Franchising is an alternative to starting a business from scratch. It offers name recognition, strong business relationships, and an established customer base. However, running a business carries risks. These could include being unable to meet financial obligations. When a business struggles financially, filing for bankruptcy can be an excellent option to help the business get back on track.
Filing for business bankruptcy is similar to filing for personal bankruptcy. However, there are more complications when the business is a franchise. Businesses often file for Chapter 11 bankruptcy, which allows them to make debt repayment plans and reorganize their finances.
If you run a franchise in California and are considering Chapter 11 bankruptcy, you will benefit from the insight of a seasoned bankruptcy attorney. Your lawyer will guide you through the complicated franchise bankruptcy process to ensure you follow the proper procedures and guarantee a favorable outcome of your bankruptcy petition.
An Overview of Franchise Operations
A franchise is a business where the owner gives the right to other business owners to operate under their name. Being part of a franchise allows you to receive the customer base and good reputation the original enterprise shares. In this case, the franchise owner will often be referred to as the franchisor, while the owners of other businesses will be the franchisees. There are several ways in which a franchise can be structured, including:
Product Franchises
With this type of franchise, the franchisee sells the goods produced by the franchisor's owner using the franchisor's trademark. In this case, the franchisee must pay for the right to advertise and sell these products.
Business Format Franchises
In this case, a franchisor will license the franchisee to use a business system they created to run their business. This could include marketing plans and strategies. If you are a franchisee, you must directly follow the control methods put in place by the franchisor.
Distribution
A franchisor allows a franchisee to sell their products through this type of franchise.
Franchises could be structured differently depending on the type of business. You can have a single-unit franchise that will operate in one location and in a geographical location that protects it from competitors. Another way the franchise could be structured is through area development, which allows you to run multiple franchises at a given location. Franchises consist of contracts and agreements binding small business owners, allowing them to use the original company's patents, trademarks, and copyrights.
Franchise Bankruptcy
When a franchise is struggling financially and staying afloat, filing for bankruptcy is often an option. Chapter 11 bankruptcy is a reorganization bankruptcy that allows the franchise to restructure its operations and avoid closing down.
Franchise contracts and agreements are significant when considering a bankruptcy filing. These contracts could be considered separate or unitary obligations. Before the decisions in Chapter 11 are made, the franchisees and other parties involved in the contacts must be on board with the decision.
Typical considerations for franchise bankruptcy include:
Estate Property
If you terminate a franchise agreement before filing for Chapter 11 bankruptcy, the property will no longer fall under estate property. This will include agreements that were terminated under state or federal laws.
Defaults
Sometimes, a franchise can default on an agreement in a non-financial way. If the contract stipulates that the franchise must remain in operation, closing it could cause a default settlement or termination of the contract. However, the contract could be fixed when the business resumes operations.
Agreement Termination
If a termination notice for an agreement is issued but cannot be effective immediately, the court considers nothing left for the franchise to cure. Therefore, the contract is considered terminated for the sake of bankruptcy. However, the court believes the contract is still binding if your franchise makes legitimate efforts to cure the debts before the agreement is terminated.
When you file for Chapter 11 bankruptcy, you will have up to 60 days to cure the debts you have accumulated before the termination of the contract.
Signs that You Should Consider Franchise Bankruptcy
Most signs of trouble in your franchise may not be noticeable until it is too late and you are on the verge of bankruptcy. However, you should look out for these warning signs:
- The company has to hire external auditors to offer financial reporting services.
- Attempts to expedite the terms of selling the business
- Delinquencies in the payment of essential bills like rent and wages
- Lawsuits from different creditors for unpaid loans
- Unachievable financial expectations for growth and expansion of the business
- Multiple attempts at financial restructuring
When the signs are noticed early on, you can take different measures to save your franchise from bankruptcy and keep your business running. If the warning signs come too late or your attempts to avoid bankruptcy are futile, filing for Chapter 11 bankruptcy will allow you to stabilize your business's finances and continue as a healthy and profitable venture. You may be able to accomplish the following goals by filing for Chapter 11 bankruptcy for your franchise:
- Pay off your debts.
- Reorganize the company's financial operations.
- Liquidate assets
With this type of bankruptcy, you will fill out paperwork disclosing all the aspects of your franchise. This includes daily operations, contracts, financial obligations, and debts you may have accumulated throughout its existence. With the guidance of a bankruptcy attorney, you can file the petition in court.
The court appoints a bankruptcy trustee to ensure that you follow all the requirements for filing for bankruptcy and disclose all relevant information about your assets. Chapter 11 bankruptcy will not cause the liquidation of your franchise assets. Instead, you will make a repayment plan around the franchise income and cover your debts over time.
The repayment plan allows you to make affordable monthly installments on your debts. Chapter 11 bankruptcy benefits your franchise and creditors because their debts cannot be discharged.
You can continue to operate your franchise while you go through bankruptcy proceedings. Additionally, you can sell some business assets out of bankruptcy by obtaining authorization from the court. Such action will allow you to cover your daily operational expenses and keep the business open.
Benefits of Filing for Chapter 11 Bankruptcy for Your Franchise
If your franchise is struggling financially, there are some benefits you will accrue from filing for Chapter 11 bankruptcy, including:
Continue Running the Business During Bankruptcy
Unlike a Chapter 7 bankruptcy, where your assets are liquidated to pay creditors, you can continue running your business franchise while you go through Chapter 11 bankruptcy. When you have worked hard to build your business or purchased an existing franchise, you do not want to lose the effort by closing it down.
By filing for this type of bankruptcy, you can continue your operations and avoid losing your customer base and goodwill. However, you may need permission from the court to engage in certain business activities during this period.
Automatic Stay for Creditor Actions
When you run behind in debt, creditors could contact your business to demand payment. Additionally, creditors could act like they are suing you for the debts. You will enjoy the automatic stay when you file for Chapter 11 bankruptcy for your franchise.
This means that creditors' debt collection measures will be halted. If creditors contact your business or attempt to take measures against you after filing for bankruptcy, the court can void these measures. The automatic stay allows you to evaluate your financial situation and negotiate with creditors for a favorable repayment plan.
However, the exclusive right to the automatic stay will last up to 120 days from filing a bankruptcy petition. You must act within this time to make the necessary arrangements for the reorganization process.
Emergency Relief for Daily Operations
A few days after filing your Chapter 11 franchise bankruptcy, the court will order a hearing addressing the emergency motions for your business and its bankruptcy. During this hearing, you can request the court grant you the authority to undertake specific measures for the continued running of your franchise. The actions you can request to continue include paying wages for your workers, paying taxes, and meeting the franchise contractual agreements.
Treatment of Unexpired Leases and Contracts
Leases and other contracts to which your franchise has obligations could impose financial burdens that force your business into bankruptcy. You can reject these contractual agreements when your franchise is in Chapter 11 bankruptcy. This causes the other parties in the agreement to become unsecured creditors. Additionally, you can choose to assume the contacts after handling outstanding defaults.
This means that the other parties in your contract must continue to perform their obligations regardless of your decision to pursue bankruptcy.
Possibility of Obtaining Loans with Favorable Rates
In addition to being allowed to continue your franchise's daily operations after filing for Chapter 11 bankruptcy, you can seek authorization to take other loans at normal interest rates. These loans can help you with daily business expenses like purchasing supplies and paying wages.
Before seeking a loan to fund your daily business operations during franchise bankruptcy, you must ask for permission from the court. If the court allows you to obtain loans while undergoing bankruptcy, the new creditors will receive preferential treatment in your repayment plan. This allows you to continue with smooth franchise operations without incurring extra loan interest rates.
Freedom to Sell Property and Clear Liens
Your business could decide to sell the assets it does not need as part of its restructuring strategy. This allows the franchise to generate money to fund its business operations. When you file for bankruptcy in California, you can no longer sell the properties attached to a lien outside the bankruptcy.
However, with Chapter 11 franchise bankruptcy, you can seek court permission to liquidate some assets. This will allow you to clear the liens and encumberments hindering its sale. When the court allows you to sell the property, you can fetch a favorable price. Buyers are more interested in purchasing distressed properties when the court issues orders to protect them from potential liens.
Disadvantages of Chapter 11 Bankruptcy for Your Franchise
Reorganizing your business's finances can provide the relief you need to move forward with business operations. However, the decision to file for bankruptcy can negatively impact your business. Some of the drawbacks of filing for Chapter 11 bankruptcy for your franchise include:
Loss of Privacy from Your Franchise
A franchise seeking to reorganize its finances can do so by filing Chapter 11 bankruptcy. This involves filing numerous documents with the court indicating substantial information about your business. These documents are treated as public records and could be assessed by anyone who reviews the bankruptcy court files, causing your business to lose its privacy.
Financial Reporting Requirement
When you file a bankruptcy petition, you must disclose all your financial issues to the court. The nature of your disclosure will depend on your franchise. For example, if your franchise's primary asset is real estate, you must disclose all the rental information.
Profitability Requirements
When you file for Chapter 11 reorganization bankruptcy, you should be able to continue running your business and make enough money to facilitate the repayment plan. Therefore, before you can file for bankruptcy for your franchise, you must prove that your business is profitable, or the reorganization plan will bring it back to profitability.
Loss of Control Over Business Operations
When you file for Chapter 11 franchise bankruptcy, you can continue with the essential activities needed to run your business. However, for some complex actions, you will need approval from the court. This could be time-consuming and tedious, especially when these activities are urgent to ensure your business continues successfully.
The Cost of Chapter 11 Bankruptcy
Filing for Chapter 11 bankruptcy for your franchise can be a complex and costly venture. In most cases, filing for this reorganization bankruptcy is a once-in-a-lifetime chance. Therefore, you must be careful when planning and executing the legal process to ensure your business does not return to a similar position.
Alternatives to Franchise Bankruptcy
A franchise will consider bankruptcy when it is in overwhelming debt and cannot repay it. By filing for Chapter 11 bankruptcy, you can create repayment plans for your debts and reorganize your business's finances. However, filing for bankruptcy comes with many setbacks, like loss of privacy for your business, restrictions on debtor compensation, and loss of shareholder control.
Therefore, there are other non-bankruptcy options you could explore before you opt for bankruptcy, and they include:
Voluntary Sale of Assets
Although Chapter 11 bankruptcy is an alternative for franchises in financial distress, it should not be considered the only option. Instead, you can voluntarily sell some business assets. This means that you will not be involving the court in the proceedings. Selling business assets in a financial crisis could be complicated due to the liens and liabilities you need to work on for a successful sale.
However, the process will be easier if all parties involved in the franchise can agree on restructuring the business finances out of bankruptcy. The voluntary sale of assets allows you to control the amount you can fetch for particular properties. You can decide what to sell and what is worth keeping for the smooth running of the franchise.
Internal Restructuring
When a franchise is struggling financially, filing for franchise bankruptcy becomes an option. Instead of declaring bankruptcy, you can restructure the business internally to alleviate the financial distress. This could be done by cutting down unnecessary expenses, consolidating different departments, and suspending some operations. Additionally, you can find new ways to increase sales, like developing and investing in new marketing strategies.
Debt Restructuring
Bankruptcy can cause losses for creditors. For this reason, most creditors are always open to debt restructuring for distressed companies. These informal workouts for the debt can benefit both parties, eliminating the hassle of bankruptcy.
Debt restructuring to avoid franchise bankruptcy could involve measures such as extending the payment duration of debts, reducing interest rates on loans, and negotiating discounts for the debts.
Find a Reliable Bankruptcy Attorney Near Me
Companies and businesses facing financial struggles can file for bankruptcy to avoid further financial distress. Depending on the financial circumstances and the expected outcome, a franchise can file a Chapter 7 or 11 bankruptcy. Chapter 11, or reorganization bankruptcy, allows you to restructure your business and make repayment plans for your company's debts.
This allows you to continue running the business and gain income to pay the debts. When filing for Chapter 11 bankruptcy for a franchise, you must deal with your financial situation and the contractual obligations under the franchise agreement, which can complicate the bankruptcy process.
If you are considering Chapter 11 bankruptcy for your franchise, you should hire a competent attorney. This allows you to receive expert guidance on matters ranging from breach of franchise contracts to unlawful trade practices and other franchise transactions.
At the San Diego Bankruptcy Attorney, we deeply understand the relationship between Chapter 11 bankruptcy and franchises. Our skilled attorneys can help you understand your rights and navigate your options regarding franchise bankruptcy in San Diego, CA. Call us at 619-488-6168 to discuss your bankruptcy case.
