FRANCHISE LAW
When Franchises Fail: Your Rights as a Franchisee
When a franchisor files for bankruptcy, franchisees often assume the worst — that their agreement is void and their investment is gone. The law is more protective than that. A franchise agreement is generally treated as an executory contract under Section 365 of the Bankruptcy Code, which the franchisor (as debtor) can choose to assume or reject — and even rejection doesn’t simply erase a franchisee’s rights. This guide explains what actually happens to franchisees when a franchisor goes bankrupt, the key trademark-rights ruling every franchisee should know, and the options available.
The Franchise Agreement as an Executory Contract
In bankruptcy, contracts where both sides still owe meaningful performance are “executory,” and Section 365 lets the debtor decide their fate:
- Assume — the franchisor keeps the agreement, which usually requires curing defaults and continuing to perform. For a franchisee, assumption generally means business continues much as before.
- Reject — the franchisor declines to keep performing. Rejection is treated as a breach of the contract, giving the franchisee a damages claim (typically as an unsecured creditor) — but, crucially, it is not a rescission that wipes out the franchisee’s rights.
- Assume and assign — the franchisor transfers the agreement to a buyer, often as part of selling the franchise system.
The Trademark Rights That Survive: Mission Product v. Tempnology
The most important development for franchisees came from the U.S. Supreme Court’s 2019 decision in Mission Product Holdings v. Tempnology. The Court held that a debtor’s rejection of a trademark license operates as a breach, not a rescission — meaning the licensee does not lose its right to keep using the trademark. Because the right to use the franchisor’s marks is central to any franchise, this ruling matters enormously: if your franchisor rejects your agreement in bankruptcy, you generally retain the ability to continue using the brand under the license terms, while also holding a claim for damages. It transformed a once-uncertain question into real protection for franchisees.
What Franchisees Can Actually Do
Beyond your statutory rights, you have practical options when a franchisor is failing:
| Option | What it involves |
|---|---|
| Continue operating | Keep running your unit; understand your rights if the agreement is assumed, rejected, or assigned |
| File a claim | Submit a proof of claim for damages caused by rejection or franchisor breaches |
| Organize | Join or form a franchisee association or cooperative for collective leverage |
| Acquire the brand | Franchisees have, collectively, bought systems out of bankruptcy (as Ground Round’s did) |
| Negotiate | Work with the buyer of an assigned system on go-forward terms |
The franchisees who fare best are usually those who understand their position early and act — individually and collectively — rather than waiting to see what the bankruptcy does to them.
Diligence: Spotting the Risk Before You Buy
The best protection is bought before you sign. A franchisor’s financial health is disclosed in FDD Item 21 (audited financial statements), and signs of strain there are a real warning. Pair that with Item 20 (closures and turnover) and the broader structural risks that sink franchise systems. You can’t eliminate the risk of a franchisor failing, but you can avoid the systems that telegraph it — and know your rights if it happens anyway.
Frequently Asked Questions
What happens to a franchise agreement when the franchisor goes bankrupt?
It’s generally treated as an executory contract under Section 365 of the Bankruptcy Code, which the franchisor can assume (keep, usually curing defaults), reject (decline to keep performing, treated as a breach), or assume and assign to a buyer. Rejection gives the franchisee a damages claim but does not rescind its rights.
Can I keep using the brand if my franchisor rejects my agreement in bankruptcy?
Generally yes. Under the Supreme Court’s Mission Product Holdings v. Tempnology decision, rejecting a trademark license is a breach rather than a rescission, so the licensee retains the right to keep using the trademark under the license terms — important protection given that brand use is central to franchising.
Do franchisees lose their money when a franchisor fails?
Not necessarily. Franchisees usually retain the right to operate and to use the brand, can file claims for damages, and can organize collectively. Some franchisee groups have even bought failed systems out of bankruptcy. Outcomes depend on the facts, but franchisees have more options than commonly assumed.
How can I protect myself from a franchisor bankruptcy?
Before buying, scrutinize the franchisor’s financial statements (FDD Item 21) and outlet/closure data (Item 20) for signs of strain. After buying, understand your bankruptcy rights, keep your own records, and consider organizing with other franchisees so you can act collectively if the franchisor falters.
A franchisor’s bankruptcy is a serious event, but it is not the end of your rights as a franchisee. Reidel Law Firm advises franchisees on franchisor distress, bankruptcy, and their options on flat-fee terms. Talk to a franchise attorney.
