Years ago, younger children’s report cards had a category labeled “Plays Well Together.” In the franchise world, in order for the concept to be a success, a number of players must play well together. The franchise system often involves interaction amongst the following key players: the franchisor, the franchisee, the franchisee’s lender, the landlord and the landlord’s lender.
As the franchisee opens its first location or when it expands to further locations, its lender will require that the franchisee grant the lender a lien on all the franchisee’s assets. When the location is a leased location, the lender will require that the furniture, fixtures and equipment not be subject to a lessor’s lien and will ask the franchisee to get a waiver of any lien the landlord may have. If you are a franchisee with multiple locations, it is smart to contact your landlord as quickly as possible because these landlord waivers take time. If you wait until the last minute, your lender will more than likely postpone closing until the waivers are obtained. Therefore, you need the cooperation of your landlord in order to satisfy your lender.
A franchisee’s lender will often ask for a security interest in the franchise agreement, to which franchisors rarely consent. Realizing that a franchise agreement provides valuable collateral for a lender, lenders and franchisors have accepted a compromise position that essentially allows the lender to get the proceeds from the sale of a franchisee’s assets, which includes a franchise agreement. If the franchisee were to default under the terms of its loan, then the lender will not be able to take over the franchisee’s rights under the franchise agreement and operate as a franchisee, but would only collect if the franchisee’s assets are sold and proceeds of that sale are available. The Uniform Commercial Code specifically covers this type of situation in Section 9-408 and many lenders will be satisfied with this position.
If the franchisee is operating from a leased site, the franchisor will often require that the lease contain certain key provisions to protect the franchisor if the franchisee defaults. Lease provisions such as allowing the franchisor to step into the shoes of the franchisee or to receive notice that franchisee is in default are common. In addition, the franchisee’s lender will also seek concessions from the landlord. So it is not uncommon for a landlord to be triple teamed — the franchisee as potential tenant, the franchisee’s lender and the franchisor. Be prepared for the time and effort necessary to communicate amongst all these parties and their respective legal advisors. It is not easy getting everyone to row in the same direction, and in order for everyone to get along there will have to be compromises, concessions and the need for all the players to play well together.