ZOMBIE FRANCHISEES: Can We Save Them? Franchise attorney Peter Lagarias describes the plight of a growing number of franchise owners. These Zombie Franchisees are going deeper in debt each month, but are prevented from closing by both legal and financial constraints. According to Lagarias, the Coronavirus pandemic will only make this bad situation worse… much worse.
(UnhappyFranchisee.Com) by Peter Lagarias
Zombies are scary, being alive and suffering yet unable to die.
But what does this have to do with franchising?
Zombie Franchisees: Only Half Alive and Afraid to Pull the Plug
Zombie Franchisees are only half alive and afraid to pull the plug.
The first characteristic of Zombie Franchisees is that their franchise businesses are unprofitable.
With only half-alive businesses, Zombie Franchisees survive only because they inject money to keep their businesses afloat.
The second characteristic is that, like the curses which keep movie zombies stumbling along, there are monetary and legal constraints keeping the Zombie Franchisees from closing.
The first constraints keeping unprofitable franchisees from closing are legal ones.
Legal Constraints That Plague Zombie Franchisees
Franchise agreements, from one system to another, contain severe consequences for franchisees who close their businesses.
Most franchise agreements are one-sided, such that the law calls them adhesion contracts, and are written by and for franchisors.
Franchisors seldom negotiate terms at all, and when they do the concessions are minimal.
Many of these contracts impose liquidated damages on franchisees who cease operations. If franchisees close, they must pay large amounts to the franchisor at once.
Even without such clauses, many states allow for damages against franchisees who close their businesses prematurely. And all franchise agreements prohibit franchisees from operating a competing business for a year or two. These non-compete provisions are enforceable in most states (although not in California).
Because most franchisees have a long term commercial lease to pay, if they close down and cannot compete, they will have to keep paying rent for an empty space.
Financial Constraints That Plague Zombie Franchisees
The second constraint keeping unprofitable franchisees from closing is financial.
One would think that the best answer for unprofitable businesses is to close.
But this is often not the case.
If a hemorrhaging franchisee stays open, they will still have some cash flow. That cash flow can be used to help pay obligations that cannot be eliminated simply by closing, such as rent, royalties and ad fees to the franchisor, and other expenses. Each month their revenues fall short of these obligations, they will need to inject money into the business to cover the shortfall.
If, for example, the rent is $10,000 a month, and the shortage one month is $5,000, they have to cover $5,000.
But if they close, there would be no income at all, and they would still owe $10,000 a month in rent.
Rationally, such franchisees stay open. They are half dead with losses, but better staying open with a $5,000 shortfall rather than a $10,000 shortfall on closing.
Loans, Including Those “Guaranteed” by the SBA, Also Haunt Zombie Franchisees
The financial problem, the second constraint, becomes even more problematic for franchisees with loans to pay.
Franchisee loans, often guaranteed to banks by the Small Business Administration, are invariably secured.
Many franchisees use the equity in their homes as security for their loans to buy and open their franchises. In such situations, if franchisees close the franchise business, there is no income at all to cover the loan. Desperate Zombie Franchisees must cover their operational expenses and the loan to keep the entire house of cards from collapsing.
If the franchisee closes, they may lose everything, including their homes, even if they file for bankruptcy.
Sadly, Zombie Franchisees Are Rampant in Some Franchise Systems… And it’s Getting Worse.
So franchisors are not necessarily legally obligated to either be competent nor to act in good faith toward the franchisee investors who are trusting them and their franchise system.
With the shutdown of so many franchisees due to public health requirements of Coronavirus governmental edicts, the number of Zombie Franchisees is likely to skyrocket.
While economic losses pale next to the suffering and loss of life due to the virus, consideration must be made for the future of franchisee businesses.
The new federal Payroll Protection Program, as currently structured, provides some needed relief. But it is limited in amount and duration, covering only certain expenses for two months or so.
And not all franchisees are eligible or have been able to obtain these loans.
At some point, even on obtaining PPP loans, Zombie Franchisees may simply run out of funds altogether and then crash and burn.
How Can We Save Current – And Prevent Future – Zombie Franchisees?
The plight of Zombie Franchisees is an agonizing one.
Its victims are not only the once-hopeful entrepreneurs who dreamed the American Dream of small business ownership, but also their families, their employees, and their communities as well.
But what can be done?
Legislation is likely the only effective answer.
Franchisors simply do not negotiate fair and equal agreements.
Sometimes most, if not all, franchisees of an entire franchise system are failing and unprofitable.
But what should the legislation start with to help Zombie Franchisees?
First, bankruptcy statues should address this situation and provide full unequivocal discharges for Zombie Franchisees. And from the famous line in the movie Jaws about needing a bigger ship: “We’re going to need more bankruptcy judges.”
Second, we need to enact a duty of competency, or at a minimum a duty for franchisors to negotiate agreements, and to operate, in good faith.
And that’s just a start.
Zombie Franchisees Need Our Help
In the long run, the Franchisee Bill of Rights should be enacted.
Franchisees are Main Street, not Wall Street.
They are our neighbors who provide jobs, pay taxes, support Little League teams and PTA functions, and more…
And they need our help.
Peter Lagarias is a franchisee advocate and respected franchise attorney who has represented franchise owners for more than forty years.
A former prosecuter for the Federal Trade Commission (FTC), Peter Lagarias is based in San Rafael, CA.
Learn more at Franchise Law Advocates.
What do you think? Are you a Zombie Franchisee? Or have you been one in the past?
Share your experience and opinions in the comments below… or email ADMIN in confidence at UnhappyFranchisee[at]gmail.com
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