Recession-Resistant Franchising: A Legal Roadmap for Multi-Unit Operators
As a franchise attorney with years of experience in the franchise restaurant space, I’ve observed a troubling trend emerging in the last 18 months: a significant uptick in bankruptcy filings among multi-unit franchisees. Leveraging brand recognition can help mitigate some of the financial risks, but this wave of financial distress spans across various well-known brands and highlights the complex challenges facing franchise operators in today’s economic climate.
Recent Notable Bankruptcies
Burger King: A Royal Struggle
Burger King has been hit particularly hard, with at least 377 franchised units impacted by Chapter 11 filings in 2023 alone. Notable cases include:
1. Toms King (January 2023): This large Burger King operator’s bankruptcy set a somber tone for the year.
2. Meridian Restaurants Unlimited (Later in 2023): This operator faced difficulties after acquiring underperforming stores in hopes of turning them around.
3. Premier Kings (November 2023): Operating 172 units, this franchisee cited high inflation, increased borrowing rates, and the untimely death of its owner as contributing factors.
Other Major QSR Brands Affected
The financial turbulence wasn’t limited to Burger King:
– Wendy’s: Starboard Group, a 72-unit operator, filed for Chapter 11 in November 2023.
– Hardee’s: Summit Restaurants, operating 145 Hardee’s locations, sought bankruptcy protection in spring 2023.
– Popeyes: Premier Cajun Kings, a 19-unit franchisee, filed in March 2023 following the death of its owner.
– McDonald’s: A franchisee filed for bankruptcy in March 2023, citing litigation expenses.
– Denny’s: Denn-Ohio, a 10-store franchisee, went bankrupt in fall 2023.
– Pizza Hut: EYM Pizza, operating about 140 units, filed for Chapter 11 in 2023.
– Subway: River Sub, a 48-unit operator, declared bankruptcy in June 2023.
– Arby’s: Miracle Restaurant Group, with 25 units, filed for Chapter 11 in June 2023.
Common Threads in Franchisee Bankruptcies
I’ve noticed several recurring themes in these bankruptcy filings:
Inflationary Pressures: Rising costs across the board, from ingredients to labor, have squeezed profit margins. While the speed of inflation seems to have slowed, there is no indication that prices will fall anytime soon.
Understanding and navigating franchise opportunities can help mitigate some of these common issues.
Declining Customer Traffic: Many operators report lower customer counts, potentially due to economic uncertainties and changed consumer behaviors post-pandemic. Customers have changed their habits and preferences post-pandemic combined with increasing financial strain for US consumers have made many restaurant chains a luxury today.
Labor Challenges: Increased labor costs and difficulties in staffing have strained operations. Labor costs have risen significantly across the country. In many areas today finding qualified workers is an even larger challenge than operations.
Debt Burdens: Many franchisees took on significant debt for remodels or expansions, which became unsustainable in the face of reduced revenues. The pressure of EIDL and other pandemic financing is also weighing down many franchisees still.
Pandemic Aftershocks: While the acute phase of the COVID-19 pandemic has passed, its long-term effects on consumer behavior and the economy continue to impact franchisees.
Brand-Specific Issues: Some franchisees, like those of Burger King and Subway, cited challenges related to brand positioning and marketing effectiveness. Subway continues to be hobbled by its legacy marketing for the famous (or infamous) $5 footlong. Customers are now balking at the higher inflation pricing for Subway sandwiches.
Operational Complexities: Managing large, geographically dispersed networks of stores has proven challenging for some multi-unit operators. Managing people and units across multiple states does not scale in a linear manner, certain costs will jump significantly with each unit.
From a legal standpoint, these bankruptcies raise several important considerations:
Franchise Agreement Obligations: Bankrupt franchisees must navigate complex legal territory regarding their ongoing obligations under franchise agreements. These bankruptcy filings will typically result in the immediate termination of franchise rights, calling into question whether continued operations will be permitted after any filing.
Asset Protection and Liquidation: The bankruptcy process often involves careful negotiation to protect assets and manage the orderly liquidation or transfer of franchise units. Franchisors will have a major influence and legal rights on how the assets and franchise rights may be handled in a bankruptcy, including the potential to terminate franchise agreements or exercise right of first refusal on store sales.
Creditor Claims: Managing the claims of various creditors, from banks to suppliers to the franchisor itself, requires careful legal navigation. Any payments to creditors of the business in the months preceding the bankruptcy filing may be clawed back by the bankruptcy court and distributed evenly to other creditors.
These bankruptcies serve as a stark reminder of the financial vulnerabilities in the franchise model, particularly for multi-unit operators. However, there are strategies that franchisees can employ to mitigate risks and avoid similar financial distress.
Risk Mitigation Strategies for Multi Unit Franchisees
Proactive risk management can make the difference between a thriving multi-unit operation and one teetering on the edge of bankruptcy and ultimately the outcome of any bankruptcy proceeding. Evaluating each franchise opportunity carefully is crucial to developing effective risk mitigation strategies. Here are some key strategies that multi-unit franchisees should consider to mitigate risks, especially during economic downturns:
1. Structuring Multi-Unit Holdings to Minimize Overlapping Liabilities
One of the most crucial steps a multi-unit franchisee can take is to structure their holdings in a way that isolates liabilities. This typically involves:
– Creating Separate Legal Entities: Establish each unit or small group of units as a separate LLC or corporation. This can help contain liabilities within each entity, preventing a problem in one location from threatening the entire operation.
– Maintaining Corporate Formalities: Ensure each entity maintains its own books, records, and bank accounts. This separation is crucial for the liability protection to hold up in court.
– Strategic Use of Holding Companies: Consider creating a holding company structure to further separate valuable assets from operational risks.
As an attorney, I cannot stress enough the importance of consulting with legal and tax professionals to create a structure that balances liability protection with operational efficiency and tax considerations.
2. Tightening Employment Policies and Oversight
Employment-related issues can be a significant source of liability for franchisees. To minimize these risks:
– Develop Robust HR Policies: Implement comprehensive policies covering all aspects of employment, from hiring to termination.
– Regular Training: Conduct regular training sessions for managers and employees on crucial topics like sexual harassment prevention, workplace safety, and anti-discrimination practices.
– Compliance Audits: Regularly audit your practices to ensure compliance with labor laws, including wage and hour regulations.
– Documentation: Maintain thorough documentation of all employment decisions and incidents.
– Insurance Coverage: Ensure you have adequate employment practices liability insurance (EPLI) coverage.
Remember, an ounce of prevention in employment practices can prevent pounds of legal troubles down the road.
3. Vigilant Financial Oversight
In my experience, franchisees who maintain a tight grip on their financials are best positioned to weather economic storms. This involves:
– Frequent Financial Reviews: Collect and review financial data monthly, or at the very least, quarterly. This should include not just top-line revenue, but detailed breakdowns of costs and margins.
– Benchmark Against Industry Standards: Regularly compare your financial metrics against industry benchmarks to spot potential issues early.
– Cash Flow Projections: Maintain rolling cash flow projections to anticipate and prepare for potential cash crunches.
– Vendor Contract Reviews: Regularly review and renegotiate vendor contracts to ensure you’re getting the best terms possible.
4. Swift Action on Underperforming Units
One of the hardest decisions for a multi-unit franchisee is when to close an underperforming location. However, hesitation can often lead to greater financial strain. Consider:
– Establishing Clear Performance Metrics: Set clear, objective criteria for what constitutes an underperforming unit.
– Regular Performance Reviews: Conduct thorough reviews of each unit’s performance on a consistent schedule.
– Turnaround Plans: For underperforming units, develop specific, time-bound turnaround plans with clear milestones.
– Quick Decision-Making: If turnaround efforts aren’t successful, be prepared to make the tough decision to close the unit quickly.
– Negotiating with Franchisors and Landlords: Work closely with your franchisor and landlords when considering unit closures. Sometimes, temporary relief or assistance can be negotiated to help weather difficult periods.
5. Diversification and Adaptation
– Brand Diversification: Consider operating units across multiple brands or industries. This can help insulate your business from brand-specific challenges.
– Embrace Technology and Innovation: Stay ahead of industry trends by investing in technology that can improve efficiency and customer experience, such as mobile ordering systems or data analytics tools.
6. Building Strong Relationships
Lastly, never underestimate the value of strong relationships in the franchise world:
– Franchisor Relations: Maintain open lines of communication with your franchisor. A good relationship can lead to more support during tough times.
– Franchisee Networks: Engage actively with other franchisees. These networks can provide valuable insights, shared resources, and collective bargaining power.
– Legal and Financial Advisors: Cultivate relationships with experienced franchise attorneys and financial advisors who understand your business and industry.
By implementing these strategies, multi-unit franchisees can build more resilient operations capable of withstanding economic pressures and avoiding the path to bankruptcy. Remember, the key is to be proactive rather than reactive. As a franchise attorney, I’ve seen too many cases where franchisees sought help only when it was too late. Don’t let your multi-unit operation become another bankruptcy statistic – take action now to protect your investment and secure your future in the franchise world.
