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.
Know Before you Go – Non-Compete Provisions in Franchise Agreements
In general, non-compete provisions state that the franchisee will not, during the term of the franchise agreement and for a reasonable period thereafter (typically two or three years), own or be involved in any “competitive business.” What constitutes a “competitive business” will vary from franchise system to franchise system, but most franchisees can generally expect to be prohibited from taking part in any business that offers goods/services that are either identical to or competitive with the goods/services offered under the franchise system. Non-compete provisions must be limited in geographic scope, and generally cover a set radius (usually somewhere around 5 to 25 miles) around the former franchised outlet, and possibly also the outlets of other existing franchisees.
Getting Out: Important Points for Selling a Franchise
In either case, the franchisee’s right to sell the franchise will be governed by the transfer provisions in their franchise agreement.
Franchise Buying Tips: Purchase Without Passion
Yet that is exactly what most franchisees do. It's good to be enthusiastic about your future business plans. It's bad to fall in love with the deal and let your emotions take the lead. Think that won't happen to you? If you talk to a hundred franchisees you will find that few knew exactly what they were getting into. Most are sensible people with plenty of information who selectively twisted the facts to support an emotional decision.