The principal issue in any bankruptcy case involving franchise issues will be the effect of the filing on the franchise agreement. As with most contracts, the party filing bankruptcy – the debtor – has two options. The debtor may assume the franchise agreement, obligating the debtor to pay all past due amounts and to continue performing for the agreement’s remaining term. Alternatively, the debtor may reject the franchise agreement, allowing the debtor to walk away from its obligations under the agreement and generally leaving the non-debtor party with only an unsecured claim in the bankruptcy case, often payable at pennies on the dollar.
Tha nature of a franchise agreement adds an extra layer of complication to the assumption/rejection framework. By definition, a franchise agreement involves a trademark license. The effect of rejecting a contract that includes a trademark license will depend on whether the debtor is the licensee (i.e., the franchisee) or the licensor (i.e., the franchisor). A franchisee’s rejection of a trademark license follows the normal contract rules: the franchisee loses all rights under the agreement – including the right to use the trademark – and the franchisor files a claim in the bankruptcy case for damages resulting from the rejection.
If the franchisor is the debtor, rejection of the trademark license may not follow this well-worn path. The Bankruptcy Code provides protection to licensees of “intellectual property” when the licensor files bankruptcy and attempts to reject the license. The policy reasoning is that – since the licensee’s business very often centers on the license – permitting a rejection under the normal framework would immediately drive the franchisee out of business.