Don’t Get Stuck: Avoiding Problems and Pitfalls When Selling a Franchise
With the right location, lots of hard work, and a popular brand, owning a franchise can be a lucrative endeavor. Some franchise owners in Maryland and throughout the country have also tried to cash in on their franchise ownership by selling their business soon after purchasing it. Much like “flipping” a condominium to cash in on ever-increasing value of land, some franchise owners have purchased underperforming businesses with the express goal of fixing them up, enhancing their value, and realizing a quick profit by turning around and selling it. While this may sound like a winning strategy, there are practical problems that may frustrate such a sale, and can leave a franchise owner “stuck” owning a franchise indefinitely that he or she planned to sell. At least two potential problems exist for the franchise owner hoping to “flip” his or her franchise business.
Franchisor Retains Right to Accept or Deny Transfer
First, the franchisor, often a national or regional company which controls the right of the franchise owner to use their logo or brand name, almost always retains the right to disapprove of the would-be purchaser of the franchise business. For the national franchisor, it is crucial that the person or entity running a local franchise has a demonstrated history of scrupulously maintaining the franchise’s corporate image and standards, as well as the experience to avoid running the business into the ground and thereby possibly damaging the brand in the eyes of consumers. Many franchise owners have struck tentative deals to sell their business, only to find out that the franchisor refuses to accept the transfer to the would-be buyer. While most contracts between franchisors and franchisees state that consent to sell the business (in technical jargon – “to assign the franchise agreement”) shall not be “unreasonably withheld,” not all contracts contain this operative language, and even if they do, it might require an expensive lawsuit to force the franchisor to “accept” the new owner. It is crucial for purchasers of a franchise who are contemplating selling their business to check that their contracts permit assignment of the franchise agreement and the conditions that must be met.
Landlord May Prevent Sale Without Guaranty
Second, the landlord of the real property on which the business dislocated also may be able to prevent the sale of a franchise business. Unless the franchise owner also owns the real estate on which his or her business resides, the owner of that real estate will sometimes require that the national franchisor guaranty the rent payment if the franchise owner cannot make its payments (i.e., agree by contract that it will pay the rent if the franchise owner cannot). But the franchisor is under no obligation to do so. Thus, situations can arise in which a franchise owner seeks to sell his or her business, but the landlord will not accept the new owner without a guaranty from the national franchisor, which often will refuse to offer one. Unless the franchisor agrees, or the landlord relents, the franchise owner may not sell his or her business no matter how willing the buyer and seller are.
Eminent Domain Takings
While a very rare occurrence, franchise owners should also be aware that their businesses could be vulnerable to what is known as “eminent domain.” Under the Constitution, the government (including state and local government) is permitted to permanently take land for public use, provided that it pays “just compensation” to the owner of the seized land. However unfair or inconvenient the government’s actions may be, the landowner is at least guaranteed some compensation for the loss of his or her land. In contrast, however, the question of whether the government is required to compensate a business owner whose business is located on land seized under eminent domain powers is less clear. One Maryland court has come out in favor of compensating a business owner for lost goodwill, while a District of Columbia court recently went the other way. The law is not settled on this issue, which promises further litigation as the courts attempt to reach a consensus on what property rights are compensable. Thus, if a franchise owner does not own the real estate on which his or her business rests, and the real estate is taken by the government pursuant to its eminent domain powers, no matter how large the initial investment nor the amount of goodwill created, the business owner may or may not be compensated for these losses.
While some Courts have begun to recognize that this rule can be extremely unfair to business owners who lose all of their investment and goodwill, and the trend is towards forcing the government to compensate business owners for these losses, a risk still exists that the state’s exercise of eminent domain will not result in compensation for the unfortunate business owner. Of course, to the extent that the business is movable, and loyal customers follow a business owner to a new location, the goodwill he or she generated over the years will not be lost entirely. But for the franchise owner whose business success is linked to a certain location, eminent domain could threaten his or her livelihood.
In sum, a franchise owner looking to sell his or her business must beware of certain pitfalls that can arise. A careful review of the franchise contract will reveal what role the franchisor will play in determining whether or not the franchise can be sold. The landlord of the property on which the business resides may also have the authority to disallow a sale. Finally, state eminent domain law can have a significant effect on the compensation an owner receives should the property be taken. While purchasing a franchise to re-sell can be very profitable, individuals who are contemplating doing so should be on the lookout for these issues.