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Filing for Bankruptcy as a Franchisee

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By Christopher Coble, Esq. on December 06, 2016 10:57 AM

You may have thought that buying into an existing franchise, with its business plan, name recognition, and even supply chain all sorted, would be a less risky way to own your own business. But even less risky doesn't mean risk-free and not all franchisees avoid failure, as one Iowa-based McDonald's franchisee recently learned.

As it turns out, declaring bankruptcy as a franchisee has some different quirks than shuttering a business you own outright. For instance, what happens to your franchise license? Can a franchisor just take back your contract once you file for bankruptcy? Here's a look.

Serious Chapter 7

Filing for bankruptcy under Chapter 7 means that the franchisee will likely lose the business. Following a Chapter 7 filing, the court will appoint a trustee to oversee the bankruptcy estate who will have the power to dispose of the franchisee's business assets in order to settle the bankrupt company's debts.

While the trustee will attempt to pay off all the franchisee's creditors equally, in most Chapter 7 cases, the franchisee's business remains encumbered by loans and worthless. As executor, the trustee may also terminate the franchise agreement, meaning franchisee loses the business, but avoids any debts owed to the franchisor.

Even Under Chapter 11

Chapter 11 is also referred to as a "reorganization" bankruptcy, so the franchisee can request that the court to let them erase out some of the business's debts while paying off others. The court must also agree to allow the franchisee to "assume," or continue, the franchise agreement despite the bankruptcy.

Most bankruptcy courts seek to maintain the obligations under franchise agreements, and failure to adhere to the terms of the agreement could constitute a breach of contract. But it is up to the franchisee to prove to the court that assumption of the franchise contract is sound business judgment.

Your best resource on bankruptcy filings, and which option might be the best for your franchise, is an experienced bankruptcy attorney in your area.

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