A franchise owner declaring bankruptcy starts a major business procedure. A "bankruptcy estate." contains all their business assets, including the franchise agreement.
This agreement is often their most significant corporate asset. The franchisee might temporarily block the franchisor from regaining the franchise agreement by filing for bankruptcy. This time lasts until the franchisee overcomes bankruptcy.
Note that this step doesn't guarantee the franchise owner's retention. It shows the complexity of franchise bankruptcy.
In the year leading up to September 30, 2023, there was a 13% increase in overall bankruptcy filings, with business bankruptcies notably surging by almost 30%. This result marks a continued moderate increase following over ten years of significant declines.
The latest statistics from the U.S. Courts show that bankruptcy filings have increased over the past year. As of September 2023, there were 433,658 cases, up from 383,810 the previous year. Business-related bankruptcies significantly rose nearly 30%, jumping from 13,125 to 17,051.
Non-business filings also increased by 12.4%, reaching 416,607, compared to 370,685 in September 2022. These bankruptcy figures are updated and reported four times a year.
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Understanding Franchise Bankruptcy
Chapters 7 and 11 are the most common types of bankruptcy for franchises.
Chapter 7 bankruptcy closes franchises. The court appoints a bankruptcy trustee. All creditors are treated equally when this trustee sells business assets. The trustee ends the franchise agreement since these enterprises are generally indebted and worthless. Franchise owners lose business but are released from franchisor debt.
On the other hand, the Chapter 11 bankruptcy method is known as "reorganization" bankruptcy. This franchisee wants to pay off some debts. Debt reduction is the purpose of bankruptcy. It works if the court lets the franchisee keep their agreement. The US considers such agreements contracts with ongoing obligations. Contract breaches can result from violating these requirements.
Franchisees must convince the court that being under Chapter 11 is best for them, their creditors, and bankruptcy. Franchiser contract extension opinions don't matter. Chapter 11 eliminates many debts, but owners must accept the franchise agreement to keep it.
Non-monetary contract infractions are challenging to resolve. Unless a franchisee runs continuously, the franchisor may seek compensation before continuing the contract. The franchisee must address such issues immediately upon contract assumption, such as reopening a temporarily closed business.
How Bankruptcy Affects Franchise Agreements
Bankruptcy significantly impacts franchise agreements, affecting both franchisors and franchisees. When a franchisor declares bankruptcy, it creates uncertainty for franchisees, potentially disrupting operations and jeopardizing their investments.
Conversely, a franchisee's bankruptcy can lead to the closure of franchise units, harming the overall brand reputation.
Franchise agreements should include specific clauses addressing bankruptcy scenarios, outlining the rights and responsibilities of both parties. In bankruptcy, franchisees might restructure debts or exit the business, impacting daily operations and customer confidence.
Franchisors may need to restructure their franchise network, ensuring ongoing support for remaining franchisees.
Both parties must understand their jurisdiction's bankruptcy laws, as they influence franchise operations and agreements, particularly regarding the transferability of franchise rights and ongoing royalty obligations. Proactive measures, such as thorough agreement negotiation and seeking legal counsel, are crucial for mitigating bankruptcy-related challenges.
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