It’s important for prospective franchisees to fully understand the personal guarantee section in the franchise agreement. The reasons why franchisors require this covenant and what the implications are in the event the franchisee has problems.
With few exceptions all franchisors require its franchisees to personally guarantee all contractual commitments in their franchise agreement, especially the financial obligations, of the corporate entity owning and operating the franchise.
Obtaining personal guarantees from individuals is a common practice for lenders, creditors and landlords. Banks that lend money to a franchisee will require the owner to personally guarantee repayment of the loan. Landlords leasing space to franchises, usually require the personal guarantee of the franchise owner.
A personal guarantee provides the franchisor, with additional security in the form of the personal assets of the guarantor rather than relying upon a corporate entity with limited or few assets.
Since franchises are typically granted to individuals, who then establish a corporation, a franchisor views the operation of the franchise resting with an individual rather than a corporation. The franchisor uses the personal guarantee to protect its trade secrets, enforce non-competes and recover monies owed by the franchisee. Without this tool the franchisor would most likely pursue a shell corporation with few assets.
Personal guarantee provisions in the franchise agreement enable the franchisor to proceed against the individual guarantor (franchisee) in addition to the corporation operating the franchise. This is because the individual franchisee is usually required to waive the rights to require the franchisor to proceed first against the franchisee’s corporate entity. The personal guarantee provision is contained in the Franchise Agreement and will include an exhibit of the guaranty agreement the individual must sign.
Most franchisors require the spouse of the individual franchisee execute the guarantee obligation. This allows the franchisor to pursue those assets held jointly in the marriage, such as bank accounts, investments, personal property and real estate.
- Royalty payments
- Advertising fund payments
- Claims and lawsuits brought by third parties which the franchisee must indemnify the franchisor for
- Confidentiality agreement
- Other financial obligations
Most franchisors will refuse to waive the requirement of a personal guarantee. However, a franchisor may be agreeable to negotiating some changes which can make the guaranty less onerous. Your franchise attorney can provide suggested language to the franchisor to include as an addendum to the franchise agreement.
Suggested modifications to “soften” the personal guarantee:
- Cap the financial amount under the personal guarantee.
- Limit the personal guarantee to particular obligations.
- Third party claims under the franchisee indemnity, should not be the responsibility of the franchisee when it’s followed franchisor policies and procedures.
- Request a process for resolving disputed royalty payments to include a time extension.
- A franchisor indemnification provision that protects the franchisee from claims and reimburses for costs pertaining to the use of the franchisor marks, when used properly by the franchisee.
A personal guarantee provision in the franchise agreement is used by franchisors to protect its financial interests. This provision is rarely waived. Prospective franchisees should understand the implications of a personal guaranty when evaluating a franchise opportunity and when performing due diligence. Be confident in your decision to be a part of the franchise network because you’ll be required to guarantee your obligations.