an attorney that knows franchising immediately, so that they can understand their rights.

The bottom line; if your franchisor runs into serious problems, don’t take a wait and see approach. Move quickly, so you can protect yourself, and increase your odds of staying in business.

Going Under Photo via Shutterstock

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