FRANCHISE LAW
Franchise Agreements and Bankruptcy: What Happens
When a franchisor or franchisee files for bankruptcy, the franchise agreement is treated as an “executory contract” under the U.S. Bankruptcy Code — and what happens next turns on whether the filing party assumes it, rejects it, or assigns it. Bankruptcy does not automatically end the franchise. Instead, it triggers a court-supervised process with its own rules, and several familiar contract terms behave very differently once a petition is filed. This guide explains how bankruptcy reshapes the franchise relationship, what changes when each side files, and which clauses actually survive.
The Franchise Agreement Is an “Executory Contract”
A franchise agreement is almost always an executory contract — one where both sides still owe meaningful performance (the franchisor owes ongoing brand and system support; the franchisee owes royalties and standards compliance). That classification matters, because the Bankruptcy Code gives the filing party (the “debtor”), with court approval, three options for an executory contract:
- Assume it — keep the franchise, but only by curing past defaults (paying overdue royalties, for example) and showing it can perform going forward.
- Reject it — walk away from future obligations, which counts as a breach the other side can claim damages for.
- Assume and assign it — keep it and transfer it to a third party, subject to important limits discussed below.
Two protections kick in the moment a petition is filed. The automatic stay (Bankruptcy Code § 362) freezes most collection and termination efforts, so a franchisor generally cannot terminate or sue a franchisee mid-bankruptcy without the court’s permission. And “ipso facto” clauses — terms that purport to terminate the franchise automatically upon bankruptcy or insolvency — are generally unenforceable under § 365(e). A clause that says “this agreement ends if you file bankruptcy” usually will not work.
When the Franchisor Files for Bankruptcy
If the franchisor files, franchisees worry first about their right to keep using the brand. Historically that was uncertain, but the U.S. Supreme Court settled the core question in Mission Product Holdings, Inc. v. Tempnology, LLC (2019): a debtor’s rejection of a trademark license is a breach of the contract, not a rescission of it. In an 8–1 decision, the Court held that rejection does not claw back the rights the licensee already had — so a licensee (and, by extension, a franchisee relying on a trademark license) generally retains the right to keep using the licensed marks for the remainder of the term, even after the franchisor rejects the agreement.
That is real protection, but it is not a guarantee that nothing changes. A bankrupt franchisor may stop providing support, supply, or marketing; may sell the system to a buyer who runs it differently; or may reorganize in ways that affect the network. Franchisees should monitor the case, file proofs of claim for damages where appropriate, and get advice before assuming the brand will simply carry on as before.
When the Franchisee Files for Bankruptcy
A franchisee’s filing usually falls into one of two tracks. In a Chapter 7 liquidation, a trustee winds down the business, and the franchise is typically rejected or sold. In a Chapter 11 or Subchapter V reorganization, the franchisee tries to keep operating, which means assuming the franchise agreement — and that requires curing defaults and demonstrating future performance.
Assignment is where franchise and trademark licenses get complicated. While § 365(f) generally lets a debtor assign a contract despite an anti-assignment clause, § 365(c) can block assumption or assignment where non-bankruptcy law would excuse the franchisor from accepting performance from someone other than the original franchisee. Because a franchise rests on a trademark license and personal trust in the operator, courts disagree about how far a franchisee can assign over the franchisor’s objection. The result is fact-specific, and both sides should expect to litigate it if a sale is on the table.
Which Clauses Survive Bankruptcy
| Clause or obligation | What happens in bankruptcy |
|---|---|
| Ipso facto / terminate-on-bankruptcy clause | Generally unenforceable (§ 365(e)) |
| Anti-assignment clause | May be overridden under § 365(f), but limited by § 365(c) for franchise/trademark rights |
| Unpaid pre-petition royalties | Treated as a claim; must be cured if the debtor assumes the agreement |
| Personal guarantee | Survives the business’s bankruptcy; the guarantor stays liable unless the guarantor personally files and discharges it |
| Post-termination non-compete and confidentiality | Often survive rejection, though enforceability still depends on state law |
For how termination notices and damages provisions interact with this process, see our guides to the franchise termination notice and the liquidated damages clause.
Practical Steps for Both Sides
Franchisees facing distress should get advice before defaulting — options like restructuring, negotiating with the franchisor, or selling the unit are often better than liquidation, which usually means losing the business. Franchisors dealing with a bankrupt franchisee should avoid self-help termination that violates the automatic stay, file timely claims, and decide early whether they want the unit assumed, rejected, or transferred to an approved buyer. On both sides, the clauses you negotiated up front — cure rights, assignment standards, guarantees — drive the outcome once a petition is filed.
Frequently Asked Questions
Does filing for bankruptcy automatically end a franchise agreement?
No. The agreement is an executory contract. Clauses that try to terminate it automatically on bankruptcy are generally unenforceable, and the debtor decides — with court approval — whether to assume, reject, or assign it.
If my franchisor goes bankrupt, can I keep using the brand?
Often yes. Under Mission Product Holdings v. Tempnology, a franchisor’s rejection of the agreement is a breach rather than a rescission, so the franchisee generally keeps its license rights for the remaining term — though support and supply may still change.
Am I still liable on my personal guarantee if my franchise files Chapter 7?
Usually yes. A personal guarantee is the guarantor’s own obligation. The business’s bankruptcy does not discharge it unless the guarantor personally files bankruptcy and discharges the debt.
Can a bankrupt franchisee sell the franchise to someone else?
Sometimes, but not freely. Section 365 allows assignment in some cases, while limits tied to trademark licenses and the franchisor’s consent rights frequently restrict it. The answer depends on the facts and often has to be resolved in court.
Reidel Law Firm helps franchisees and franchisors navigate distress, default, and exit — including bankruptcy-driven terminations and transfers. Get help with a franchise exit, or contact us to talk through your options before you default.
