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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 considerable.

One 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.

Be 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.

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