Franchising/Termination of Franchise
Thanks for taking my question and for your kind advice!
We are a franchisee registered as LLC in Virginia. My wife and I invested our retirement savings to buy the internet marketing franchise by paying $50,000 to the Franchisor, registered in the state of Delaware. Franchise agreement was signed in October 2009 valid for 10 year period. We pay a monthly franchise management fee of $400.
Our revenue since October 2009 has totaled less than $2500. Due to my poor health condition, I am unable to run the franchise and want to disengage. The Franchise agreement provides for termination of the Franchise by franchisee on grounds of noncompliance of the agreement by Franchisor. It does not provide any other ground for termination.
It also states that the franchisor "may" end the franchise contract if the franchisee defaults payment of franchise fees over three months.
If I stop making the monthly payment any further, I would like to know what are the liabilities for us, the owners of the franchise running as an LLC under such a circumstance?
We do not owe any money to anyone. We have withdrawn funds from our company account that we had deposited in capital account when we started the business. Our IRS 1120 tax return for October 09 - September 2010 shows a loss of $20,332.
If we are legally liable for monthly management fees for the rest of the agreement period, do we have to declare bankruptcy under chapter 7 in order to avoid paying management fees further? Are there any other options for us?
You have asked several questions, and all are, sadly, impossible to answer without reviewing the documents that you signed back in 2009. Questions of oneís rights under complex contracts are rarely simple to answer. However, I can offer you the following general information about such situations in the franchise industry. This will give you an idea of some of the possible outcomes.
1. Sometimes franchise agreements require ongoing minimum royalties or fees from the franchisee even if the franchisee stops doing business. More frequently, though, franchise agreements do not have liquidated damages or minimum royalty clauses that would require the franchisee to continue paying after shutting the business down. This means that, frequently, franchisees are able to just shut the business down and walk away. In order to know the situation you face, I would have to review your franchise agreement.
2. Even if the franchise agreement does not specifically provide for a termination of the agreement in the event of the failure of your business, you may be able to work out a termination and settlement agreement with the franchisor. And this may be possible even if the contract calls for ongoing royalties or liquidated damages.
3. Sometimes a unilateral termination of a franchise agreement by the franchisee can result in a claim for actual damages brought by the franchisor. The franchisorís argument is that it invested in infrastructure in anticipation of ongoing revenues from the franchiseeís operation and the unilateral termination caused that investment to go to waste. Other times, franchisors do not attempt to make such claims and simply let franchisees walk away when their business fails. Until I see the documents and learn a little bit about the history of the franchisorís dealings with other terminated dealers, I really canít predict what will happen in your situation.
4. You asked about bankruptcy in order to avoid paying ongoing management fees. That would be an extreme step to take. It is very frequently avoided by making some sort of compromise agreement with the franchisor as noted above. If bankruptcy does become an option, the payments under the franchise agreement are probably dischargeable.
I don't know if you can afford professional assistance at this stage, but I recommend it. My experience is that a little help from someone familiar with the franchise industry makes the negotiations go better.
Our firm is dedicated to the needs of clients involved in franchise industry transactions. We frequently represent franchisees that have run into difficulties and need assistance negotiating with their franchisors.
I would be very happy to help you better understand your agreements and try to negotiate a resolution of this difficult situation with the franchisor. You can contact me as shown below.
Scott C. Kern
Kern & Hillman, LLC
2911 Dixwell Avenue Suite 203
Hamden, CT 06518
Tel: (203# 782-9076
Fax: #203) 782-9081