Franchise Legal Team

The struggling economy has created new obstacles for the nation’s franchise businesses. The 2009 Franchise Business Economic Outlook, prepared by PricewaterhouseCoopers LLP, predicted that the number of franchise establishments would decline by 10,000, that there would be roughly 207,000 jobs lost, and that there would be a loss of $2.2 billion in economic output. This financial crisis has caused franchisees to breach their franchise agreements not only more frequently, but in new ways, providing new excuses for nonpayment of royalties, asking for additional assistance, and failing to comply with system-wide standards. However, there is no need to rush into sending out the default or termination letters or, in the alternative, writing off the loss. There are several things that you, as a franchisor, can do to help weather this storm, while also preserving a healthy, stable relationship with your franchisees.

Investigate.

Although many times the economy will be the source of the franchisee’s troubles, you should not blindly accept the "economy" excuse as true. To protect your franchise system, you need to investigate. Go to the franchisee’s site and perform a critical analysis of the business operations. First, perform an internal investigation by thoroughly researching and reviewing the franchisee’s accounting processes and corresponding documents. Look beyond the books and assess whether there are operational problems. Is theft a possible problem? What about waste? Portion control? After performing an internal investigation, you need to step outside and consider the neighborhood, the competition, and the regional product market. Are other similar businesses suffering? Once you have performed the investigation, you will have a much better idea whether the "economy" is truly causing the issues.

Reflect.

Following your investigation, you need to look at yourself to determine if there are things you can do to assist your troubled franchisee. If you noticed during your investigation that the business operations were not running smoothly, you may need to consider implementing operational support and training. If similar businesses nearby are booming while your franchisee falters, you should consider providing additional local and national advertising, as well as offering promotional incentives in the struggling territory. By investing in your franchisee, you will inspire confidence, provide reassurance, and preserve a healthy relationship that will last years beyond this economic downturn.

Protect.

Now that you have examined the problem and invested in the future of your system, it is time to protect yourself. Not all problems are fixable. And, sometimes franchisees fail because they are not cut out for the endeavor. When that appears to be the case, do not hesitate. Act quickly and decisively. Do not condone or ignore nonpayment of royalties or permit your brand to be tarnished based on any excuse related to a bad economy. Your brand is too important to allow for damage, no matter the claim of hardship by the franchisee. When you need to, you may wish to consider as a first step entering into either a deferral agreement or forbearance agreement with your franchisee. A forbearance agreement requires your franchisee to remain current on its royalty payments, but will create a temporary payment plan so that your franchisee can pay off the past due amounts. A forbearance agreement delays your legal right to default a franchisee so that your franchisee can catch up on its payments. Therefore, a forbearance agreement is a great option for a franchisee that has struggled in the past, but is beginning to prosper. In the alternative, you can enter into a deferral agreement that simply allows a franchisee to defer payment of royalties to some future date. Clearly, this is the better option for a seriously troubled franchisee.

Still, both of these approaches have downsides. First, once your franchisee gets accustomed to lower payments, it will be harder to change its habits and increase payment. Second, your system as a whole may suffer as your cash flow decreases. That said, these approaches do provide some alternative to immediate termination.

Whether you choose a forbearance agreement or deferral agreement, you must include certain provisions to protect your business. First, make sure your franchisee acknowledges the amount of its indebtedness. Second, make sure your franchisee accepts its breach of the franchise agreement, and waives its right to contest the breach in the future. Third, set a term. Fourth, provide a detailed payment plan. Fifth, include other actions you may want your franchisee to take and provide a mechanism for increased monitoring of benchmarks. Lastly, make sure your agreement provides a remedy for defaulting under the new agreement.

By following these three simple steps, you can take measures to avoid prematurely terminating the relationship and, instead, strive towards establishing a healthy, thriving relationship.