Personal Guaranties in Franchise Agreements: to Sign or Not to Sign
by Mario Herman, Esq.
Prospective franchisees should be aware of the personal guaranty and its
implications. This article presents an overview of the personal guaranty and
the reasons why caution is the word.
Obtaining personal guarantees from franchisees has become the standard
business practice in the franchise industry. Some franchisors do this
by having the franchisee sign a separate document entitled "personal
guaranty," and some try to incorporate it into the language of the lengthy
franchise agreement, which is often overlooked by the franchisee.
Either way, a word of caution: your personal liability maybe
purpose of incorporation, or other business entity forms, is to protect
against personal liability on the debts of the business. Not only are
you potentially waiving such protection as to past and future royalties and
other fees by signing a personal guaranty, but there are other dangers to
consider. Franchise agreements typically bind the franchisee to more
than the payment of royalties and other fees. Franchise agreements
also bind the franchisee to keep confidential the franchisorís trade
secrets, to indemnify the franchisor against third party claims, to not
compete with the system, etc. To put this in perspective, let us
consider the hypothetical person who goes into a franchise with
others, simply intending to be a silent partner and to provide funds for the
startup/operational needs of the business. As a franchisee however,
this person may also be required to sign a personal guarantee, or simply may
be bound by a provision stealthily included in the franchise agreement.
The not so silent partners then leave the franchise system and start
competing with the franchisor. The franchisor then comes after the
silent partner on the theory of joint and several liability even though the
silent partner was not involved in the operational decisions that resulted
in termination. The silent partner potentially could be liable for
breach of the non-compete, future royalties, past royalties, breach of
confidentiality, trademark/trade dress violations.
Moreover, even if you are not in the position of the silent partner
discussed above, and you have nothing but good intentions toward your new
franchisor and starry dreams of success; life happens, and most franchise
agreements are for ten years or more in length. While no one goes into
a business expecting to fail, sometimes franchise businesses fail to become
profitable and need to close the doors. This potentially places the
franchisee and guarantors on the hook for "future royalties," the royalties
the franchisor would have earned throughout the remaining term of the
franchise agreement. And remember, the franchisor is earning
royalties, even if the franchisee is not making a profit, so this amount can
potentially be tens to hundreds of thousands of dollars.
sure to have an experienced franchise law attorney review your franchise
agreement before you sign, to ensure there is not a hidden guaranty in the
franchise agreement itself, or that the term "franchisee" is not defined so
as to include the owners of the enterprise named as the franchisee.
Additionally, having an experienced franchise law attorney on your side
before you buy a franchise will provide you with someone to assist in
negotiating the terms of any personal guaranty a franchisor may require, as
well as to review the franchise agreement and disclosures for any other red
flags or pitfalls.
Mr. Herman based in Washington, D.C., represents franchisees domestically
and internationally negotiation, mediation, arbitration, and litigation.