When a Franchisor Files for Bankruptcy
When a franchisor files for bankruptcy, what happens to its franchisees? The answer, as with most legal questions, is “It depends.” It depends, in fact, on a multitude of legal and circumstantial issues, each of which may or may not come into play, and each of which may have one or more possible outcomes.
This article provides a brief history of some well-known franchisor bankruptcies of recent years -- including Denny's, Bennigan's, Steak & Ale, Original Roadhouse Grill, Cork & Olive, The Ground Round, Church's Chicken, Popeyes, and 7-Eleven -- with a look at the outcomes of these bankruptcies for both the franchisors and their franchisees.
The Denny’s franchise filed for Chapter 11 bankruptcy protection back in 1997, following the $54 million settlement of a class-action lawsuit in which the franchisor was charged with racism. The franchisor maintained its franchise structure and undertook an expansive diversity campaign, which included increasing its number of minority-owned franchises. The system eventually expanded to 1,000 franchisees.
Bennigan’s and Steak & Ale Restaurants
The parent corporation for the Bennigan's and Steak & Ale restaurant chains filed for Chapter 7 bankruptcy in 2008. Company-owned locations closed, but more than 100 Bennigan’s franchisees remained in operation.
Original Roadhouse Grill
The franchisor of the Original Roadhouse Grill restaurant chain filed for Chapter 11 bankruptcy in 2007, and converted to Chapter 7 later that year. Franchisees continued to operate, but as with Bennigan’s, corporate-owned restaurants were shuttered.
Cork & Olive Wine Retailers
Cork & Olive was a regional franchisor in the Southeast that filed for Chapter 7 bankruptcy in the summer of 2008, after roughly a year of problems meeting inventory obligations to its franchisees. For a time, franchisees had to create their own websites and pay out of pocket when customers redeemed corporate-issued gift cards. Ultimately, their franchisor went into full-on Chapter 11 liquidation, but by banding together to work with vendors, compare notes, and share best practices, the system's former franchisees were able to pull through and continue to operate independently.
Ground Round Restaurants
The Ground Round franchise filed for Chapter 11 bankruptcy in 2004. Many, but not all, of the franchisees remained in the system and worked cooperatively to purchase the Ground Round trademark for several million dollars. Those franchisees who purchased the trademark continued to operate under the Ground Round name.
Church’s Chicken and Popeyes Restaurants
After merging with the Church’s Chicken system in the late 1980s in a debt- laden deal, Popeyes franchise owner AFC Enterprises took both franchise systems into bankruptcy. The Church’s Chicken franchise system was later sold, and both systems maintained support for their franchisees.
7-Eleven Convenience Stores
Similar to Church’s and Popeyes, 7-Eleven underwent a Chapter 11 bankruptcy restructuring in the early 1990s after a $5 billion buyout failed to produce its intended results. Majority ownership in the franchisor was sold off, and the system has since developed into one of the most successful stories in the franchise industry, with thousands of stores worldwide.
Of course, these stories mask many of the day-to-day implications and practicalities of dealing with a franchisor in bankruptcy. Sometimes the effects can be minimal, but other times—with small and large franchisors alike—a franchisor’s bankruptcy can significantly impact the success or failure of a franchisee’s operations. From loss of supply of branded inventory, to loss of affiliation with the franchisor’s trademark entirely, to loss of operational support, to customer confusion or defection as a result of less-than-flattering headlines, franchisors’ bankruptcies can have real and long-term effects for the businesses of their franchisees.
Although it's certainly no guarantee of protection, a critical factor for prospective franchisees evaluating several franchise opportunities should be a franchisor's outstanding litigation or history of bankruptcy filings (Item 3 and Item 4 of the Franchise Disclosure Document, respectively) -- elements to be investigated seriously by anyone hoping to find a franchise.
Jeff Fabian is the owner of Fabian, LLC, a boutique intellectual property and business law firm serving new and established franchisors and prospective franchisees. Visit www.fabianlegal.com or www.thefranchisecafe.com for more information, or contact the firm directly at 410.908.0883 or firstname.lastname@example.org. You can also follow Jeff on Twitter @jsfabian.
This article is provided for informational purposes only, and does not constitute legal advice. Always consult an attorney before taking any action that may affect your legal rights or liabilities.
5 Traps for the Unwary Prospective Franchisee
When evaluating a potential franchise opportunity, prospective franchisees need to take care to put the hype and their emotions in check, and carefully consider all factors relevant to their buying decision. After all, the franchise will be a 5- to 10-year relationship (at minimum, under most franchise agreements), so it is well worth the investment to put in some research and analysis before taking the leap.
Advanced Franchise Accounting Terminology
If learning about things like GAAP accounting, revenue recognition policies, and the intricacies of cost vs. expenses fires you up, you're going to love this post.
Why I Have an Issue with the Forbes Franchise Rankings
The 5-Year Growth Rate and 5-Year Franchise Continuity are both great independent metrics of how a franchise is doing on average. As a potential franchisee both of these statistics are vital for selecting a franchise - you want to select a franchise that will provide you with a high return on investment and which will survive in the long run. I think these are, as FRANdata and Forbes suggested, two of the biggest (if not the two biggest) and most obvious metrics for whether or not a franchise is a “good” opportunity for a franchisee. But how do you use these to determine which franchise is BEST? This is the fundamental difficulty in coming up with a ranking system - it isn’t the difficulty in separating the good from the meh from the bad - it’s separating the great from the good and the best from the great. In the case of these rankings I found it to be pretty difficult to comprehend how they differentiated between the top ranked franchises. For instance, if you look at the difference between Discover Map (Forbes #4), Just Between Friends (Forbes #5), & Seniors Helping Seniors (Forbes #6) they all have extremely close continuity ratings and substantially different growth rates. In fact, in the case of these three, the overall rankings are opposite the growth rate rankings. Seniors Helping Seniors is ranked at the bottom of these three franchises despite having a growth rate that is 31 percentage points higher than Discovery Map and a continuity that is only 2 percentage points lower. This suggested to me that continuity was viewed as the dominant factor. But that logic didn’t hold for the rest on the “Economy Class” Top 10, as BrightStar Care (Forbes #7) had the same growth rate as Pop-a-Lock (Forbes #8) but a continuity rate that was 12 percentage points lower. These comparisons show that these were not the only two factors that went into the rankings, which is understandable, but no other factors that are explicitly listed in their results seem to be major factors.