Answering the Call

Recognizing the challenges of today's retail markets, most franchisors are creating strategic solutions for their franchise systems. All systems are bound to encounter distressed units as they grow in number. Legal solutions, already complex given the unique relationship between franchisor and franchisee, are further complicated by third parties connected to the franchise business, such as landlords, banks, vendors, and others doing business with a franchisee.

With the continuing stranglehold on the credit markets, many chains have shrunk or flatlined their growth. But simply closing distressed units without evaluating the circumstances may be shortsighted. Instead, preparing a rescue plan for distressed units will serve both franchisor and franchisee.

Franchise attorneys can assist franchisors in creating rescue plans to evaluate underperforming franchise units. A comprehensive rescue plan will critically evaluate original site selection, regional sales, operations, marketing, occupancy cost, and other factors. Because one size doesn't fit all, a "franchise rescue plan" should be tailored specifically to each franchisee's individual needs and unique situation. The following four-phase process will orient a plan specific to each franchise company:

• Phase I-Evaluation: Initial evaluation includes lease review, market analysis, P&L statement (unit-level economics), and the franchise or area rep agreement.
• Phase II-Recommendation: The attorney provides a recommendation report to the franchisor with a proposed budget for the execution phase.
• Phase III-Execution: The franchisor takes the recommended action (e.g., unit closings, lease renegotiations, lender refinancing, franchise agreement and royalty deferment, valuation and packaging of distressed inventory, etc.).
• Phase IV-Exit: The attorney, in coordination with the franchisor, franchisee, and interested third parties, packages the distressed inventory to be closed, sold, transferred, managed by a third party, sold to a third-party operator, etc. The attorney provides multiple exit options to the franchisor.

Making it work

I estimate that 80 percent of executive team time is spent trying to save the bottom 20 percent of the chain. Franchisors may promote a specific price point to increase sales and royalty revenue, while cutting into franchisees' margins. Such promotions, coupled with factors such as slow economic recovery, increased competition from online channels, and a failure to adapt to new market conditions, have a number of retail chains searching for solutions.

Even brands that are performing well at the unit level need to develop a rescue plan--not unlike having an evacuation plan for a building. Taking an investor's approach to running the franchise company--cutting back on necessities such as store maintenance and downplaying traditional metrics like same-store sales--is not a rescue plan, but more often a death sentence. An effective plan should be oriented specifically to the brand and promote franchisee participation. Therefore, by example, a franchisor should not introduce a promotion that spikes unit-level volume to the detriment of the franchisee as a "rescue plan." Also, franchise companies must address the sensitive balance of Internet promotion against consequences for its brick-and-mortar partners.

Having a turnaround or rescue plan on hand that includes an independent evaluation is critical. Franchisees who remain in denial usually get marginalized by creditors and ousted before the end of the restructuring process. On the other hand, those who accept the reality of the workout and move proactively to return the franchise unit(s) to profitability are seen as part of the solution and are welcomed at the table. The willingness to accept the help of a rescue plan is usually a strong indication that franchisees and area developers or representatives are proactively looking for solutions

Legal solutions other than litigation will most often best serve the brand, the franchisee, and all third parties. With a sound plan in place and with an understanding of the complex franchising issues of both the franchisor and franchisee, implementing and executing a franchise rescue plan applying detailed business knowledge of ever-changing retail market factors is critical to long-term sustainability.

Anthony J. Calamunci is partner-in-charge in the Toledo, Ohio office of Roetzel & Andress LPA. He practices in a wide range of business matters, with a focus on franchise law and franchise litigation. Contact him at 419-254-5247 or acalamunci@ralaw.com.