FRANCHISE LAW
Bankruptcy and Your Franchise: A Legal Guide
In a franchise bankruptcy, the franchise agreement is usually treated as an “executory contract” that the bankruptcy estate can choose to keep or walk away from, and the automatic stay temporarily freezes the franchisor’s ability to terminate or collect. Whether you reorganize or liquidate, the agreement — and your personal guaranty — drive the outcome more than the bankruptcy chapter you file.
Watch — What’s With All the Franchise Bankruptcies:
The Three Chapters That Apply
The chapter you file determines whether the goal is to liquidate or to reorganize.
| Chapter | What it does | Typical use |
|---|---|---|
| Chapter 7 | Liquidation — assets sold, most debts discharged | A franchisee winding the business down |
| Chapter 11 | Reorganization — restructure debt and keep operating | A franchise with a viable path forward |
| Chapter 13 | Reorganization for an individual with regular income | A sole-proprietor franchisee |
Chapter 11 also has a streamlined track, Subchapter V, designed to make small-business reorganization faster and cheaper. Eligibility depends on a debt ceiling that is adjusted periodically and has been the subject of pending federal legislation, so confirm the current limit before assuming you qualify rather than relying on a figure that may have changed.
The Automatic Stay Buys Time
The moment a bankruptcy petition is filed, the automatic stay under Section 362 of the Bankruptcy Code stops most collection and enforcement activity. For a struggling franchisee, that means the franchisor generally cannot terminate the agreement, sue, or pursue collection while the stay is in place. The stay is a pause, not a cancellation — it gives the debtor breathing room to decide whether to reorganize or liquidate, but the franchisor can ask the court to lift it, and it does not erase the underlying obligations.
The Franchise Agreement as an Executory Contract
The central bankruptcy question for any franchise is how the franchise agreement is treated, and the usual answer is that it is an executory contract under Section 365 — a contract where both sides still owe meaningful performance. That status gives the bankruptcy estate a choice:
- Assume the agreement — cure defaults (including back royalties) and continue performing, which is the route a reorganizing franchisee takes to keep operating.
- Reject the agreement — stop performing, treating the rejection as a breach that gives the franchisor a damages claim.
- Assume and assign — cure, then transfer the agreement to a buyer, often subject to the franchisor’s contractual approval rights.
This treatment also blunts a clause franchisors rely on. Many agreements say that filing for bankruptcy is itself an event of default allowing immediate termination. These “ipso facto” clauses are generally unenforceable in bankruptcy under Section 365(e) — a franchisor usually cannot terminate solely because you filed. Defaults that exist independently of the filing, like unpaid royalties, still matter; see default and cure provisions and the cross-default clause.
The Trademark License Survives Rejection
A franchise depends on the right to use the franchisor’s trademarks, which raises a question the Supreme Court settled in Mission Product Holdings, Inc. v. Tempnology, LLC (2019). The Court held that when a debtor rejects a trademark license, the rejection is a breach — not a rescission — so the licensee can keep using the marks for the remainder of the license term. In plain terms, a franchisor’s rejection of the agreement in its own bankruptcy does not automatically strip the franchisee of its trademark rights. The decision is most relevant when the franchisor is the one in bankruptcy, and it gives franchisees more protection than was previously assumed.
Personal Guaranties Often Outlast the Business
The hardest truth in a franchise bankruptcy is that the business filing may not protect you personally. Most franchisors require the franchisee’s owner to sign a personal guaranty of the franchise obligations, and a guaranty is a separate promise. If only the business entity files, the guaranty can leave the owner on the hook for amounts the business cannot pay. This is why so many franchise bankruptcies become personal financial events, and why the guaranty has to be part of any honest assessment of your options. Our analysis of when franchises fail looks at how these cases actually unfold.
Reorganize, Sell, or Exit
For a franchisee facing insolvency, the realistic paths are to reorganize and keep operating (assume the agreement and cure defaults), sell the unit as a going concern to an approved buyer, or wind down and exit. Bankruptcy is one tool among several, and it is not always the best one — a negotiated exit or sale outside of court can sometimes preserve more value and avoid the cost and credit damage of a filing. The right move depends on the agreement, the guaranty, and whether the unit has a viable future. Our guide to exiting a franchise agreement covers the non-bankruptcy options.
Frequently Asked Questions
Can a franchisor terminate my franchise just because I filed bankruptcy?
Usually not on that basis alone. Clauses that make bankruptcy an automatic ground for termination (“ipso facto” clauses) are generally unenforceable under Section 365(e), and the automatic stay stops most termination efforts. Independent defaults, like unpaid royalties, can still support termination.
What does it mean that the franchise agreement is an “executory contract”?
It means both sides still owe significant performance, so the bankruptcy estate can choose to assume the agreement (cure defaults and continue), reject it (a breach giving the franchisor a damages claim), or assume and assign it to a buyer. That choice shapes the whole case.
Does bankruptcy wipe out my personal guaranty?
Not by itself. A personal guaranty is a separate obligation. If only the business files, the owner who signed a guaranty can remain personally liable. Discharging that liability usually requires the individual to address it in their own bankruptcy.
Will I lose the right to use the brand’s trademarks?
Not automatically. Under Mission Product Holdings v. Tempnology (2019), a debtor’s rejection of a trademark license is treated as a breach, and the licensee can keep using the marks for the rest of the license term. This most often protects franchisees when the franchisor files.
Bankruptcy in a franchise is rarely just about the business — the executory-contract rules, the automatic stay, and your personal guaranty all interact, and the right strategy depends on the specifics. Reidel Law Firm counsels distressed and exiting franchisees on a flat fee with direct attorney access — get flat-fee franchise exit counsel before you make an irreversible move.
