Common Issues Franchisors Face When Franchisees Divorce

The franchise might be the most valuable asset on the marital balance sheet. Consequently, both parties will try to determine the value of the franchise and may look to whether the franchisor has an internal valuation methodology regarding the value of its franchises or other historical data maintained by the franchisor concerning the buying and selling of other existing franchise units.

In response, a franchisor's counsel may suggest requesting a protective order if the discovery is too onerous or burdensome, and the franchisor can push back by challenging which information is really needed by the party requesting the discovery. Further, counsel should consider seeking a confidentiality order to protect the sensitive documents sought in discovery.

On occasion, the deposition of key personnel in the franchise may be requested. Similar to litigation against a franchisor or pursued by a franchisor, key personnel should take these depositions seriously. They should arrive prepared.

Ownership of a Franchise Post-Divorce

The franchise agreement governs exclusively the relationship between the franchisor and franchisee. The divorce of franchise owners has no effect on the underlying franchise agreement because the entry of a divorce decree does not void contracts the spouses have with third parties. An interesting idea to consider is including language in the franchise agreement that if a franchisee's divorce changes the underlying ownership of the franchise, the change in ownership gives the franchisor the right to require the spouse retaining the franchise to enter into a new, updated franchise agreement.

If the franchise is owned by a husband and wife, and one spouse wants out of the franchise agreement, the most effective manner to transfer ownership is for the divorcing parties to execute an assignment and assumption agreement in which the departing spouse assigns all of his or her right, title and interest in the franchise to the spouse retaining ownership. If the franchise is owned by an entity, rather than by individuals, the underlying corporate and regulatory documents need to be amended to reflect the change in ownership of the franchise due to the divorce. The franchisor should have the departing spouse execute a general release to the franchisor to avoid any future claims or litigation by the departing spouse.

Franchisee Buyout

As a general rule, a franchisor is not in the business of finding suitable buyers for franchisees going through a divorce. However, helping a divorcing franchisee might be a prudent course of action if the alternative is to have an underperforming franchise.

All franchise agreements contain language giving the franchisor the right to vet potential new buyers and, ultimately, to approve or disapprove the new buyer. This language allows the franchisor to determine if the potential buyer is qualified to own the franchise under the terms of the franchise agreement. If the ongoing relationship between the current franchisee and the franchisor is good, and the right potential buyer and fit arises, the franchisor may opt to broker a deal to assist a franchisee in selling the franchise, particularly if it will help preserve the franchise. If the relationship between franchisor and franchisee is not in good standing, the odds are the franchisor will choose to not become involved, instead relying upon the terms and conditions of the franchise agreement.

Special Accommodations

When a divorce occurs, one spouse typically buys out the other spouse's interest in the value of the franchise. While this is a clean solution for the divorcing parties, buying out the spouse can create cash flow problems for the spouse retaining the franchise. The franchisor is possibly left with the dilemma of whether the cash-strapped franchisee should be accommodated, and how. The decision of whether to make accommodations to a franchisee can be problematic and is most often dealt with on a case-by-case (and issue-by-issue) basis. There are no clear answers about what, or which type of, accommodations a franchisor is willing to make. The decision varies across the franchise industry, and it is largely dependent on the extent of the accommodation the franchisee seeks and the franchisor-franchisee relationship.

Usually, varying from the franchise agreement for the franchisee's benefit is contrary to the franchisor's business plan and creates difficulties for the franchisor to manage its brand. Once word gets out the franchisor bent the rules for one franchisee, Pandora's Box has opened, and other franchisees going through adverse circumstances will surely request accommodations in operations and financial commitments as well.

Some franchisors are willing to make accommodations for the franchisee's benefit because it is in the franchisor's interests for the franchise to remain successful and profitable. Other franchisors choose to strictly follow the franchise agreement. Ultimately, if the franchise is not performing under the terms of the franchise agreement over an extended period of time, the franchisor may take action to terminate the relationship pursuant to the franchise agreement. A franchisor will often decide to cut its losses to avoid protracted litigation with its franchisees.

Just Stay Away

Should franchisors try to stay as far away as possible from franchisees' divorces? With rare exception, the answer is “yes.” Franchisors should become involved only when necessary to maintain an important franchisor-franchisee relationship or to maintain an important aspect of the franchise itself. The involvement in a divorce is distracting at best, and requires the franchisor to utilize time and energy on an issue not in keeping with its business plan.

From a business point of view, franchisors should consider expanding the franchise agreement to include language requiring franchisees to provide notice of a divorce filing because a divorce could ultimately lead to a change in ownership or be an indicator the franchisee may be experiencing problems that could ultimately have a negative impact on the franchise. The filing of a divorce by or against a franchisee should trigger the notification requirement to the franchisor. From that point, open communication between the franchisor and franchisee is imperative and will enable the franchisor to respond appropriately as developments occur. Importantly, however, being informed of the pending divorce does not create any sort of liability or require action on the part of the franchisor; it simply provides knowledge that personal trouble may be looming on the horizon for the franchisee.

On the other hand, it is not advisable for a franchisor to simply put its head in the sand and ignore divorce litigation. Rather, the franchisor must assess each matter individually to determine what involvement, if any, would be beneficial. Keep in mind that divorce is common. Hundreds of thousands of people go through divorces every year, and many of those individuals are still able to maintain their employment and run successful businesses. Divorce may cause some problems and be an irritant from a franchisor's perspective, but it may be a total non-event in the life of the franchise. Accordingly, a case-by-case analysis of each circumstance is critical to understanding how the franchisor should handle the situation.

John L. Collar, Jr. is a founding partner and family law attorney with Boyd Collar Nolen & Tuggle LLC in Atlanta, a firm dedicated to exclusively to divorce, custody arrangements, child support alimony issues and other topics of interest to divorced families. Brooke M. French is a senior associate with the firm. They may be reached by phone at 770-953-4300 or by e-mail at [email protected] or [email protected], respectively.

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While the marital status of a franchisee may seem unimportant to most franchisors, with nearly 50% of all first marriages ending in divorce (and higher for second and subsequent marriages), it is inevitable that a franchisor will be asked at some point, on some level, to become involved in the divorce of a franchisee. Handling the issues that arise can ensure that the specific franchise unit(s) owned by the divorcing parties continue to thrive and that the brand is not damaged.

Discovery motions are typically the first area in which a franchisee's divorce will affect a franchisor. Divorce litigation involves discovering and obtaining many pieces of information regarding the assets, debts and income accumulated during a marriage. When the ownership and value of a franchise are involved in a divorce, the franchisor may be called upon for a variety of reasons, including producing information and documents associated with the franchise.

The franchisor can expect discovery will be issued in the form of a request for production of documents or a subpoena for deposition seeking, among other things, documentation about the franchise, including the following: the franchise agreement; royalty and revenue reports; the franchisee's income tax returns; profit-and-loss statements; balance sheets; leases associated with the franchise; customer complaint reports; the application to purchase the franchise (which might include a personal net worth statement from the franchisee); any promissory notes and guarantees signed by the franchisee; credit reports; criminal background investigations; and other personal information provided by the franchisee-owner concerning its prior employment and residential history. Generally, all of these documents are discoverable in a divorce action because they are used to decide the issues of equitable division or property, alimony and child support.

The franchise might be the most valuable asset on the marital balance sheet. Consequently, both parties will try to determine the value of the franchise and may look to whether the franchisor has an internal valuation methodology regarding the value of its franchises or other historical data maintained by the franchisor concerning the buying and selling of other existing franchise units.

In response, a franchisor's counsel may suggest requesting a protective order if the discovery is too onerous or burdensome, and the franchisor can push back by challenging which information is really needed by the party requesting the discovery. Further, counsel should consider seeking a confidentiality order to protect the sensitive documents sought in discovery.

On occasion, the deposition of key personnel in the franchise may be requested. Similar to litigation against a franchisor or pursued by a franchisor, key personnel should take these depositions seriously. They should arrive prepared.

Ownership of a Franchise Post-Divorce

The franchise agreement governs exclusively the relationship between the franchisor and franchisee. The divorce of franchise owners has no effect on the underlying franchise agreement because the entry of a divorce decree does not void contracts the spouses have with third parties. An interesting idea to consider is including language in the franchise agreement that if a franchisee's divorce changes the underlying ownership of the franchise, the change in ownership gives the franchisor the right to require the spouse retaining the franchise to enter into a new, updated franchise agreement.

If the franchise is owned by a husband and wife, and one spouse wants out of the franchise agreement, the most effective manner to transfer ownership is for the divorcing parties to execute an assignment and assumption agreement in which the departing spouse assigns all of his or her right, title and interest in the franchise to the spouse retaining ownership. If the franchise is owned by an entity, rather than by individuals, the underlying corporate and regulatory documents need to be amended to reflect the change in ownership of the franchise due to the divorce. The franchisor should have the departing spouse execute a general release to the franchisor to avoid any future claims or litigation by the departing spouse.

Franchisee Buyout

As a general rule, a franchisor is not in the business of finding suitable buyers for franchisees going through a divorce. However, helping a divorcing franchisee might be a prudent course of action if the alternative is to have an underperforming franchise.

All franchise agreements contain language giving the franchisor the right to vet potential new buyers and, ultimately, to approve or disapprove the new buyer. This language allows the franchisor to determine if the potential buyer is qualified to own the franchise under the terms of the franchise agreement. If the ongoing relationship between the current franchisee and the franchisor is good, and the right potential buyer and fit arises, the franchisor may opt to broker a deal to assist a franchisee in selling the franchise, particularly if it will help preserve the franchise. If the relationship between franchisor and franchisee is not in good standing, the odds are the franchisor will choose to not become involved, instead relying upon the terms and conditions of the franchise agreement.

Special Accommodations

When a divorce occurs, one spouse typically buys out the other spouse's interest in the value of the franchise. While this is a clean solution for the divorcing parties, buying out the spouse can create cash flow problems for the spouse retaining the franchise. The franchisor is possibly left with the dilemma of whether the cash-strapped franchisee should be accommodated, and how. The decision of whether to make accommodations to a franchisee can be problematic and is most often dealt with on a case-by-case (and issue-by-issue) basis. There are no clear answers about what, or which type of, accommodations a franchisor is willing to make. The decision varies across the franchise industry, and it is largely dependent on the extent of the accommodation the franchisee seeks and the franchisor-franchisee relationship.

Usually, varying from the franchise agreement for the franchisee's benefit is contrary to the franchisor's business plan and creates difficulties for the franchisor to manage its brand. Once word gets out the franchisor bent the rules for one franchisee, Pandora's Box has opened, and other franchisees going through adverse circumstances will surely request accommodations in operations and financial commitments as well.

Some franchisors are willing to make accommodations for the franchisee's benefit because it is in the franchisor's interests for the franchise to remain successful and profitable. Other franchisors choose to strictly follow the franchise agreement. Ultimately, if the franchise is not performing under the terms of the franchise agreement over an extended period of time, the franchisor may take action to terminate the relationship pursuant to the franchise agreement. A franchisor will often decide to cut its losses to avoid protracted litigation with its franchisees.

Just Stay Away

Should franchisors try to stay as far away as possible from franchisees' divorces? With rare exception, the answer is “yes.” Franchisors should become involved only when necessary to maintain an important franchisor-franchisee relationship or to maintain an important aspect of the franchise itself. The involvement in a divorce is distracting at best, and requires the franchisor to utilize time and energy on an issue not in keeping with its business plan.

From a business point of view, franchisors should consider expanding the franchise agreement to include language requiring franchisees to provide notice of a divorce filing because a divorce could ultimately lead to a change in ownership or be an indicator the franchisee may be experiencing problems that could ultimately have a negative impact on the franchise. The filing of a divorce by or against a franchisee should trigger the notification requirement to the franchisor. From that point, open communication between the franchisor and franchisee is imperative and will enable the franchisor to respond appropriately as developments occur. Importantly, however, being informed of the pending divorce does not create any sort of liability or require action on the part of the franchisor; it simply provides knowledge that personal trouble may be looming on the horizon for the franchisee.

On the other hand, it is not advisable for a franchisor to simply put its head in the sand and ignore divorce litigation. Rather, the franchisor must assess each matter individually to determine what involvement, if any, would be beneficial. Keep in mind that divorce is common. Hundreds of thousands of people go through divorces every year, and many of those individuals are still able to maintain their employment and run successful businesses. Divorce may cause some problems and be an irritant from a franchisor's perspective, but it may be a total non-event in the life of the franchise. Accordingly, a case-by-case analysis of each circumstance is critical to understanding how the franchisor should handle the situation.

John L. Collar, Jr. is a founding partner and family law attorney with Boyd Collar Nolen & Tuggle LLC in Atlanta, a firm dedicated to exclusively to divorce, custody arrangements, child support alimony issues and other topics of interest to divorced families. Brooke M. French is a senior associate with the firm. They may be reached by phone at 770-953-4300 or by e-mail at [email protected] or [email protected], respectively.

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