2011 June 20 by Andrew Savard
Would you go to Vegas, belly up to a roulette wheel and bet the deed to your house, your retirement account and your personal savings and assets on Red? Probably not. But that’s not a far cry from signing a personal guarantee when you sign a franchise agreement.
Requiring a corporate (or LLC) franchisee to sign a personal guarantee has become the norm. It’s not without reason. Franchisors are concerned that franchises which are newly formed corporations (or LLCs) can too easily file bankruptcy to get out of their obligations if the franchise does poorly – leaving the franchisor with nothing. So, by requiring a personal guarantee from the officers or shareholders of the corporation (or the members of the LLC), the franchisor gets a little of the franchisee’s “skin in the game.”
However, signing such a personal guarantee frustrates the whole purpose for establishing the corporation (or LLC) in the first place – to shield your personal assets from the debts and obligations of your business. The good news is that as long as you adhere to the required corporate (or LLC) formalities, this “side-stepping” of the legal liability protection will only apply to the franchisor. It will not allow the rest of the world (i.e. customers, employees, the general public) to seek damages against you personally. But, as to the franchisor, you’re betting it all on Red.
What can be done? First and foremost, have a franchise attorney review the franchise agreement, the personal guarantee and any other agreements required by the franchisor. Even if you don’t have a separate personal guarantee, comparable language can often be found couched in the text of the franchise agreement itself. Not uncommonly, franchisors will require that you sign the franchise agreement as an individual (thereby putting you personally on the hook for all of the obligations therein), and then transfer ownership/operation to your corporation (or LLC). The transfer agreement may very likely contain language specifically stating that you, the individual, are not relived of the obligations to which you agreed, regardless of the transfer. Personal guarantee language can also pop up in agreements to sell or transfer ownership to a third party, if you decide to sell your business. In no circumstance should you agree to guarantee the performance of a buyer of your business!
Once reviewed, you can try to negotiate the language and terms of the guarantee, or try to have it eliminated in its entity. Setting caps on recoverable damages, creating a list of “off-limits” assets, or even an expiration date for the guarantee are just a few options. Unfortunately, with most franchises, the agreements are “take it or leave it.” In that instance, you need to take what few steps you can to insulate your personal assets from the risk of exposure to your creditors, namely the franchisor.
In most states, you can file for a Declaration of Homestead for your primacy residence (some states apply this protection automatically by law). This will protect the equity value in your home, up to a set amount (i.e. in MA, your home is protected up to $500,000 if you file; $125,000 if you do not), and prevents a creditor from forcing the sale of your home to pay off your debt. Additionally, you can put investment or vacation properties into Real Estate trusts or Real Estate holding companies. Additional businesses that you may own should be held by separate business entities (corporations or LLCs).
In the end, your best bet is to avoid signing a personal guarantee whenever possible.
If you need more information or assistance with a franchise agreement, personal guarantee or other business contract, please call our office for a free initial consultation. 781-333-4182 Or visit us on the web: www.SigmanLaw.us
2010 November 3 by Andrew Savard
So you’ve decided that buying a franchise is right for you. Congratulations! Whether you are working with a broker (or consultant) or pursuing this opportunity on your own, you need to conduct your due diligence. This means, among other things, that you need to validate the model and verify the financial information. Towards the end of this due diligence period is a good time to have an attorney review the FDD and Franchise Agreement.
The FDD is a formulaic document, required of all franchisors, by the FTC. Since not all franchises are the same, the standardized format of the FDD allows potential franchisees to compare apples to oranges (as much as possible). A good analogy is to consider the FDD as a federally regulated and mandated brochure.
Every FDD consists of 23 Items. Each Item must contain specific facts about the franchise and all material obligations and limitations that appear in the franchise agreement must be disclosed in the FDD, in the appropriate Item. Additionally, there will be a number of Exhibits accompanying the FDD, including a copy of the Franchise Agreement and ancillary agreements with the franchisor or specified vendors.
The FDD is not a negotiable document. It is a uniform disclosure of the required information, which must be provided to every potential franchisee. The FDD must be updated annually, within a specific number of days of the closing of the franchisor’s fiscal year – typically new FDDs are issued in April or May.
Some states require the registration of the FDD and franchise agreement, some do not, and some will allow an exemption from their registration requirement. Regardless, no governing body verifies the information, accuracy or truthfulness of the FDD. This is why it is imperative that you perform your due diligence in a thorough manner.
Despite the rigid disclosure requirements, not all of the terms of the franchise agreement are covered in the FDD. Do not rely on a review of the FDD as a summarization of your franchise agreement. Instead, use the FDD to help compare franchise opportunities as you narrow your decision, to help you in your validation process, and to orient yourself as to the specifics of a particular franchise.
Why should you have an attorney review the FDD and Franchise Agreement? Can your real estate attorney or the attorney that drafted your will review it? An attorney familiar with the FDD format and requirements will read it with an eye to ensure that you are being fully disclosed and will be able to interpret information that you might otherwise just gloss over. Ideally, a legal review of the FDD will include a comparison with the terms included in the Franchise Agreement for consistency, confirmation that all required information is included, and notation of any “red flags” (such as incorrect start-up cost disclosures).
While any licensed attorney is capable of reading and digesting an FDD and Franchise Agreement, one that is not familiar with customary terms and language may be inclined to try to negotiate more favorable terms on your behalf. Only an attorney experienced in the review of FDDs and Franchise Agreements will know what terms, if any, are typically negotiable and when it’s acceptable to “push back” against the franchisor..