How to Salvage a Failing Franchise Unit

by Harold Kestenbaum

Ways to Save a Sinking Franchise

Even the best franchise systems have weak spots. Maybe you have a franchisee who doesn’t communicate well or one who won’t participate in special programs and offerings. Some franchisees won’t participate in advertising, fail to report sales and become delinquent with fee obligations.

These frustrations are all too common and are usually the result of a financial issue. If both the franchisee and the franchisor are willing to put in hard work, there are options for fixing these faults.

This process is called a work out, and this occurs when a franchisor and franchisee come up with an out-of-court plan to fix or mitigate a failing business. It could include a plan where the franchisee’s relationship is restructured or in some cases, a plan where the franchisee exits the franchise.

Pros and Cons of Work Outs

Before pursuing a work out strategy, the individual circumstances of each situation should be evaluated in terms of its potential benefits and risks.

When handled carefully, there are several advantages to pursuing a work out. Work outs tend to be less expensive than filing for chapter 11, they can maintain customer confidence, and they help preserve a positive franchise morale.

You do need to tread carefully, because things could go wrong, and a work out may not be the best choice for you. A failed work out can result in a host of legal headaches, and you may be wasting your time extending the franchisee’s inevitable failure.

Selecting the Best Work Out Plan

If you decide that the pros outweigh the cons for your situation, you will need to select the type of work out that makes the most sense for you. A common type of work out is called forbearance. This work out allows the parties to work together to save the franchise relationship. Typically, the franchisor makes arrangements to allow the franchisee to pay off debts over time. Other common work outs are called exit strategies, and their goal is to allow the franchisee to exit from the franchise system with the investment intact. In some cases, they also may allow the franchisor to receive full fees owed and retain the unit in the franchise system. Exit strategies are often about finding the best way to mitigate the parties’ losses.

A third common work out is called a Collective Creditor Compromise or a Composition Agreement. This method is faster and less expensive than bankruptcy that allows the debtor to pay creditors a percentage of their claims in exchange for the rescinding of those claims.

A Strategy for Reading Your Documents

A best practice when reviewing the FDD and the Franchise Agreement is to go in reverse order. Go through the Franchise Agreement first, clause by clause, and the FDD second.

If it helps, you can think of the Franchise Agreement as the “lease” for the trademark and system, while the FDD is, in part, the marketing material. When viewing your FDD and Franchise Agreement through this prism, prospective franchisees can make a more informed decision.

What Should You Do Next?

If you have a failing franchise on your hands, you have some important decisions to make. You need to decide if the franchise is worth saving at all, and then you need to discern the best work out strategy for your situation.

Harold L. Kestenbaum joined Spadea Lignana in 2019, having unrivaled experience in the franchise industry and in franchise law. He founded and served as President and Chairman of the Board of FranchiseIt Corporation. Harold also authored the first book dedicated to the entrepreneur who wants to franchise called “So You Want to Franchise Your Business.” Contact Harold at hkestenbaum@spadealaw.com or call at 215.774.3365 x136.