Franchisee MCA Debt: 6 Contract Questions About Liens, Consent, and Termination

For a franchise owner, the franchise agreement decides as much or more about what happens when you are behind on a merchant cash advance. The funder’s lien usually can’t take away your franchise. The franchise agreement lets the franchisor act in many ways that are as bad or worse than the MCA’s penalties. The fastest route to trouble is franchisor default and termination. Ask your lawyer these six questions about your agreement.

Defaults You Can Cure

First, what does your franchise agreement call a default? Besides nonpayment, franchisors worry about a judgment or levy on your assets, your insolvency, your encumbering the business, or your not staying open for business. Cross-default clauses mean that if you default anywhere you may be at risk everywhere. Item 17 of the Franchise Disclosure Document maps termination, defaults you can cure, and transfer approval. Read the agreement itself to find out what is and is not a curable default. Read both before missing a payment.

Do you get any time to fix it? Some states limit termination. In California the franchisor generally needs a good cause, at least 60 days to cure, but for unpaid fees, five days after written notice. New Jersey has a good-cause test. Check your state law.

When MCA debits drain the business account, the franchise system’s royalty EFT may be the next payment that fails. Unpaid royalty or brand-fund fees can trigger quicker action by the franchisor. Protect the royalty draft and payroll taxes.

If your funder sues and gets a judgment or attachment against your business account, the next royalty or payroll draft could fail. That action may meet the franchise agreement’s test for a default. A summons must be answered in a set time: usually 20 to 30 days in most states.

Termination turns a bad situation worse. The franchisor can claim damages like unpaid royalties, brand fees, and lost future royalty under some agreements. Your landlord may claim rent for the remaining term. And every lender can enforce its guaranty.

The MCA’s Lien on Your Accounts

Next, did you break your franchise agreement by signing the MCA and its lender’s lien? If you did not get the franchisor’s OK beforehand, the MCA’s lien on your accounts probably is unapproved. But it is not the end of the world for your agreement with the franchisor. UCC 9-408 says that the franchise agreement itself can’t bar a security interest in the franchise, nor can it make grant of the lien a default, and UCC 9-406 says the same for receivables. But telling a franchisor that your business can’t pay its debts may itself count as a default. Check the franchise agreement. Some franchisors offer temporary royalty deferral in hardship cases. But talk to an attorney before you discuss problems with the franchisor.

Some MCAs rely on the payment processor to “split fund” your income at the source. Also, the franchisor may have some rules about merchant accounts, processors, or point-of-sale machines. Switching may require franchisor consent, so check your agreement first. The MCA contract may trigger an acceleration clause if you stop your automatic payments.

Can the MCA funder use its lien to take over your franchise? The lien holder generally can’t take the franchise, and can’t use it or assign it to anyone. They might go after the revenue stream from you, but they can’t pull the franchise from you. That is the province of the franchisor, and UCC 9-408(d) bars funders from muscling the franchisor or cashing in on the license. Even with the franchise safe, the lien holder may go for other business property or for an order forcing you to pay. After judgment, the lienholder can also levy and take your non-exempt equipment or inventory. A lien will generally last five years unless the funder files a continuation. A lien on your property can be a problem in securing Small Business Administration refinancing or a new SBA loan.

A franchisor often also holds collateral in the business. That can include a security interest for unpaid fees, a right to buy the unit’s assets on termination, and assignment of the franchisee’s lease. Check the contract’s default and security sections.

How might one location’s default affect the others? In many franchise arrangements, every location of a multi-unit owner is a separate LLC. When an MCA names affiliates as co-merchants, has them cross-guarantee, and files UCC-1s on all of them, if one unit defaults, the other locations may be at risk. Ask your lawyer if your separate entities signed as one entity, or if a cross-default among units appeared on the paperwork. Even if you want to settle up just one unit’s debt, check with an attorney about the possible effect of the lien, the franchisor’s cross-default clauses, and UCC filings against the other locations.

Filing Bankruptcy

Last, would filing bankruptcy stop the franchisor from terminating? A franchise agreement is usually an executory contract in bankruptcy. But Section 365(e) generally bans the franchisor from terminating the contract solely because the owner is insolvent or files bankruptcy. If you want to stay in business, you generally must cure or show the court how soon you will cure the present default, compensate any losses the franchisor suffered, and show that the business can carry on and honor its commitments in the future. But the Code is unlikely to revive an agreement already finished before filing.

If you settle with the funder instead, you usually need to leave enough income in the business for royalties, rent, and wages. Ask the plaintiff to dismiss the suit, cancel the lien in writing, and add a termination statement to all the debtor’s UCC filings. Seek release of a guarantor and affiliates, if you can, if they signed as cosigners or with contract guarantees, and be sure the settlement bars any new UCC financing statements and stops any confession of judgment clauses. Once a lien holder has your final payment, UCC §9-513 states that you can send a written demand that they send back or file in your state their termination statement. The lender has 20 days. A termination statement only removes the MCA lien. It doesn’t affect other problems that prompted the default.