model, under which the company
does not own or operate any stores;
a company-owned model, under
which the operator owns and manages
all locations; or a combination of
company-owned stores and franchisees.
Any debtor that maintains a franchisee
system must effectively address certain
challenges inherent to this model in
conjunction with a Chapter 11 filing.
concept must ensure that its franchisees
maintain their focus on operations
to maximize cash-flow royalty
payments to the franchisor. Adequately
communicating a viable plan to exit
Chapter 11 with each franchisee will aid
a franchisor in maintaining stable cash
flows among the desirable franchised
locations a debtor will choose to assume
in conjunction with a transaction.
Exacerbating current capital markets
challenges, the stigma and uncertainty
of a Chapter 11 filing may impede
interest from potential franchisees and
negatively impact lenders’ willingness
to fund a new franchisee’s location.
As such, a concept’s valuation may
be damaged if an operator’s financial
distress has eliminated its pipeline
of prospective franchisees.
A financially distressed restaurant
operator often carries underperforming
franchisees within its system. As such,
debtors must thoroughly evaluate a
franchisee base to determine whether
each distressed franchisee may be
rehabilitated or rejected as an executory
contract. If a franchise agreement is
rejected, franchisors in certain cases
may need to take legal action to prevent
unauthorized use of their intellectual
property by former franchisees, who,
as sole proprietorships, have incentive
to continue operating a location,
even without the rights and services
provided under a franchise agreement.
In certain cases, a debtor may also
have material claims against some
franchisees related to past-due royalty
payments. However, realizing full value
for these delinquent receivables in
conjunction with a transaction poses
a challenge for debtors because new
investor parties may be unwilling to
pursue aged claims themselves or to
allow the estate to pursue collections
from the investors’ new franchisee
base following a transaction.
In the face of the potential uncertainty
associated with a franchisor’s bankruptcy
proceeding, a franchised restaurant
For a restaurant operator relying on
a franchised unit model, a growing
location base is a key driver of value.
However, many distressed operators
have been challenged to maintain their
pipeline of future franchisees because
of difficulties in obtaining financing.
Distressed operators may also benefit
from pursuing the conversion of
stores to franchised locations. In many
cases, a franchised location receiving
requisite attention from a highly
motivated owner may outperform
a company-owned store. As such,
some operators have benefitted from
turning over unprofitable company-owned restaurant locations (that
would be rejected in a bankruptcy
proceeding) to entrepreneurial
franchisees, eliminating cash losses
associated with failing restaurants and
replacing them with future royalty
streams from new franchisees.
continued on page 16
the one item
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