Chrysler’s announcement that almost 800 franchised dealers must shut their doors as part of its bankruptcy reorganization shook the foundations of every city, town, hamlet, and ’burb in the nation with an affected dealership.
The move is not only one of the biggest blows to Main Street in recent memory, but also one of the biggest franchise disasters ever. It raises new questions about the value of franchise agreements and franchisee protections offered by federal and state laws while tossing up a host of red flags for franchisees outside of the auto industry.
As the global recession grinds on, a growing number of franchisors are likely to be forced to take similar action, leaving hundreds if not thousands of franchisees in the lurch. The Chrysler bankruptcy has also shed light on some troubling systemic issues that have made the franchise industry particularly unstable in the bad economy.
The biggest problem is franchisor debt. During the boom years, when money was easy, far too many franchisors loaded up on debt to speed their expansion. But with the credit crunch and the economic downturn, franchisor debt has become a ticking time bomb for the industry.
The other major issue is over-storing. Franchise agreements often contain provisions designating exclusive “territories” for franchisees. When the economy was flush, territorial boundaries for some franchisors suddenly became less clearly defined. There was also nothing to prevent competing franchises from moving into a territory.
It may not have mattered so much back then, because there was enough business to go around. But it matters now. The auto industry is a classic example of over-storing, but far from the only example. The worst case of over-storing may well be the casual dining industry.
Major chains have increased the number of casual dining restaurants at a nearly 8 percent clip every year since 2000, even though the restaurant industry as a whole has grown around 1 percent per year, according to Techonomic, a Chicago food industry consulting firm.
The industry was rocked last July when the pub-themed casual dining chain Bennigan’s filed for Chapter 7 bankruptcy. The chain shuttered all of its company-owned locations and announced plans to sell off the assets. The remaining 138 franchisees were effectively orphaned.
The Bennigan’s bankruptcy is significant for two reasons. It signaled what is likely to be a brutal shakeout in the casual dining segment, and it chose Chapter 7 bankruptcy instead of Chapter 11, which would have allowed it to reorganize and continue operating.
There have been big franchisor bankruptcies in the past, notably during the 1990-91 recession. Major chains such as 7-Eleven, Days Inn, Popeye’s, and Church’s Chicken went under. In each case, enormous debt loads were responsible for their collapse.
But, unlike Bennigan’s, those chains either reorganized or found ready buyers who largely honored franchise agreements. In today’s economy, that outcome is far less likely because of the severity of the downturn and the credit crunch. So where does that leave franchisees who are suddenly confronted with a bankrupt parent?