Burger King, Popeyes, McDonald’s, Wendy’s—those are just some of the chains that saw multi-unit operators go belly up last year. And the trend has bled into 2024. Each case has its own unique set of triggers, but collectively, the rising tide of franchisee bankruptcies points to an array of challenges facing the industry.
There’s the surging costs of ingredients and labor along with stagnant or dwindling foot traffic. Not to mention a general sense of “doom and gloom” from consumers when it comes to where the economy is headed, says Chris Desiderio, counsel in Nixon Peabody’s corporate restructuring and bankruptcy group.
Another factor at play is the move from city centers and the exodus of office workers from downtown business districts.
“I think that’s been more sustained than people envisioned,” Desiderio says. “Granted, people are pushing back, but occupancy rates are still low. You have landlords that are now in default as a result of lower tenancy rates, and they’re in a harder position to be able to work with restaurants.”
In short, franchisees are facing plenty of challenges with their economic models.
“There’s a lot of things hitting at once, and I don’t think we’ve seen the end of it,” Desiderio says. “I don’t see the headwinds ending anytime soon. I don’t think they ramp up. I think it’s just going to be a ‘put your head down and grind it out’ type of process. It’s not like interest rates are all of the sudden going to double and everything starts collapsing, but it’s going to be a challenging couple of years.”
There are two primary types of bankruptcies. There’s Chapter 7, which is a liquidation, and Chapter 11, which is a reorganization. A lot of the stigma attached to bankruptcy comes from the former. But the reality is that the vast majority of corporate bankruptcies fall into the second camp. Every airline you’ve ever flown has been through it, Desiderio says. Most hospitals in the country have done it, too. It’s simply a tool that can be used to deleverage a balance sheet in order to pave the way to a successful business going forward.
The biggest hurdle can sometimes be coming to grips with the fact that a Chapter 11 bankruptcy is something you need to implement.
“Sometimes you just need to do it in order to advance the ball, because maintaining the status quo just means self-assured destruction, which makes absolutely no sense,” Desiderio says. “I often get viewed as an undertaker, but I prefer to be more of a surgeon, where we triage the situation and see what the stressors are. Some can be solved in bankruptcy and some can’t.”
Bringing people back to central business districts? The courts can’t do anything about that. Burdensome leases or significant debt problems? Those are things that can be addressed.
“Things like renegotiation of leases, closing unprofitable locations but keeping others open, restructuring your secured debt—that can all be achieved,” Desiderio says. “There are definitely tools available that are not necessarily available outside of bankruptcy court.”
The sooner a franchisee starts thinking about those tools, the better, he adds.
“Margins are getting thinner, things are getting more difficult, and you look at the headwinds of things like minimum wage coming down the pipeline—that’s when you start thinking about it because that’s when most tools are available,” Desiderio says. “When you’re a week away from missing payroll, or the electric company shutting you off, or the landlord serving an eviction notice, you’re kind of too late.”
On the franchisor side, it’s important to keep your eye on the pulse of your system, says Keri McWilliams, another lawyer at Nixon Peabody who co-leads the firm’s franchise and distribution team.
“The more you can be ahead of it—whether it’s providing some financial support, looking at the royalties you charge, or figuring out what tools you have to try to mitigate whatever they might be struggling with—the better,” she says. “If the reason that your franchisees are struggling is that so many of them are located in city centers, maybe you encourage them to have those proactive conversations with their landlord. Maybe you try to make your potential relocation process a little bit easier. It’s going to be different for every system, but thinking about that early and trying to figure out ways to support your franchisees to minimize their distress is only going to be better for the system as a whole.”
There are other ways to support a franchise, Desiderio adds. The last few years have seen many chains undergo “pretty extreme renovation projects” that require a lot of capital expenses.
“Upgrades to kitchens, specific ovens, renovating colors or tables and chairs, those are really expensive,” he says. “Meanwhile, on a liquidation value basis, they’re worthless. So to force someone who’s already struggling, to say ‘OK, but we want you to put $250,000 or $300,000 in improvements today’ when they can already not afford the payments, now you’re putting an additional debt burden on them. Is it better to keep the old model for a little bit longer to allow them to get on their feet?”
Ultimately, Desiderio says franchisors should have enough tools through the various reporting systems that are available to understand how their operators are doing and know when they might be headed for financial distress.
“The franchisor’s worst nightmare is one of their franchisees files for bankruptcy and allows their store to go into disrepair,” he says. “Now, anyone who goes to that location thinks, ‘this is a failing chain.’ It reflects on the larger system as a whole. You want to avoid that. The problem is, once there’s a filing, the automatic stay is in place, which prevents us from taking certain actions without court approval. With that in mind, if you’re providing the goods being sold and they start falling behind on those payments, or they start falling behind on their franchise fee payments, or you start getting a sense that things are falling into disrepair, a conversation needs to happen immediately. If you wait until the filing, you lose some of your ability to monitor that.”
