This post provides general information and is not a substitute for legal advice tailored to your specific situation. If your franchisor has filed for bankruptcy, contact a franchise attorney immediately.

What Is an Executory Contract in Bankruptcy?

A franchise agreement is an executory contract, meaning both parties still have ongoing obligations to each other. You owe royalties; the franchisor owes you brand support, marketing, and intellectual property rights. When a company files for bankruptcy, the trustee or debtor-in-possession gets to decide what to do with these executory contracts.

Under 11 U.S.C. § 365, a bankruptcy trustee can either “assume” the contract (keep it going with all its terms intact) or “reject” it (effectively terminate the contract). Rejection is treated as a breach of contract by the franchisor, which gives you a damages claim as an unsecured creditor. But that damages claim is often worth very little in a bankruptcy with no assets.

That is where § 365(n) comes in.

How Does 11 U.S.C. § 365(n) Protect You?

Section 365(n) was added to the Bankruptcy Code specifically to protect licensees of intellectual property when a licensor (like a franchisor) goes bankrupt. Here is what it means for you in plain terms:

If the trustee rejects your franchise agreement, you have a choice. You can accept the rejection as a termination and file a damages claim. Or, you can elect to retain your rights to the intellectual property: the trademarks, systems, and brand that your franchise is built on.

If you elect to retain rights under § 365(n), you can keep operating under the franchise brand. You must continue making royalty payments. The franchisor is relieved of its ongoing obligations, meaning you lose the active support and services you were entitled to. But you keep the license, which means you can keep your doors open and your brand intact.

This distinction can be the difference between protecting a $500,000 investment and losing it entirely.

Chapter 7 vs. Chapter 11: Two Very Different Situations

The type of bankruptcy your franchisor files makes an enormous difference in what happens next.

Chapter 7: Liquidation. In Chapter 7, the franchisor is shutting down. A trustee takes over, sells assets, and winds everything up. Chapter 7 trustees almost always reject franchise agreements because there is no ongoing business to support them. You will almost certainly need to invoke § 365(n) quickly to preserve your rights. The brand may eventually be sold to another company, which could offer new franchise terms, but that process takes months and is uncertain.

Chapter 11: Reorganization. In Chapter 11, the franchisor is attempting to restructure its debts and continue operating. The company may assume your franchise agreement as part of the reorganization plan, which is generally good news for you. Or it may reject your agreement to shed unprofitable relationships. Chapter 11 gives more time to negotiate, and you should be an active participant in the bankruptcy process from day one.

At Lopes Law LLC, we have counseled franchisees through both scenarios. Chapter 11 gives you more leverage and more options. Chapter 7 requires faster decisions with less information.

Real-World Examples: Quiznos and Sbarro

Two franchise bankruptcies from 2014 illustrate what franchisees actually face.

Quiznos (2014). Quiznos filed for Chapter 11 in February 2014 with approximately $570 million in debt. Franchisees faced immediate uncertainty about supply chain pricing, brand marketing, and whether their agreements would be assumed or rejected in the reorganization. Many franchisees had already been struggling due to a mandatory purchasing program that required buying supplies through the franchisor at above-market prices. The bankruptcy process ultimately resulted in new ownership, with some franchisees receiving modified terms and others losing their locations.

Sbarro (2014). Sbarro filed for Chapter 11 in March 2014, its second bankruptcy in three years. The reorganization closed a significant number of mall locations, primarily company-owned. Franchisees operating under the Sbarro brand faced significant uncertainty about whether the brand would survive and, if so, what support they would receive during the reorganization period.

Friendly’s (2020). Friendly’s filed for Chapter 11 in November 2020. The brand was subsequently sold, and franchisees had to navigate a transition to new ownership with the prospect of renegotiated terms.

In each case, the franchisees who were best positioned were those who had retained counsel immediately, filed creditor claims on time, and understood their § 365(n) rights before the trustee made decisions about contract assumption or rejection.

What to Do in the First 30, 60, and 90 Days

How Do You Protect Your Supply Chain?

Many franchise agreements require franchisees to purchase supplies exclusively through the franchisor or approved suppliers. When a franchisor goes bankrupt, that supply chain can break down within days.

Practical steps to protect your supply chain include: identifying alternative suppliers for every critical product category, securing contracts with those suppliers before you need them, reviewing your franchise agreement’s approved supplier provisions to understand your flexibility, and working with your attorney to seek emergency relief from the bankruptcy court if the franchisor cuts off supply during the proceedings.

If you are in a food service franchise, inventory disruption is among your most immediate risks. Prioritize it from day one.

What Happens to Your Personal Guarantees?

Most franchise agreements require personal guarantees, meaning you pledged personal assets to back up the franchise’s financial obligations. When a franchisor goes bankrupt, your personal guarantee obligations do not disappear.

If you signed a lease as part of your franchise operations, the landlord can still pursue you personally even if the franchisor’s corporate structure is dissolved. Loan guarantees to the SBA or private lenders remain fully enforceable. This is why franchisees in bankruptcy situations need legal counsel: the risk is not just the franchise business but potentially your personal financial future.

At Lopes Law LLC, we help franchisees assess their personal guarantee exposure and develop strategies to minimize liability while protecting business operations.

Can You Join With Other Franchisees?

Yes, and in many large system bankruptcies, this is one of the most effective strategies available. Franchisees who form organized groups can:

• Hire shared legal counsel, reducing per-franchisee legal costs
• Present a unified position in the bankruptcy court and creditor proceedings
• Pool resources to evaluate purchasing the brand out of bankruptcy
• Leverage collective bargaining power when negotiating with a new brand owner

In both the Quiznos and Sbarro situations, franchisee groups that organized quickly were better positioned than those who acted alone. Visit lopeslawllc.com/franchise-dispute/ for more on your options in a franchise dispute or systemic crisis.

Sources: 11 U.S.C. § 365 (Bankruptcy Code); FTC Franchise Rule 16 CFR Parts 436-437; Quiznos Chapter 11 filing, U.S. Bankruptcy Court D. Colorado (2014); Sbarro Chapter 11 filing (2014). This post is informational and does not constitute legal advice.