Not So Fast

Franchisors may not be able to force an acceptance or rejection of real property leases with franchisee.

One of my favorite sites, "The Creditors' Rights Blog", has an interesting article about a Seventh Circuit opinion in the case of A&F Enterprises, Inc. v. IHOP Franchising, LLC.

Typically, when a company enters bankruptcy, the trustee has a certain amount of time to assume or reject an "executory contract" or a contract in which both parties still have some unfinished business to provide to the other party. For more on executory contracts, go here.

If there are inter-related franchise and real-estate contracts when a franchisee enters bankruptcy, the matter can become turbid because the franchisee now has two executory contracts with the same party, but one may not be valid without the other.

"What’s the outcome when a debtor and its franchisor are parties to inter-related agreements: a franchise agreement under which the debtor operates its business and a real property lease under which the debtor leases its business premises from the franchisor?  The matter before the Seventh Circuit had the added complexity that the real property lease before it prohibited a use of the premises for any purpose other than for the operation of an IHOP restaurant, meaning the debtor could not assume the real property lease without also assuming the franchise agreement.

 ...The Seventh Circuit indicated that a real property lease in this type of commercial agreement is subordinate to the dominant franchise agreement, with the result that a debtor’s obligation to decide on assumption or rejection of the real property lease will run concurrently with its decision to assume or reject the franchise agreement." Creditors Rights

While I think that this is a narrow issue, the opinion is interesting because it could likely be applied to small business owners contracting out their stores to operators. The decision could also be applied to McDonald's franchisees who are leasing the stores from the franchisors. Lastly, since the decision clarifies the priority of the two contracts, it can be helpful to keep it in mind while negotiating an out-of-court restructuring.