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The Ins and Outs of Franchise Agreements

If an owner defaults on debt service, what happens with the franchise agreement?

Bankruptcy, foreclosure or receiver appointments are all standard cases of default in a franchise agreement. During a bankruptcy however, the court may require a franchisor to continue doing business with the debtor, while state receivership laws have no such provisions.

Most commercial loans include an agreement between the lender and the franchisor stipulating that if the borrower/franchisee defaults, the lender may cure the default in order to keep the franchise in place. Without such an agreement — commonly called a “comfort agreement” or “comfort letter” — neither the lender nor a receiver has any legal right to force the franchisor to allow the use of its brand.

It is important to know that the franchise can be kept in place during receivership or REO period with the franchisor’s approval. Typically the franchisor will want to keep all locations in their chain, while continuing to collect royalty and marketing fees. Although the receivership estate has no obligation to pay pre-receivership debts of the borrower, the franchisor can be assured that fees will be kept current during the receivership.

In some cases, if operations have been sub-par, the franchisor may waive some PIP (property improvement plan) items to keep the property open and operating. This is simply a judgment call for the brand and will be impacted by the subject hotel’s value of the market and site, the condition of the property, interest from other franchisees as buyers, etc.

A receiver is not required to sign a new franchise agreement; however more recently, franchisors prefer to have a temporary franchise agreement with the receiver while the receivership is in place. The receiver would never enter into a multi-year franchise agreement that might extend well beyond the receivership period itself.

The franchisor cannot force the receiver to continue operating under its brand, nor can it force a lender to do so upon foreclosure. However, the franchisor is entitled upon termination to demand immediate removal of all signs, logos, unique color schemes, branded merchandise and other trademarked materials within a short notice period.

An experienced hospitality receiver can prove beneficial in navigating these and other franchise issues.