• Howard Kline

WHAT HAPPENS WHEN A FRANCHISOR FILES FOR BANKRUPTCY?

Updated: Oct 16


Beth Azor, a respected and well known commercial leasing expert and trainer, known as the “Canvassing Queen” recently posted on LinkedIn a post about Gold’s Gym bankruptcy filing. As part of her post, Beth poses the question: “What Happens When a Franchisor files for Bankruptcy?”. The following is my partial answer and analysis.

GENERAL BANKRUPTCY OVERVIEW

While I do not consider myself a bankruptcy expert, I do have some bankruptcy experience over the last 4 decades, having represented landlords and tenants. Unfortunately, I also have experience as General Counsel for a national firm that was in Chapter 11 bankruptcy.

CHAPTER 11 REORGANIZATION

A Chapter 11 bankruptcy is for the purpose of reorganizing the debtor’s (in this case, Gold’s Gym), business with the general expectation that the business will emerge from bankruptcy as a, more, streamlined and profitable business. The hope is that the business, its owners and creditors will generally benefit from this reorganization rather than a liquidation which would occur in a Chapter 7 bankruptcy.

In a Chapter 11 bankruptcy, the debtor usually cuts out weaker performing assets. On May 4, 2020, Gold’s Gym announced that it was filing for protection under Chapter 11 of the United States Bankruptcy Code. As part of the announcement, they indicated that they were planning on closing, at least 30 of their corporately owned gyms. It is common in a retail bankruptcy for the retailer to close its under-performing locations, which appears to be what Gold’s is doing.

For a more detailed discussion on Bankruptcy Strategies of Landlords and Tenants in a Coronavirus World, CLICK HERE

GOLD’S GYM

However, Gold’s Gym is also a franchisor and many of the gym’s locations are owned by franchisees. According to Entrepreneur Magazine,  in 2019, Gold’s Gym had less than 200 US franchises, which also sell Gold’s Gym products. Gold’s has indicated that its bankruptcy filing will only effect its corporate owned locations which amount to approximately 10% of its 700 locations, worldwide. Nevertheless, Beth’s poses a great question.

ASSUMPTION OR REJECTION OF EXECUTORY CONTRACTS

For the purposes of bankruptcy, an executory contract is an agreement that still has obligations that have not yet been fully performed. In the context of a Gold’s Gym franchise agreement, among other things, Gold’s likely has continuing obligations to collect gym member payments,  perhaps to provide billing and accounting services as well as branded products.  In return, the franchisee likely has many obligations owed to Gold’s including the payment of a franchise fee, the purchase of Gold’s branded inventory and payments on purchased or leased equipment.

It should be noted and particularly relating to Gold’s stated intention that the bankruptcy will only effect corporate owned locations, unexpired real estate leases are executory contracts subject to special rules that I will not address in this post.

As between Gold’s and its franchisees, Gold’s can now reject or assume its franchise agreements. Again, it should be noted that Gold’s has indicated that it will not reject any of its franchise agreements, although it can. For the purpose of this post, however, I will assume  that it may choose to reject some of its franchise agreements.

WHAT IS “ASSUMPTION”?

“Assuming” the franchise agreement means that the franchisor, (or it’s successor) is agreeing to perform on the franchise agreement through the end of the term. However, in Chapter 11, “Assuming” an agreement usually isn’t as straight forward as just saying, OK, I will perform through the end of the agreement. There are a number of parties that participate in this decision, including the judge, bankruptcy trustee and the creditor’s committee.

WHAT IS “REJECTION”?

Sara Chenetz, a bankruptcy partner in the international law firm of Perkins Coie states that, generally, the rejection of an executory contract does not undo the contract*. A “Rejection” merely constitutes a “breach” of the contract. Victoria Vron states in a 2010 blog post, citing the 2010 case of Taylor-Wharton Int’l LLC v. Blasingame (In re Taylor-Wharton Int’l LLC), Adv. Pr. No. 10-52792 (Bankr. Del. Nov. 23, 2010) states that rejection “relieves the debtor from future performance under the contract.” Citing another case, Victoria confirms that the rejection of an executory contract can result in a claim for damages, which is typically a general unsecured claim.*

WHAT IF GOLD’S REJECTS SOME FRANCHISE AGREEMENTS?

Now, we get to the heart of the matter. We’ve already concluded that Gold’s can reject some or all of its franchise agreements although it has said that it won’t.  When considering a debtors intention going into a bankruptcy, I can’t help but recall the oft quoted line from  the poem, “To a Mouse” by Robert Burns:

The best laid schemes o’ Mice an’ Men Gang aft agley,

HOW A FRANCHISE REJECTION IS VERY SPECIFIC TO THE FRANCHISE AGREEMENT, STATE AND OTHER LAWS

To some, this may sound like a cop out, but it is true.

Franchises in most states are highly regulated by each state, the laws of which may vary from state-to-state.  The terms of each franchise agreement between Gold’s and its franchisees likely vary from country-to-country and state-to-state. Without having an opportunity to read their franchise agreements in each state, it is far to speculative to draw any conclusion. With this being said, there are a number of other laws that will likely come into play, including, but not limited to:

  • Trademark law regarding the continued use of any of the marks, signs, literature or products identified with Gold’s Gym,

  • Commercial Code as it may relate to the sale or lease of furniture, fixtures or equipment from Gold’s to the franchisee, and

  • Other bankruptcy considerations including situations in which Gold’s Gym may have some sort of possessory or remainder interest in a real estate lease between a landlord and franchisee or the guarantee by Gold’s of such lease

This still begs the question:

WHY WOULD GOLD’S REJECT A FRANCHISE AGREEMENT?


To this, I can only speculate.

It could be that Gold’s has some liability or potential liability that relates to a particular franchise or franchise location that Gold’s determines is greater than the potential benefits of that franchise, or

Perhaps the franchisee was already poorly performing before the Coronavirus pandemic, but not poorly enough to safely terminate the franchise agreement. Now in bankruptcy, Gold’s may have greater options to act.

For a more detailed discussion on Bankruptcy Strategies of Landlords and Tenants in a Coronavirus World, CLICK HERE

FOOTNOTES:

  • Sara addresses the concept of rejection, generally and is not specifically addressing the Gold’s bankruptcy.

  • Gang aft agley meaning often gone awry.

“Modern Wooden Locker” by Sira Anamwong courtesy of freedigitalphotos.net

Howard F. Kline, Esq. | LinkedIn

Howard has been focusing much of his 43 year, legal career on landlord tenant relations, whether negotiating leases or litigating disputes. Howard is the founder and host of CRE Radio & TV and has published hundreds of blog posts and podcasts on a wide array of commercial real estate topics. Howard has been published in numerous legal periodicals, including the National Law Journal, LA Daily Journal and other business.


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