Bill Burris, owner of Rent Your Boxes in Washington, D.C., a franchise that rents and delivers heavy-duty moving boxes, got the bad news in an e-mail. It was March, 2010, when Burris found out that his franchiser, an Australian company called Hire a Box, had gone bankrupt.
“I felt like the rug had pulled out from beneath me,” says Burris, who had become the first of 10 Rent Your Box franchisees in the U.S. just six months earlier.
The unfortunate truth is that given the struggling economy, no kind of business is safe from potential failure. The additional wrinkle for franchisees, though, is that while they are responsible for running their own individual businesses, they pay a parent company fees in return for benefits such as operational and advertising help. What happens, then, when your franchiser declares bankruptcy?
It’s important to note that declaring bankruptcy does not necessarily signal the death knell for a business. If a company files for Chapter 11 bankruptcy, they are actually filing for protection from their creditors, signaling that they need assistance in paying back their debt. Sometimes that can mean that the franchiser may also try to renegotiate or even terminate their franchise agreements, which are a franchisor’s main assets beside its intellectual property (trademarks, business processes, etc.).
But if a company files for Chapter 7 bankruptcy, as was the case with Rent Your Boxes, they are basically declaring the company insolvent and out of business. That means that your franchise is now literally on its own.
“If your franchiser files for bankruptcy, you could be hurt by a lack of support and training,” says Bert Martinez, a business consultant in Houston. “Franchisees pay big fees to have a franchiser guide and train them. Without this support, many franchisees—especially first-time business owners—will struggle.” Franchisees also face the loss of the buying power that being part of a franchise brings with it, especially when it comes to securing advertising and supplier contracts, says Martinez, who notes that franchisees face potential credibility issues with everyone from lenders to customers if the news of the bankruptcy is widespread enough.
Potentially more unnerving, though, is that in the advent of a Chapter 7, the franchiser’s assets—namely those franchisee agreements—are put up for sale to the highest bidder. That means, of course, that you would essentially be getting a new boss without any guarantees that they will support you and your business the way you want.
“If something happens to your franchiser, you need to know what your rights are.”
In Burris’ case, his franchisor never actually signed his franchise agreement. That meant that even though he was out the money he had paid in franchise fees, he was free to launch what was essentially a new business of his own: Rent Our Boxes, which will soon begin offering franchisee rights across the country. “Given these turbulent times, make sure that you enlist the help of a good franchise attorney before you ever sign anything,” says Burris, who served as the director of advertising and media sales at the International Franchise Association before he decided to take the leap as an entrepreneur. “If something happens to your franchisor, you need to know what your rights are.”
Another key aspect is not to give up, says Martinez, no matter how demoralized or lost you feel. That means taking action. In addition to hiring a skilled attorney, who can help map out what legal recourse you might have against the franchiser or even the individuals associated with it, there are steps franchisees can take in the wake of a franchiser filing bankruptcy that can potentially help keep their business alive, says Martinez. “Franchisees, in most cases, can gain when franchisers file for bankruptcy protection,” he says.
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The first step for franchisees faced with this scenario, then, is to band together, says David Cahn, an attorney with Whiteford Taylor & Preston in Baltimore who had advised both franchisers and franchisees. “Regardless of the scenario causing the franchiser bankruptcy, franchisees are nearly always best served by organizing as a group to protect their rights in the bankruptcy proceeding,” he says. “Bankruptcy cases moves quickly and you need your claim to stand out and you have a better chance of doing that if you are organized and speak as a group.”
This advice is particularly relevant if the franchiser has filed Chapter 7 and the franchisee agreements will be put up for sale. “A franchisee group of creditors is critical to making sure that auction process does not only focus on the financial value of the bids received, but also on the bidder's experience and management capabilities and the bidder's plans to revive the brand,” says Cahn. “Also, to the extent that franchisees as a group have common claims against the franchiser due to its misrepresentations or failures to follow through before the bankruptcy, a group approach to presenting the claims will make it more likely that the franchisees will receive some sort of favorable consideration through the process, such as an increase in support by the new franchiser or a release from the franchise agreement and its post-termination covenant not to compete.”
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In either Chapter 7 or Chapter 11 proceedings, you can renegotiate contracts as well as any monies due to the franchiser, such as franchise fees that you could try to cut by a third or even a half, says Martinez. A bankruptcy can also represent an opportunity for a franchisee to get better operational terms as well. “The thing that a lot of people don't understand is that franchisers control who the franchisees can buy from,” says Martinez. “That’s why franchisers may keep their suppliers a secret. But, in a bankruptcy proceeding, all this stuff is being disclosed so you, as the franchisee, can find out who your suppliers are and perhaps cut a deal with your franchiser so you can negotiate better terms with the supplier.”
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If the franchiser is closing its doors through a Chapter 7, this gives you and potentially your group of fellow franchisees the opportunity to strike out on your own, says Martinez. “Creditors will usually bend over backwards to accommodate any situation that has a promise of a repayment,” he says. “That means you might be able to buy the franchisers’ assets cheap and in some cases for pennies on the dollar.”
Obtaining the rights to the franchise also can provide additional benefits. For example, as the new franchiser, not only will you save on paying out royalties, you can also now collect fees from the other existing franchisees as well as any newcomers, says Martinez. “This can really be a win-win for a former franchisee because the original franchiser helped you get started and handed you the system that they had worked the kinks out of,” he says. “In that scenario, the fact that franchiser has now disappeared might not be that bad a deal.”
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