Franchise Insolvency: Bankruptcy Rights and Brand Protection

The automatic stay under 11 U.S.C. Section 362 takes effect the moment a bankruptcy petition is filed and halts any act to control property of the estate, so in franchise insolvency the franchisor cannot terminate the franchise agreement for pre-petition defaults without court approval. The standard for relief from stay requires showing cause or an imminent threat to the franchisor's trademark, and the franchise laws and bankruptcy and insolvency practice areas provide strategic guidance on evaluating stay obligations.

Section 365 of the Bankruptcy Code grants the trustee or debtor-in-possession authority to assume or reject executory contracts, and a franchise agreement qualifies because both sides retain material unperformed obligations, giving the debtor power to retain profitable agreements and shed unprofitable ones. A debtor who assumes must cure pre-petition defaults and provide adequate assurance of future performance, while rejection leaves the counterparty with a general unsecured creditor claim that typically recovers only a fraction of its face value.

The Supreme Court's 2019 decision in Mission Product Holdings, Inc. .. Tempnology, LLC clarified that rejection of a trademark license in bankruptcy constitutes a breach rather than a rescission, so the franchisee does not automatically lose its license rights, but the scope of remaining rights depends on the franchise agreement's terms and governing non-bankruptcy law. For franchisees facing franchise insolvency and the threat of rejection, the franchise laws and restructuring and insolvency practice areas provide guidance on post-rejection trademark rights under current case law.

Franchisees that have paid fees or advertising fund contributions now held by an insolvent estate should assess whether those payments were held in a constructive or statutory trust, because trust status confers a priority claim superior to general unsecured creditors in franchise insolvency proceedings. Franchisees sharing a common franchisor are most effective when they file collective Proof of Claim documents as a coordinated committee, and the insolvency and reorganization practice area provides representation in committee formation and claim drafting.

Section 365(e)(1) of the Bankruptcy Code renders ipso facto clauses unenforceable against executory contracts, so a franchisor must petition the court for relief from stay based on good cause rather than relying on a contractual automatic-termination-on-bankruptcy provision. An attorney building the good cause record will gather inspection reports, complaint data, and health department citations demonstrating the gap between the franchisee's actual performance and the brand standards required by the franchise disclosure document.

Section 365(f) of the Bankruptcy Code permits a debtor to assign an executory contract notwithstanding anti-assignment provisions, but the assignee in a franchise insolvency proceeding must provide adequate assurance of future performance under Section 365(b)(1)(C), requiring financial capacity, operational experience, and commitment to brand standards. For franchisors enforcing assignment approval rights, the franchise resales and commercial contracts practice areas provide the expertise needed to contest a proposed assignment that would introduce an unqualified operator.

The trustee in a franchise insolvency proceeding may seek to avoid pre-petition payments as preferences under Section 547, covering transfers within 90 days of the petition date, or as fraudulent transfers under Section 548, covering transfers for less than reasonably equivalent value within two years. The bankruptcy and insolvency and financial restructuring and insolvency practice areas provide counsel on the ordinary course of business defense and the contemporaneous exchange defense for parties defending avoidance claims in franchise insolvency proceedings.

A Section 363 sale allows the debtor to transfer assets with court approval, free and clear of all liens and claims, and in franchise insolvency this mechanism has sold entire franchise systems to buyers who acquire the network without successor liability. For parties on either side of a Section 363 transaction in franchise insolvency, the insolvency and reorganization and corporate liquidation practice areas provide integrated support through the sale and post-closing franchise restructuring.