Franchise agreements that are in existence at the bankruptcy filing date are property of the franchisee-debtors’ bankruptcy estates under Section of the Bankruptcy Code. Applicable federal or state substantive law determines the extent and nature of the parties’ property rights in the franchise agreement, as long as such law is not. franchise, whereby a license is granted by the franchisor to a franchisee to operate a franchise business at or from a single location. Some sort of geographic protection against competition from the franchisor and other Franchise Agreements and the Bankruptcy EstateFile Size: 1MB. Many potential business owners are confused between the concepts of a franchise and license (a.k.a. business opportunity). A key difference lies in the area of law by which each business type is governed. This legal difference forms the basis for what information needs to be included in each type of agreement.
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Under Section g 1 of the Bankruptcy Code, if the contract was not previously assumed in the bankruptcy case, this claim is deemed to have arisen as of the filing date. Accordingly, the claim receives the same treatment in a reorganization plan as other unsecured claims. The amount of the damages is determined by using a breach-of-contract analysis under state law; however, the Bankruptcy Code sets a statutory limit on the size of rejected executory contract claims to avoid dilution of all unsecured claims by one large claimant.
Section of the Bankruptcy Code does not set forth the standards the court should follow in determining whether to allow rejection of executory contracts. For example, in Jr. Food Mart v. Attebury In re Jr. Food Mart , B. The Jr. Food Mart court found that under either test, the debtor had met its burden of proving that the general unsecured creditors would be benefited by rejection of the employment contract, especially by the dollar savings in salary reduction and the elimination of administrative expense priority payments, which would have to be paid in full under the Bankruptcy Code if the contract were rejected.
Courts sometimes refuse to allow rejection. In In re Noco , 76 B. The franchisee-debtor had transferred the bulk of its assets to a new corporation on the eve of filing, and had no unsecured creditors. Based on these facts, the court did not allow the franchisee-debtor to reject the franchise agreements and dismissed the bankruptcy petition on bad faith grounds. Other cases in which courts would not allow rejection are In re Matusalem , B. For a survey of covenants not to compete in rejected franchise agreements, see Covenants Against Competition in Franchise Agreements, Second Edition Klarfel ed.
Generally, a Chapter 11 debtor is permitted to use virtually all assets during a bankruptcy, even though they may be pledged to a secured creditor. If collateral is converted to cash in the hands of the franchisee-debtor, such cash collateral cannot be used by the franchisee-debtor unless the franchisee-debtor comes forward and establishes that this can be done without prejudice to the secured creditors.
A franchisor should use the cash collateral hearing to try to persuade the court to mandate payments by the franchisee due under the franchise agreement. This suggestion should be couched in the stipulation that ongoing royalties are to be paid as adequate protection of the trademark rights.
Such a stipulation will allow the franchisor to get paid before the assumption or rejection of the agreement. If the franchisee-debtor will not agree to a stipulation to pay royalties, the franchisor can try to force the franchisee-debtor to assume the franchise rights quickly and protect post-assumption royalties as administrative claims. Often the rights of franchisors and lenders may appear to overlap.
These issues can lead to creditors fighting for a limited set of assets based on different rights. Moreover, a debtor may assert that either or both parties failed to perfect such interests or that such claims only give rise to pre-petition claims for which no specific performance is appropriate. Further, in some instances bankruptcy courts will not exercise jurisdiction over issues viewed as purely intercreditor litigation. Specific thought should be given to how goodwill, intellectual property rights, real property rights, books and records and customer information will be treated.
The foregoing has been prepared for the general information of clients and friends of the firm. It is not meant to provide legal advice with respect to any specific matter and should not be acted upon without professional counsel.
If you have any questions or require any further information regarding these or other related matters, please contact your regular Nixon Peabody LLP representative. This material may be considered advertising under certain rules of professional conduct. Home Ideas Thought Leadership. Bankruptcy basics in franchising. A typical Chapter 11 franchise bankruptcy case would follow the timeline set forth below.
Time Event Petition Date Case filed. Days 22—30 Final cash collateral and financing hearing. Days — Deadline for debtor to move to assume or reject leases of nonresidential real property; may only be extended with landlord consent.
Six months Plan and Disclosure Statement filed. In addition to the debtor the bankrupt company , the players involved in the typical Chapter 11 franchise bankruptcy case include: creditors, which include landlords, suppliers and franchisors with claims; a Creditors Committee comprised of three to seven creditors who are selected by an arm of the U.
Department of Justice called the U. Trustee Program the committee retains counsel and often a financial advisor paid for by debtor ; pre-petition lenders, including secured and unsecured, both before and after bankruptcy is filed; a DIP lender—may provide Debtor-in-Possession Financing; tax authorities and employees with priority wage claims; and a United States-appointed trustee government representative overseeing the process.
Applicable law will decide whether the cure period is: the express contractual period, any state law statutory cure period, within 60 days after the filing of bankruptcy or in a Chapter 11 case, up until confirmation of a plan of reorganization.
Franchisors may obtain relief from the automatic stay to terminate or enforce a franchise agreement Bankruptcy courts are generally reluctant to lift the automatic stay, especially in the early stages of a bankruptcy case, and will often strictly hold the franchisor to the heavy burden of showing that the requirements for lifting the stay pursuant to Section d of the Bankruptcy Code have been met.
The stay may not be lifted if defaults have been or can be cured and the franchisor is adequately protected A court will generally not lift the automatic stay to permit the termination of a franchise agreement if the franchisee-debtor demonstrates that defaults have been or can be cured and the franchisor is adequately protected.
Strategic reasons exist to move for relief even where odds of success are slim As discussed above, franchisors will rarely succeed in efforts to have an automatic stay lifted early in a case. Assumption of a contract under which debtor is not in default Court approval is required for a franchisee-debtor to assume an executory contract such as a franchise agreement or an unexpired lease.
Assumption of a defaulted contract Section b 1 of the Bankruptcy Code contains the requirements for assumption of a contract under which a debtor is in default. Under Section b 1 of the Bankruptcy Code, a debtor who has defaulted under an executory contract may assume the contract only if the debtor cures, or provides adequate assurance that the trustee will promptly cure, such defaults; compensates, or provides adequate assurance that it will promptly compensate, a party other than the debtor to such contract or lease, for any actual pecuniary loss to such party resulting from such default; and provides adequate assurance of future performance under such contract or lease.
Cure of noneconomic defaults under executory contracts Before enactment of the Amendment to the Bankruptcy Code, it was unclear whether a bankrupt company could assume an executory contract for example, a lease if there had been a pre-bankruptcy nonmonetary default. Adequate assurance of future performance Section of the Bankruptcy Code states that the franchisee-debtor must also provide adequate assurance of future performance to assume an executory contract.
Assignment of executory contracts in a franchise setting An executory contract, such as a franchise agreement, cannot simply be sold to a third party in a bankruptcy case. Lender issues in bankruptcy Use of cash collateral Generally, a Chapter 11 debtor is permitted to use virtually all assets during a bankruptcy, even though they may be pledged to a secured creditor. Intercreditor issues Often the rights of franchisors and lenders may appear to overlap.
We would also thank Craig Tractenberg for his prior contributions to this article. Whiting Pools , U. The bankruptcy court has exclusive jurisdiction over property of the estate, wherever it is located. United States , U. Nevertheless, an affirmative, active pre-petition termination of a franchise agreement on the basis of insolvency may be upheld by a court. See , e. Computerland Corp. Amoco Oil Co. See, e. Gainesville P-H Props. In re Gainesville P-H Props. Neiberg In re Neiberg , B.
In re Karfakis , B. In re Thompson , B. Ga ; In re Egyptian Bros. Donuts, Inc. Tampa Checkmate Food Servs. Many potential business owners are confused between the concepts of a franchise and license a. A key difference lies in the area of law by which each business type is governed. This legal difference forms the basis for what information needs to be included in each type of agreement.
Franchising is based on securities law while licensing falls under the purview of contract law. A license agreement is simply a business contract between two parties. A franchise agreement is a usually lengthy document and covers such area as the cost of the franchise, royalty payments, rights and obligations of franchisor and franchisee, territory rights, training and support, as well as disclosure of financial documents.
A license agreement is typically of shorter length and grants the licensee the right to use, market and sell the product of service of the licensor without penalty. In the event either of assumption or ultimate rejection, understanding and enforcing the duties and obligations of the debtor at the outset of the case can help not only in gaining compensation in the short term but also in speeding a determination of whether there will be a the future in the franchise with the debtor.
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